Asset Purchase vs. Stock Purchase: Which Is Better?
When you find the right business to buy, your first major step is to submit a Letter of Intent (LOI): a largely non-binding document that lays out your proposed deal terms.
But before you can draft an LOI, you need to decide what kind of deal you’re proposing. And in the lower middle market, that means choosing between two basic structures. You can:
Purchase the assets of the business
Purchase the stock of the business.
So which should you choose, assets or stock?[1]
Lead with an asset purchase.
It provides better liability protection and better tax treatment. And if diligence later shows that an asset deal isn’t possible or practical, you can pivot to a stock purchase and negotiate protections that preserve as many asset-deal benefits as possible.
Asset deals give buyers better liability and tax outcomes than stock deals.
Better liability outcomes
In an asset deal, the buyer forms a new company to purchase selected assets from the target company. Instead of buying the company itself, the buyer reaches into the target company and chooses what to acquire, whether equipment, contracts, or other assets.
The same is true for liabilities. In an asset deal, the buyer assumes only those liabilities she expressly agrees to take on. Subject to limited exceptions, the liabilities she does not assume stay with the seller.
Stock deals work differently.
In a stock deal, the buyer purchases the stock of the target company, and the target company itself stays intact. That means the buyer gets the whole business and everything in it, the good (assets) and the bad (liabilities).
In other words, known or unknown, disclosed or undisclosed, the liabilities remain inside the business you now own outright.
From a liability standpoint, an asset deal will give you the better starting point.
Better tax outcomes
But liability is only half the reason buyers prefer asset deals. The other half is tax treatment.
When a buyer purchases assets, the buyer receives a stepped-up tax basis in the acquired assets, meaning the buyer’s tax basis in those assets is revised upward to fair market value. This means you can depreciate or amortize those assets over time, creating deductions against taxable income in future years.
Depending on the assets being purchased, those deductions can create meaningful tax savings and improve post-closing cash flow.
Stock deals work differently. In a stock purchase, the target company keeps the existing basis in its assets. If those assets are already fully depreciated, the buyer will receive no additional depreciation or amortization benefit after closing.
So as with liabilities, from a tax standpoint, an asset deal will give you the better starting point.[2]
The tradeoff: Asset purchases create more closing friction.
That does not mean asset deals are perfect. They come with extra work.
The assets must be transferred to the buyer’s new company, including intangible assets like contracts and intellectual property. Employees may need to be terminated by the seller and rehired by the buyer. And state or local laws governing the sale of business assets may add compliance steps.
Depending on the business, the additional closing friction can be real. It is one thing to tell customers that the business has a new owner. It is another to require them to redirect future payments to a different bank account or to register with a new point-of-sale system.
In most lower middle market deals, these drawbacks are manageable. And the benefits of an asset deal justify the extra work. But if you’re concerned that the transition could cause a post-closing dip in performance, evaluate this type of operational issue before you close with an asset deal structure.
If diligence shows a stock deal is necessary, switching structures is manageable.
So what should you do when diligence later shows an asset purchase structure does not fit the deal?
After all, despite the benefits, there are times when an asset deal is simply not workable. For example:
Key contracts may not be assignable without counterparty consent, and the counterparty may refuse to consent or the number of required consents may make the process impractical.
The business may depend on licenses that cannot be assigned, or the assignment process may create long delays or risk to the continued operation of the business.
The buyer may be using SBA financing, and the seller may want to retain a minority ownership interest after closing (current SBA rules will then mandate a stock deal).
At the LOI stage, you may not know whether such issues exist. But don’t worry, if diligence later shows that an asset deal is unworkable, you can pivot to a stock deal.
Will the seller agree to this change? Often, yes.
Sellers prefer stock deals because they produce better tax or liability outcomes for the seller. By contrast, an asset deal may leave the seller holding excluded liabilities, may trigger transfer taxes, and may produce less favorable tax treatment depending on the seller’s entity type and asset mix.
That gives you room to negotiate. If you agree to move from an asset deal to a stock deal, you should ask for conditions that recreate the asset-deal result as closely as possible, including:
Seller indemnification for pre-closing liabilities (standard practice).
Tax treatment that treats the transaction as an asset purchase (if possible).
In other words, start with an asset deal unless something gives you a reason to move to stock. If a stock deal becomes necessary, you can agree to the structure while still negotiating for liability and tax outcomes that mirror an asset deal.
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[1] For simplicity, we use “stock deal” to refer to any deal where the buyer purchases the ownership interests of the target company. In an LLC, those interests are membership interests rather than stock, but the structuring question is the same.
[2] This tax analysis is simplified. The actual result depends on the seller’s entity type, the asset allocation, depreciation recapture, available elections, and the buyer’s tax position.