VIEW TRANSCRIPT BELOW
*Disclaimer: If you are watching this video, please keep in mind that Elevate Business Law has been changed to The Legal Department for Service Professionals, PA.
So there are two types of business sales. When you go to sell your business, you’re going to need to decide which type of sale is best for you. The two types are an asset sale and an interest sale. Sometimes it’s called a stock sale depending on the type of business entity you have. An asset sale sometimes is referred to as “selling the business.” Selling the business means that everything the business has and everything the business owns gets sold. In contrast, an interest sale or a stock sale means that you’re selling the business entity itself, and while you’re selling the business entity, everything inside that entity comes with it.
We’re going to talk about the two differences here. Keep in mind when I say interest sale, I’m referring to the selling of an LLC. Because the ownership of an LLC is called an interest. Sometimes it’s called a membership interest, but I’m going to refer to it as interest. When I refer to a stock sale, I’m talking about a corporation. Because the ownership of a corporation is in stock. Sometimes they’re called stockholders or shareholders, as the owners of a corporation. I’m going to use them interchangeably because, for discussions, they are the same.
So the asset sale is the first type of sale (and this is the most common for small businesses) the seller has a business entity. I’m calling it Seller, INC. The buyer has a business entity and I’m calling this Buyer, LLC. The seller, Seller, INC., is the current business that’s operating and that’s the one that’s for sale. The assets are inside the Corporation. Everything that business owns, everything that business does is inside a box. It’s the corporation box, the corporation owns it. In an asset sale, what happens is the buyer comes along and wants to buy the business. The buyer sets up its own entity, it could be an INC or an LLC. And the transfer of the business takes the assets from inside Seller, INC., takes them out and moves them over, and puts them inside Buyer, LLC. So, it’s just the assets that are moving, they come out of one entity, and they move into the other entity. The buyer always has their own entity. It doesn’t matter if it’s an LLC or a corporation, and the seller after the sale, still has its entity, either the Corporation or the LLC.
Now sometimes, keep in mind, that at the end of the sale, the seller could still end up with a completely empty entity. If all of the assets are being sold, the seller keeps the entity, but the entity has no assets, it owns nothing. Now, most of the time, the seller is keeping something, there’s something that the buyer doesn’t want to purchase in that bundle. So, the seller retains the corporation or the LLC, and whatever assets were not purchased. So, what are the assets? What is actually being sold? There are three types of assets. There’s tangible property, there’s intangible property, and there’s real property, and I’m going to discuss all three.
When you’re deciding to sell, keep in mind what these three categories are, what types of property your business has and where they fit on these definitions. The tangible property is everything you can feel and touch. It’s your furniture, computers, and equipment. It’s everything that you pay a tax on. Your tangible personal property tax. That’s what your tangible property is.
The intangible property, however, is much bigger. It’s things like your business name, your logos, and the intellectual property your business might have. If you file for registered trademarks, that’s included as well. Even the copyrights you have on your website, the things you’ve written, your manuals for your employees, your policies, and procedures that you’ve written, all of those are intangible property. Your domain name, your telephone numbers, and all the things that are valuable in your company, but you can’t touch, fall into the intangible property category.
Then the third one is real property, which is real estate. If you happen to own the building that you do business in, it may or may not be transferred in the sale. It can be transferred, as sometimes buyers want to buy the building, but sometimes sellers keep the building and rent it to the buyer. It just depends on the people.
So, here are some considerations for an asset sale. If you’re doing an asset sale, one of the most important things is to list and define the assets that are being sold. The transfer of those assets happens differently depending on if it’s tangible property or not. Remember, the tangible property will be things you can feel or touch like your equipment, your furniture, your computers, or your files. All of those things will get transferred by a bill of sale. The bill of sale and the purchase agreement will define what is actually being purchased. And that’s very important, because if you think about it, sometimes it’s hard to list everything that the business owns, that is a task that is going to take someone time to sit down and really think through, and if there’s something that the seller is not willing to sell, they will have to make sure it’s very clear that it’s not included in the definition of assets.
The big thing with an asset sale is contract transfers. If Seller, INC. is the one who’s doing the business, all the contracts for the business are with Seller, INC. When the assets transfer, the company is now Buyer, LLC. Buyer, LLC. is not on the original contracts for the business, so those contracts must be transferred. Seller, INC. will have to come off the contracts, and Buyer, LLC. must be put on them. There are a couple of ways that can happen, but as you can imagine, you need to make sure that the other party to the contract is informed (if it’s necessary to inform them) that you’re transferring that contract to a different entity. Sometimes that’s the key to an asset sale. Sometimes that’s the hurdle. If you’ve got clients that you don’t want to approach and say, “Hey, I’m selling the business and I need to transfer your contract to the buyer.” because you don’t want to worry the clients and customers, that’s a tricky scenario. It’s really a case-by-case basis as to how we handle a situation like that.
One of the contracts you could be dealing with transferring is the lease. If you don’t own your business or the building where you’re operating your business and you’re leasing it, that lease must be transferred as well. Because Seller, INC. is on that lease, Buyer, LLC. needs to be put on that lease in its place. Ideally, Seller, INC. needs to be taken off because the seller doesn’t want to continue to be responsible for the lease obligations after the buyer has taken over the business and is paying rent. Depending on the landlord, this could be easy, but it could also be hard.
The other thing you must consider is the account changes. The bank accounts of the business again are in Seller, INC’s name. After the sale, Seller, INC. still has those bank accounts. Buyer, LLC. will have to set up their own bank accounts. The accounts usually don’t transfer in an asset sale. Usually, the seller keeps the bank accounts, and the buyer sets up new bank accounts. Sometimes money is transferred as part of working capital, as part of accounts receivable and accounts payable. When you start working out who’s going to pay what before and after closing, there will be money transfers, but most of the time sellers keep their own bank accounts and the buyer starts their own.
