Acquiring a business can be structured as an asset sale or a stock sale (or membership interest sale for LLCs). Both structures achieve ownership transfer but differ in legal mechanics, tax consequences, and valuation considerations. This white paper outlines these distinctions, details common inclusions and exclusions, and explains their treatment in business valuations, particularly for SBA 7(a) lending purposes. Valuations for SBA 7(a) loans prioritize the income approach, specifically the capitalization of earnings method, to ensure robust and defensible results.

Legal Structure and Mechanics

Asset Sale

An asset sale involves the buyer purchasing selected assets and assuming certain liabilities, while the seller retains the legal entity (corporation or LLC) unless dissolved.

Typical Steps:

• Execution of an Asset Purchase Agreement (APA).
• Selection of assets by the buyer (e.g., inventory, equipment, customer lists, trademarks).
• Assumption of liabilities (e.g., accounts payable, contracts), as negotiated.
• Retention of the legal entity and excluded assets/liabilities by the seller.

Legal Ramifications:

• Reduced risk for the buyer, avoiding unknown liabilities tied to the corporate shell.
• Requirement for third-party consent to assign contracts, licenses, leases, and permits.
• Seller’s liability for unassumed obligations.

Stock Sale

A stock sale involves the buyer purchasing the stock (or membership interests) of the entity, acquiring all assets and liabilities.

Typical Steps:

• Execution of a Stock Purchase Agreement (SPA).
• Transfer of the legal entity’s ownership, including all assets and liabilities.
• No need to re-title assets or assign contracts unless required by contract or law.

Legal Ramifications:

• Inheritance of all liabilities by the buyer, including contingent or undisclosed ones (e.g., lawsuits, tax audits).
• Simplified continuity for employees, licenses, and contracts, as the entity remains unchanged.
• Critical need for due diligence and legal representations.

Tax and Accounting Implications

Asset Sale

• Buyer: Gains a step-up in basis of acquired assets to fair market value, increasing depreciation deductions.
• Seller: C-corporations face double taxation (corporate-level gain on asset sale, shareholder-level tax on distributions). Pass-through entities (S-corps, LLCs) avoid double taxation, with gains taxed at ordinary or capital gains rates based on asset types.

Stock Sale

• Seller: Benefits from tax efficiency, as proceeds are typically taxed at long-term capital gains rates.
• Buyer: Receives no step-up in asset basis unless an IRC §338(h)(10) election is made, reducing post-acquisition tax deductions.

Valuation Considerations

Enterprise Value vs. Equity Value

• Enterprise Value: Reflects the value of business operations, independent of capital structure, typically used in asset sales.
• Equity Value: Reflects the value of owners’ shares or membership interests, used in stock sales.

Asset Sale Valuations

• Included: Tangible assets (equipment, inventory, leasehold improvements), intangible assets (customer relationships, trade name, goodwill).
• Excluded: Cash, accounts receivable, liabilities (unless assumed).
• Basis: Cash-free, typically excluding normalized working capital unless specified.

Stock Sale Valuations

• Included: All assets and liabilities, known and unknown (e.g., cash, receivables, payables, debt).
• Basis: Reflects net equity value of the entity.

Stock sale valuations reflect the equity interest, including all assets and liabilities as of the valuation date.

SBA Lender Perspective:

• If existing debt is not paid off at closing, the buyer assumes it.
• If existing debt is paid off at closing (e.g., via SBA loan proceeds), the old debt is extinguished, but new acquisition debt becomes part of the buyer’s capital structure, not the historical valuation.
• Valuation Note: Stock valuations reflect the pre-transaction balance sheet, including existing debt. New SBA loan financing is generally excluded from fair market value analysis for SBA 7(a) purposes.

Conclusion

Asset and stock sales differ significantly in legal, tax, and valuation implications. Buyers and sellers must negotiate structure based on liability tolerance, tax objectives, and financing needs. Understanding transaction structure is critical to defining the standard of value, included assets, and applicable discounts or premiums.