08 Jul Stock Sale vs Asset Sale: Why Structure Matters

Written By: Matthew Safft, CVA

(5-7 minute read)

As stated in the (SOP) 50 10 8, “In order for the individual performing the business valuation to identify the scope of work appropriately, the business valuation must be requested by and prepared for the Lender. The scope of work should identify whether the transaction is an asset purchase or stock purchase and be specific enough for the individual performing the business valuation to know what is included in the sale (including any assumed debt).”

The above statement is important as all assets and liabilities that are included in the final transaction (as per the purchase agreement, letter of intent to purchase, or other form of identification) must also be included in the business appraisal. This is similar to the concept of “comparing apples to apples”. For this reason, it is important to understand the differences between an asset sale and stock sale and how they can affect a business appraisal.

An asset sale is completed when only the assets of a company are acquired by a buyer. In an asset sale, the buyer is not purchasing the entity directly and must either create a new entity or use an existing entity to purchase the assets. Typically, an asset sale includes furniture, fixtures, and equipment (FF&E) and goodwill of the company being purchased. Examples of businesses that typically transfer as an asset sale include restaurants, retail businesses, etc.. It should be noted that asset sales can include working capital (Cash, Account Receivable, Inventory, AP, etc.); although it is not common. In the case that working capital is included in the purchase price, the appraiser will include the same amount of working capital in the final value of the company.

A stock sale is completed when the shareholders’ stock is directly purchased, and the buyer obtains ownership in the existing entity. Typically, in a stock sale, all operating assets and liabilities are transferred to the buyer, or a specific target working capital is decided upon by the buyer and seller. For valuation purposes, it must be clearly identified whether any specific assets and liabilities are excluded from the proposed purchase price. In this scenario, these specified assets and / or liabilities would be excluded from the final value of the Company. Stock sales can also be structured as an asset sale for the purpose of transferring a license or certain contracts. For example, a medical practice proposed purchase could only include Fixed Assets and Goodwill (as reported on the balance sheet); however, ownership of the shareholders’ stock is acquired for the purposes of the medical license transferring to the Buyer. It is critical to understand exactly which assets/liabilities are transferring as not all stock sales include all assets/liabilities, while majority of the time they do.

To better understand the difference between an asset and a stock sale, it must be understood how each type of sale would affect a business valuation. For example, let’s assume that a company has the following balance sheet:

In scenario one, it is assumed that the valuation is being structured as a typical asset sale, including only fixed assets and goodwill. Additionally, it is assumed that the company has Seller’s Discretionary Earnings of $325,000 (EBITDA plus Officer’s Compensation to a single owner operator – utilized in the Market Approach). The following shows how all of the above assets and liabilities would be reflected in the Market Approach for an asset sale:

When calculating the Market Approach, it should be clear what is already included in the market multiples. In this scenario, it is assumed that the appraiser used DealStats and BizComps data where the multiples are obtained primarily from business brokers. The businesses are typically sold as asset only sales (excluding inventory) and already include FF&E and goodwill. Accordingly, the value generated using this method must be adjusted for the assets and liabilities that would not transfer in a normal sale. In this case, because no additional assets and liabilities are included in the sale, no adjustments are made, as can be seen in Table 1.

In scenario two, it is assumed that the valuation is being structured as a stock sale, including all operating assets and liabilities. All other assumptions stated above remain similar, including that the company has Seller’s Discretionary Earnings of $325,000. The following shows how all assets and liabilities would be reflected in the Market Approach for a stock sale:

For Table 2, because the Earnings Multiple determined only accounts for fixed assets and goodwill, the gross value must be adjusted for all assets and liabilities included in the proposed transaction (Stock Sale).

The difference between the two conclusions of value is $120,000, with the stock sale concluding a higher value. The difference between the two values is approximately the same as the adjusted book value of the Company (assets included in the sale less liabilities included in the sale) – the slight discrepancy between the two amounts comes from the fact that all values shown in the tables have been rounded. This is the same for all asset value vs. stock value comparisons in that if the adjusted book value of the company is positive, a stock value will generate a higher value on an approximate dollar-for-dollar basis equal to the adjusted book value. Inversely, if the company has a significant amount of debt that will be transferred, the stock value will generate a lesser value on an approximate dollar-for-dollar basis equal to the adjusted book value. For a lender to know if a proposed purchase makes sense from a lending standpoint, the type of transaction, and the assets and liabilities which will transfer to the buyer need to be considered.

Each transaction type usually comes with benefits or downfalls to either the seller or the buyer. For example, most buyers would prefer an asset sale as they are able to “step-up” the depreciable basis in the company’s assets along with avoiding the assumption of any contingent liabilities. At the same time, it is more difficult to transfer certain items such as licenses, contracts, leases, etc. in an asset transaction. From a seller’s point of view, stock sales may be more beneficial due to more favorable tax conditions. Because the buyer and seller have differing preferences regarding transactions structure, these preferences can influence purchase price negotiations.  Therefore, it is critical for both the lender and the appraiser to understand how the proposed transaction will be structured as it has a direct effect on the concluded value.

It should be noted that the above analysis is based on how the structure of the sale, and the assets and liabilities included in the proposed purchase price impact a business valuation in the market approach. The analysis of an income approach works slightly differently (which will be discussed in a future newsletter), although the premise is the same – the higher the working capital included in the proposed purchase, the higher the value will be.