This week on the podcast, we’re continuing our series on buying and selling a construction company, with a focus on the difference between a stock sale and an asset sale. Tune in to find out about each type of sale and its implications for taxes, liabilities, and more.
Topics we cover in this episode include:
- What’s the difference between a stock sale and an asset sale?
- How the type of sale affects the liabilities you assume
- Stock sales from a seller’s and buyer’s perspective
- Asset sale from a seller’s and buyer’s perspective
- The Asset Aquisition Statement
- The seven classes of assets and their tax treatment
- Buying a company that received an ERC
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Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | SuretyAnswers.com
Eric Wilkinson | https://www.sandhillglass.com/
[00:00:00] Wade Carpenter: Welcome to the Contractor Success Forum. In this episode, we are continuing the conversation about buying and selling a construction company. Today, we are focusing on the differences between a stock sale and an asset sale, and why not understanding the difference can cost you a lot of money. So if that’s of interest, stick around and let’s get into it.
If you’re new here, I’m Wade Carpenter with Carpenter & Company CPAs. Here with me is my cohost, Stephen Brown, with McDaniel Whitley Bonding & Insurance. Stephen, what are we talking about today?
[00:00:34] Stephen Brown: Well, we’re continuing our series of looking at buying and selling a construction business. We did from a buyer’s standpoint, from a seller’s standpoint, we’ve had talks about retirement plans, ESOP plans, things involved if you are continuing your business, if you don’t want to sell it to a buyer. We’ve talked about the importance of maximizing your assets and your value before you sell your business. And we’ve talked about what buyers look for.
From what I understand, Wade, asset purchase is literally just buying the assets of the company, but not the name, and the corporation will still exist. And then the stock company is literally buying the corporation. Would you explain the difference?
[00:01:18] Wade Carpenter: Yeah, what I’m hoping to do today is also talk about it from both the buyer and the seller’s perspective for each, but there can be a lot of implications from a tax standpoint, as well as legal and other issues with it.
I’ve walked into a situation where people ask me or walked in at the last minute and didn’t realize what they were signing when they signed an agreement. They signed an agreement to buy a business and maybe the business broker set up a stock sale when they really might want an asset sale. It can make a huge difference in things like the tax you pay.
What’s the difference between a stock sale and an asset sale?
[00:01:56] Wade Carpenter: Let me just start off with a simple definition of each. A stock sale is basically buying and selling the entire company, the stock of the company. So the company is going to continue. You’re buying the shares of the company, including all the assets and liabilities.
[00:02:13] Stephen Brown: Okay.
[00:02:13] Wade Carpenter: And then from an asset sale, you are purchasing, whichever side you’re on, purchasing or selling, individual components of a business. So it’s not necessarily the entire business, such as, the equipment or inventory or a customer list. But it doesn’t mean you’re taking on everything. And sometimes not everything is sold and it also means that you’re not necessarily assuming the liabilities of that company.
[00:02:42] Stephen Brown: Okay.
[00:02:42] Wade Carpenter: Does that make sense?
[00:02:43] Stephen Brown: Sure.
How the type of sale affects the liabilities you assume
[00:02:44] Stephen Brown: Tell me a little bit about assuming the liabilities of the company. And does it make a difference whether it’s a proprietorship, a partnership, an LLC, a C corp, or subchapter S corp?
[00:02:54] Wade Carpenter: Any of these types, if you do a stock sale where you’re taking over the entire entity, you’re also liable 4 any potential issues that come up where if you get a lawsuit or there’s unpaid payroll taxes, sales tax or anything that comes up. We also had a discussion about ERC credits and let’s table that because I think that might be an interesting discussion, but does that make sense?
[00:03:19] Stephen Brown: It does. From my perspective, what I do for a living is risk analysis. Insurance and bonding is analyzing the risk. And when you’re buying a company and you’re buying the assets and the exposures that that company have, you’re also buying the warranty on the workmanship that you’ve done and the exposures that may come up from there.
You’re buying their insurance, their workers comp experience mod. You could be buying future lawsuits that you don’t know about. There’s a lot to this.
[00:03:49] Wade Carpenter: Well, if it’s okay, I want to break this down into the different buckets.
[00:03:53] Stephen Brown: All right.