One of the things that buyers particularly like about an asset sale is that they can take all the good out of the company, and they can leave the bad with the seller. So, if there are liabilities that have happened, and liabilities can be anything, use your imagination, it could be employees, it could be customers, it could be vendors, it could be anybody months or years later, so, when that happens, those obligations come back to Seller, INC. They don’t necessarily transfer to Buyer, LLC. Sometimes they do, and sometimes they don’t.
Another consideration (especially if you are a service provider) is a liquor license, if you’ve got a professional license, any type of licensing for the business that you’ve had to go through a regulatory process, you need to look and make sure that those licenses can be transferred to the buyer. Sometimes the buyer must apply for the licenses separately and independently. They must apply and be able to qualify and stand on their own and get their own licenses. Then once the sale happens, the seller just terminates their license, and the buyer continues with their own. But sometimes those licenses can’t be transferred depending on what type of license it is.
You should also be considering the receipt funds. One thing I want to make sure you understand is with an asset sale, who is the seller? The seller is Seller, INC. It’s the business entity that is the seller so, it is the business entity that will receive the purchase price. When the buyer pays for the business, it goes into the business’s bank account, not the personal owner’s bank account, the business’s bank account, and this can sometimes be a determining factor as to what type of sale you want.
In the second type of sale, we will be looking at the interest stock sale. We are still going to be using the Seller, INC. analogy. But now we have this new layer that deals with the actual shareholder. Let’s say John Smith individually owns Seller, INC. He’s the shareholder. Sally Jones comes along, and she wants to buy the business. Sally’s not going to set up her own corporation or LLC this time. What she’s going to do is buy the stock or the interest directly from John Smith. And when that happens, Sally Jones now becomes the owner of Seller, INC. She steps into the shoes of John Smith. Seller, INC. stays the same. It has the same contracts; it has the same assets; it carries on the same business it did the day before. The only difference is Sally now owns the stock and John Smith does not.
So here are the considerations for this. When Sally steps into Seller, INC., she gets the good, the bad, the ugly, and the fantastic. Whatever is in the corporation, she gets it. She cannot pick and choose. The seller keeps nothing, the buyer gets everything. That’s why a stock or interest sale takes a little bit longer. The buyer must do their due diligence, and the buyer tends to dig deeper and longer to make sure they understand exactly what’s there before they make this kind of commitment. But unlike an asset sale, an intro stock sale is a much easier transition. You don’t have to transfer any contracts, the contracts stay in the name of Seller, INC. You don’t even have to necessarily notify the other parties to the contracts because nothing’s changing. The corporation is staying the same. The business is saying the same. Everything’s the same, so the contracts carry on just as they had before the sale. The bank accounts also stay the same. Seller, INC. is still on the bank accounts. It’s still the business’s bank account. We only change the signatories on the bank accounts. So, Sally would be added to the bank account and John would be taken off the bank account. It’s a very smooth transition.
The licenses are a different story, however. A lot of times licenses are not necessarily just tied to the seller entity. Seller, INC. has its licenses, but when a regulatory agency looks to grant the license, they’re looking at who’s running the business. So, they looked at John, and they might have looked at John hard and said, “Does he have a criminal background?”, “Is he a good person?”, “Does he qualify for this license?”, and so for those types of licenses, they’re challenging to transfer. Sally would have to go in and either do a change of ownership process, or she would have to apply for those licenses individually. And again, through Seller, INC., but she would have to qualify personally for those licenses. Sometimes the license doesn’t go that deep and it’s easy to do. It just stays the same so it’s not a big deal.
Next, I would like to touch on the receipt of funds for this type of sale. If you remember the asset sale, the receipt of funds went into the business’s bank account, because Seller, INC. was the seller. In this case, John Smith is the seller. So the proceeds (the purchase price Sally pays to John) is actually going to go into John’s personal bank account. Why does this matter? For one, it matters for tax reasons, and two, it matters because sometimes when it goes into your personal account, you feel it instantly. If it were to go into the corporation’s account, there might be other factors when it comes to withdrawing that money. So that’s a big consideration for the interest and stock sale.
When you’re making a decision about what type of sale you want there are four things, four big things that really make a difference in that decision. Number one is the buyer’s preference. You’re not going to force a buyer to buy the stock of the company if all they want to do is buy the assets. If the buyer comes in and they have a very strong preference for an asset sale, most likely it’s going to be an asset sale.
Number two is the contracts and relationships. Imagine if you have a business that has three really big clients, they’re going to have a contract with each client. And maybe those contracts last two, three, four years, maybe they are worth a couple million dollars. Those three contracts are a huge part of the business revenue. If it is difficult to go to those clients and say, “I’m selling.” Sometimes we end up doing an interest or stock sale for that reason, because they don’t want to rock the boat on those contracts, or maybe they can’t, or maybe it’s not permitted because there’s no transfer provision. If you can’t assign the contract at all, then a stock interest purchase would be the option and the way to go. The relationships and keeping the relationships steady with those clients is a very important business consideration.
The third decision-making factor is taxation. There are going to be different tax effects from an asset sale than a stock interest sale. The seller, John, could end up paying different amounts of taxes depending on what type of sale it is. Same business, same purchase price, everything’s the same, but the way it’s structured could have a big difference in tax effect on that seller.
The fourth consideration we’ve talked about already is licensing. If there’s a critical license to the business, can it be transferred? And if it can’t, then maybe a stock interest is okay. But if it can be transferred, then we’re looking at the easiest way to accomplish that. So those are the four decision-making considerations when you decide how to sell your business.
If you are looking to buy or sell a business and would like our help, please reach out to schedule a free 30-minute introductory meeting at 904-860-3111 or email [email protected]