An asset sale occurs when a bank or other type of firm sells its receivables to another party. A type of nonrecourse sale, it occurs for a variety of reasons, including to mitigate asset-related risk, obtain free-cash flows, or for liquidation requirements.
Asset sales can, and often do, affect a company’s net income.
The seller retains legal ownership of the company that has sold the assets but has no further recourse to the sold assets.
The buyer assumes no liabilities in an asset sale.
Typically, for reasons having to do with tax benefits, buyers prefer asset sales, whereas sellers prefer stock sales.
Asset sales involve actual assets of a business–usually, an aggregation of assets–as opposed to shares of stock. They can involve a complex transaction from an accounting perspective. Accounts receivable are kept as an asset on a balance sheet. An asset sale is classified as such if the seller gives the buyer control of the property after payment is made.
The buyer cannot have further recourse to the assets after the sale. If recourse were allowed, this characteristic will cause the transaction to be regarded as financing–a loan, basically. That would not give the company the desired result of increased free cash flows.
For banks, assets sales are often accomplished through the sales of individual loans or pools of whole loans, or through the securitization of the bank’s receivables. For other sorts of companies, assets could be tangible (inventory, real estate, equipment, investments, working capital, or even an entire subsidiary or division) or intangible (patents, trademarks, copyrights, or goodwill).
In an asset sale, a business can choose what it’s selling. While the buyer purchases any or all of these individual assets, the seller retains possession of the legal business entity. The buyer may create a new company or use an existing subsidiary to acquire the selected assets, along with management and contracts. An asset sale carries much less risk for a buyer since any liabilities (litigation, debts, etc.) and contingent expenses remain the seller’s responsibility.
Typically, buyers prefer asset sales, whereas sellers prefer stock sales. However, if a business is unincorporated, an asset sale might be its only option, as it has no stock to sell or transfer.
Along with the lack of exposure to corporate liabilities, asset sales offer tax benefits to buyers. Asset sales allow buyers to step-up the tax basis in the acquired assets. By allocating a higher value for assets that depreciate quickly (like equipment) and by allocating lower values to assets that amortize slowly (like goodwill, which has a 15-year life), the buyer can achieve considerable tax breaks.
In contrast, for the seller, asset sales often generate higher income taxes. Although some long-held intangible assets, such as goodwill, are taxed at capital gains rates, other assets can be subject to higher ordinary income tax rates. If the assets sold are held in a “C” corporation, the seller is exposed to double taxation. The corporation is first taxed upon selling the assets to the buyer. The corporation’s shareholders are taxed again when the sales proceeds are distributed by the corporation as a dividend or in another form.
With stock sales, all proceeds get taxed at the lower capital gains rate; in fact, if the business is taking a loss, there is a possibility that the entire price it’s being paid may be tax-free.