Buying a Business: Asset Purchase vs Stock or Equity Purchase

The first structural question in most small business acquisitions is deceptively simple: is the buyer purchasing the assets of the business, or the ownership interests of the entity that owns them? The answer influences taxes, risk, contract assignments, and price. Each side has reasons to prefer one structure, and negotiation often trades price against structure.

The two basic structures

Asset purchase. The buyer purchases specified assets (equipment, inventory, customer lists, intellectual property, goodwill) and assumes only specified liabilities. The seller entity keeps everything else, including unassumed liabilities.

Stock or equity purchase. The buyer purchases the shares of a corporation or the membership interests of an LLC from the owners. The entity continues, with all of its assets and liabilities, contracts, and history. The buyer becomes the new owner.

A third path, merger, combines entities under statutory rules and can be structured to resemble either for tax purposes.

Why buyers usually prefer asset deals

Stepped-up tax basis. The buyer's basis in the acquired assets is the purchase price allocated to them. That allows depreciation and amortization deductions on the higher basis, including amortizing goodwill and other intangibles over 15 years. See purchase price allocation.
Leaving behind liabilities. The buyer generally is not responsible for unknown or unassumed liabilities of the seller, such as past tax issues, lawsuits, or wage claims, although successor liability doctrines and specific statutes can still apply in some situations, particularly for taxes and employment matters.
Choosing what to acquire. The buyer can exclude unwanted assets or contracts.
Clean start for employees, contracts, and registrations.

Why sellers often prefer stock or equity deals

Single layer of tax, often at capital gain rates. For C-corporations, a stock sale avoids the corporate-level tax that would apply if the corporation sold its assets and then distributed the proceeds. For pass-through entities, a stock or interest sale may produce mostly capital gain treatment, although portions related to inventory and unrealized receivables in a partnership can be ordinary.
Simplicity. The entity stays intact, so contracts, permits, and employees continue without assignment.
Clean exit with fewer retained obligations, subject to reps and warranties and indemnification.

Costs and frictions of asset deals

Contract assignments. Many contracts require counterparty consent to assign. Landlords, key customers, and licensors may use the opportunity to renegotiate.
Licenses and permits. Some are not transferable and must be reissued to the buyer.
Employees. They are terminated by the seller and rehired by the buyer, which can affect benefits, seniority, and payroll accounts.
Transfer taxes and title requirements for real estate, vehicles, and certain assets.
Bulk sales and successor liability rules in some states, requiring notice to tax agencies and creditors, and confirmation of tax clearance.
Different tax treatment across assets. Sellers may face ordinary income on depreciation recapture, inventory, and receivables.

Costs and frictions of stock or equity deals

The buyer inherits history, including unknown liabilities, tax exposures, and compliance problems. This raises the importance of diligence and indemnification. See buyer due diligence checklist.
No stepped-up basis in the entity's assets in most cases, unless an election is made. The buyer's basis in the stock is the price, but the entity's asset basis and depreciation history continue.
Minority holders may need to be bought out or dragged along.
Entity-level attributes such as tax elections, S-corp status validity, and tax filings carry over. An invalid S election, for example, can be a large hidden problem.

Tax elections that mimic an asset deal

For certain transactions, tax law allows the parties to treat a stock purchase as an asset purchase for federal tax purposes, giving the buyer a stepped-up basis while the legal form remains a stock sale.

Section 338(h)(10) election: available for qualifying purchases of S-corporation stock (and stock of certain subsidiaries of consolidated groups), when the buyer is a corporation and acquires at least 80 percent, and both buyer and seller jointly elect. The transaction is treated as a sale of assets by the target followed by a liquidation.
Section 336(e) election: a similar election in cases where the buyer is not a corporation, subject to conditions.
LLC and partnership interests: the purchase of all interests in an LLC taxed as a disregarded entity is treated as an asset purchase for tax purposes. The purchase of all interests of a partnership by a single buyer is also treated as an asset purchase by the buyer for tax purposes under partnership rules, and Section 754 elections can adjust basis when buying part of a partnership.

Because the seller may recognize different character of income under an asset treatment, elections often involve price adjustments. Consult a tax adviser before signing a letter of intent.

Entity type of the target

Sole proprietorship: always an asset deal, since there is no entity to buy.
Single-member LLC (disregarded): usually treated as an asset purchase for tax even if the legal form is a purchase of the membership interest.
S-corporation: stock deal or asset deal, with the option of a 338(h)(10) election.
C-corporation: stock deal or asset deal, with different tax stakes. Sellers of C-corps usually strongly prefer a stock deal because of double taxation on an asset sale.
Partnership or multi-member LLC: buying interests is the typical approach. Buying assets is also possible.

Deal terms that interact with structure

Purchase price allocation: in an asset deal, allocate among asset classes on Form 8594. See purchase price allocation.
Representations, warranties, and indemnities: especially important in equity deals to protect against unknown liabilities.
Escrows and holdbacks: portions of price held back to cover claims.
Earnouts and seller notes: payments over time. See earnouts and seller financing.
Non-compete agreements: part of the consideration and tax allocation.
Working capital adjustments.
Transition services.

Real estate

If the business owns real estate or leases it, the structure affects transfer taxes, lender consent, and lease assignment. Where real estate is held in a separate entity, the deal may involve separate documents. See owning your building in a separate LLC.

A simple heuristic

If the target has significant unknown liability risk or regulatory complexity, buyers lean toward assets.
If the target has valuable, non-assignable contracts or licenses, and the risk is low, equity may be easier.
If the target is an S-corp or LLC with good records, an election or disregarded treatment can deliver a step-up while keeping the entity.
If the target is a C-corp, expect a tension in price.

Common mistakes

Negotiating price before agreeing on structure.
Ignoring assignment and consent requirements in asset deals.
Not checking the validity of the target's S election in stock deals.
Missing a 338(h)(10) or 336(e) opportunity, or making the election without seller buy-in.
Failing to allocate purchase price or to file Form 8594.
Underestimating employee and licensing transitions.
Relying on a template purchase agreement with no advisers.

For help evaluating the tax effects of deal structure, AE Tax Advisors can assist, and a discovery call is a good first step. Legal documentation belongs with a transactional attorney.