Selling Your Business: Mergers, Stock Sale, or Asset Sale?

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So you’re are nearing the long awaited finish line: you have finally reached the point where you are selling your business. You have probably been working on, and refining, your exit strategy since you started your company, but as you get closer to negotiations and the reality of business acquisition, it is worth revisiting a very fundamental question: how do you want to structure this deal?

Broadly, you have three options to choose from (although that is somewhat of an oversimplification, as you will see below): a merger, the sale of your company’s stock, or the sale of your company’s assets. Each of these options have different advantages and disadvantages – both for you as seller and the buyer. The options also have different tax implications that have to be taken into account. There is no one right answer, and it will be well worth your while to spend some time considering your options.

Mergers

Overview

A merger is the technical term used for when two companies are combined into one single company. Lawyers typically distinguish between three types of mergers:

A straight merger occurs when the selling company (your startup) merges with the buying company, and the buying company becomes the surviving corporation. This type of merger requires the approval of both the buyer’s and the seller’s stockholders)
A reverse triangular merger occurs where a wholly owned subsidiary of the buying company mergers with the selling company with the seller as the surviving company.
A forward triangular merger occurs where the seller merges with a wholly owned subsidiary of the buyer, with the subsidiary as the surviving corporation.

In the case of triangular mergers, the buyer’s stockholders do not need to approve the merger. For this reason, triangular mergers are most often used. Reverse triangular mergers are preferred by sellers, for obvious reasons: you want your company to be the surviving company after the merger. If your company does not survive the merger, it disappears as a legal entity and that might create a landslide of contractual complications and unnecessary risk.

Advantages and disadvantages

The advantage of a merger is the relative ease with which it can complete the business acquisition process. This is because you won’t need the approval of all your stockholders for the merger to take place (the exact percentage of stockholders’ approval that you will need depends on your bylaws).

The disadvantages often outweigh that one advantage, however. A merger is legally complicated, and by default regulated. Although a small merger with no significant impact on market concentration won’t be stopped by authorities, it still implies regulatory hurdles and compliance issues that won’t arise in the case of stock sales or asset sales.

Stock sale vs asset sale?

If you decide against pursuing a merger, you are faced with another tradeoff: stock sale vs asset sale. From the buyer’s perspective, of course, the choice is: asset purchase vs stock purchase. As we will see, buyers and sellers tend to have diverging preferences in this regard.

Overview

An asset sale occurs when the buying company pursues only asset acquisition. This means that the you as the seller will transfer specifically listed assets (and sometimes certain liabilities as well) to the buyer in exchange for the purchase price. These assets typically constitute the core value proposition of your startup: your technology, for example.

A stock sale occurs when the buying company buys the stock of your company in exchange for a determined purchase price. Here, you (and all the other shareholders in your company, of course) essentially transfer ownership of the entire company – assets and liabilities – to the buyer.

Advantages and disadvantages

Buyers prefer asset acquisition to stock acquisition. When doing this, the buying company knows exactly what it is buying: it does not assume risk of any unknown risks or liabilities. Additionally, an asset transaction allows a buyer to allocate the purchase price to specific assets based on their fair market value. This value is usually higher than the assets’ book value, allowing for tax savings.

Asset acquisition is less beneficial for sellers, however. The need to list and report every single asset can be a costly and complicated process. More importantly, asset sale causes double taxation – your company will be taxed on the capital gains when you sell assets, and again when you distribute the income from the transaction to shareholders.

By contrast, sellers benefit more from a stock sale. A stock sale transfers all liabilities to the buyer and in that sense allows for a more “clean” way of selling your business. A stock sale also allows sellers to avoid the double taxation that occurs with asset sales. Buyers, on the other hand, don’t benefit that much from stock sales and take on the risk of unknown and undisclosed liabilities.
There are some unique circumstances within which you might be able to get the best of both worlds: structuring the business acquisition as a stock sale but taxing it as an asset sale (Section 338(h)(10) elections). However, in most cases, the stock sale v asset sale decision will be a matter of negotiation.

However, knowing the benefits and costs of each allows you to negotiate more effectively and to include the costs and benefits of your deal structure into your demands.

Hire a startup attorney

LawTrades is a marketplace of online legal services that is committed to helping startups with their legal issues. We offer services for all stages of business, and we’d be happy to do the same for you during the process of selling your business. We believe that quality legal help should be both affordable and attainable no matter the size of your business.