What is an Asset Purchase and Why Does It Matter to My Small Business For Sale?
The Small Business Association (SBA) reports that while most businesses in the United States are small enterprises, a quarter of these are more than 20 years old already. In 2018, it was found out that the top causes why entrepreneurs are closing down their small businesses include personal (opening a new business) and retirement (an aging Baby Boomer population) reasons.
Low interest rates and financing, increased millennial's ability to buy businesses, and good financials of companies being put in the market contribute to favorable conditions for the increased number of small businesses for sale.
When selling your small business, structuring the deal is decided between an asset sale and a stock sale. In this article, I’ll be discussing an asset sale and why your small business can benefit from it.
What is an Asset Sale
An asset sale is the purchase of individual assets and liabilities of your small business. As a seller, you keep possession of the legal entity but the buyer takes ownership of your business’ assets. This includes equipment, machines, fixtures, account receivables, licenses, trade name and inventory, to name a few.
It is different from a stock sale (or entity sale), which involves the purchase of the shares in a corporation. Because such deal structure involves the acquisition of company shares, it does not apply to businesses that are sole proprietorship's, partnerships and limited liability companies (LLC) because these legal entities do not have any stock.
What Happens in an Asset Sale
In the sale of your small business’ assets, the buyer may only seek specific assets that he or she wants to purchase. In addition, you may be required to present proof that the assets are free from any debts or claims (unencumbered). Bear in mind that while this deal structure lets you still own the entity, be warned though that the entity itself can be worthless upon the sale.
It is important therefore to have a clear and verified asset agreement in place to close the deal easily and avoid any disputes and conflicts in the future. You and the buyer will have to agree on the purchase price, payment deposit, payment terms, timeline of the deal, restraints, limitations and warranties, types of assets to be included, excluded assets, among others.
In addition, you need to consider the following factors:
The buyer will not assume any of your business’ liabilities or pre-existing debts unlike in a stock sale. This is not absolute though. If the buyer is willing to assume the liabilities, the purchase is considered a merger, or the buyer is proven to have committed a fraudulent sale to avoid paying his debts, then the liabilities will be assumed by the buyer after the sale.
Buyers prefer an asset purchase over a stock purchase because they receive depreciation benefits much faster. Unless what they’re buying is a C corporation, they’re not exposed to double taxation. In addition, the buyer will not be entitled to the seller’s tax attributes such as credit carryforwards.
You, as a seller, will be paying a higher income rate and be unprotected from business’ liability risks, however. Even though your concern is to minimize your tax payments on realized gains (the difference between sales and tax basis in the stock), there’s a likelihood for double taxation resulting from the sale of assets and liquidating the distribution (unless it is an S corporation).
Advantages of an Asset Sale for Small Business Owners
Warranties and indemnities
You may provide indemnities for specific losses or costs that the potential buyer may incur. You may also limit the scope of the warranties and be very specific to create full disclosure. During negotiations, you may demand more limitations and protections.
Retaining other assets
If there are assets that you prefer not to include in the sale, you may choose to do so. These include cash-on-hand, security deposits and account receivables.
You may offset your losses from the proceeds from the asset sale.
Disadvantages of an Asset Sale for Small Business Owners
You may not be able to secure the consent of your suppliers, landlord or other parties involved in your business to revised agreements involving the potential new owner, which would result to delays in closing the deal.
Document transfer restrictions
Some parties may object to the transfer of assets because of conflicts with intellectual property, which are not assignable.
Because the buyer has the right to select only the assets that it wants to acquire, you may be left with assets that would otherwise have been better disposed.
Aside from the tax burden attached to an asset sale, there might be local and state taxes involved. Negotiate a better deal so you’d still have money left from the sale.
Considerations for an Asset Sale of a Small Business
Once you have agreed with the seller on all terms of sale, you need to make sure the following considerations are ironed out:
Schedule of due diligence by the buyer
Assumed contracts and liabilities
Warranties and indemnities
Licenses and permits
Transfer of licenses, when applicable
Consents and approvals
Employment matters (including pay off obligations, retirement plans, compensation)
Real estate inspections
Financial considerations (creditors, escrow accounts, agreements)
Security and escrow agreements
NOTE: This is not an exhaustive list. Consult your attorney, accountant and business adviser to determine all the required documents.
Do You Need a Broker for Your Small Business?
While a business broker may help you with your asset sale, not all business brokers are qualified to represent your best interests. A better alternative is to sell your enterprise through FSBO or For Sale By Owner. This keeps you from paying commission fees, waiting for a broker to return your calls, and having a middleman take a portion of the sales proceeds.
A direct buyer for your small business can perform the same functions of a broker while still representing your best interests. To find out more, check out my article on the difference between a business broker and a direct buyer for your small business.
Fair Valuation for Your Business
A recent survey among current small businesses owners revealed that 23% of these entrepreneurs fail to sell their companies because they do not understand fair business valuation. Thirteen percent of business buyers, on the other hand, feel the same way.
PROFESSIONAL ADVICE: Your small business needs to have its value unlocked before putting it on the market, but this can be a difficult and cumbersome process. However, you can utilize a variety of online tools that will help you assess your business value by generating quantifiable insights for higher ROI.
One trusted tool is The Value Builder System, which shows a scorecard that grades business performance in the 8 key drivers of value (financial performance, growth potential, Switzerland structure, valuation teeter totter, annuity-based revenue, competitor differentiation, customer satisfaction and business performance with an absent owner). It only takes 13 minutes to generate your Value Builder Score.
Take the survey here: https://score.valuebuildersystem.com/transphorm-llc/brett-pittsenbargar.
Brett Pittsenbargar is a savvy business investor and turnaround strategist dedicated to assisting business owners reach their objective at every growth phase. With a background in business development and investment experience, Pittsenbargar understands that business is much more than written contracts, it is about the people working every day in the business that matter most for small and medium sized enterprises generating $1-20+ million in revenue annually. He invests in, mergers and acquisitions, growth partnerships, cash out purchases and adding shareholder value.
Consult with a seasoned business investor that has decades of experience helping small and mid-sized businesses. A business strategist who can work directly with you in developing exit strategy plans, partnering growth partnership, building shareholder value and organizing mergers is critical for your business.
Contact Growth Point Holdings today to arrange a one-on-one consultation with a dedicated business strategist to start building a synergistic long-term business relationship together.
Disclaimer: This article is intended to give you general business information, not to provide specific legal or financial advice. Be sure to consult your attorney, accountant, and financial professionals for any specific questions relating to your business.