[00:03:54] Wade Carpenter: So what I first like to talk about is the stock sale. And then we’ll go from the seller’s perspective and then talk about the buyer’s perspective. Is that all right?
[00:04:03] Stephen Brown: Sure.
[00:04:03] Wade Carpenter: Okay.
Stock sales from a seller’s perspective
[00:04:04] Wade Carpenter: If you’ve got a stock sale, which is the one where we’re actually selling the company, the stock of the company, from the seller’s perspective, that’s typically a simpler process because they’re going to sell it lock, stock, and barrel. Everything that goes with the company, unless they specifically carve it out or take it out, it’s not part of the sale.
So from their perspective, it’s a simpler process. If they’ve got an S corporation and they’re selling the stock, typically they’re going to have capital gains on whatever the gain is on the stock. They may have very low basis in that stock if it’s a C corporation, if it’s an S corporation, it’s going to be around what their retained earnings are.
But the big thing here is that you’re going to get the capital gains rate, which could be 15%, 20%. There are actually provisions I won’t get into like Section 1202 stock where you could potentially get some of this capital gains tax free if you set it up properly.
Again, for a seller on a stock sale, you are transferring the liabilities. So anything that you walk away from, unless you specifically carve something out for it– we were discussing that on the sale you had, where they say that they’re going to guarantee it or something like that, but by and large, you transfer the liability. So it’s off your plate. So you’re walking away clear conscience, and it’s not really your problem for warranty work and that kind of stuff.
And, again, because of this, the last point I want to make on the seller side is the valuation possibly could be somewhat lower because of what it does on the buyer’s side, because of the potential issues to the buyer, which I’ll get into in a second.
If you look at a company one way or another, you value it, but then you start taking into account what’s got to go into what the buyer has to accomplish.
I remember our last podcast with Eric Wilkinson, he was talking about, you got to have something left over to be able to run the business. And, if you end up having a bunch of taxes, if you’re not able to deduct some stuff, that can definitely play into it.
[00:06:15] Stephen Brown: What kind of due diligence do you need to do to explore all of the exposures that are there in a stock purchase?
[00:06:22] Wade Carpenter: So that kind of leads me right on into the buyer’s perspective.
Stock sales from a buyer’s perspective
[00:06:26] Wade Carpenter: On the seller’s perspective, it’s easy for them, they’re just like, here it is, and yeah, you should be prepared to answer a whole bunch of questions. But from the buyer’s perspective, they are inheriting everything, including these liabilities we’re talking about, whether it’s disclosed or not, it’s your problem. So that’s exactly where you’re talking about what you’re inheriting, so you’ve got to do a lot more due diligence on a stock sale to make sure you’re not walking into some of these hidden liabilities. And that’s where a lot of people don’t understand what the differences are on this. They can get really burned by this whole thing.
With a stock sale, there’s nothing you can write off
[00:07:01] Wade Carpenter: The next point I wanted to make on this is the fact that you’re buying stock. Just like the stock on your balance sheet, you can’t deduct that money that you put in the stock. Unlike an asset sale, there’s nothing you can write off. There’s nothing you can depreciate. You’ve got the cost of that stock and it goes into your basis, and if you hold on to this company for another 20 years, there’s nothing you’re going to get out of it until you sell or liquidate it. So that’s a huge selling point for a buyer that they need something to be able to write that off.
They’ve got to be able to cover what they put into it. And if they can’t write any of it off, that’s a huge issue. You may need to knock that valuation down because of that.
So those are my major points on the stock sale. Did I hit your questions or anything–
[00:07:50] Stephen Brown: You did.
The main thing that I wanted to pump you for information for as a CPA, the tax consequences of, the capital gains tax to the seller, the ongoing tax obligations that the buyer may have.
How does someone who’s buying a company tie up all the accounting and tax issues before purchasing a company? I, of course, would suggest hiring someone like you to go in there and do forensic information, but there’s a difference between what accounting groups do in that regard and also business valuation. And then going in there and literally seeing if all the job costs have been posted properly for the jobs that are in progress.
[00:08:33] Wade Carpenter: Right. There’s a lot that goes into it. And exactly what you said. I think there’s a huge. point to be made that, especially if you’re doing a stock sale, but even if you’re doing an asset sale, you really need to dive into what you’re buying. And there are firms out there that specialize in this.
And in a former life, I actually did an 8 billion sale, one of my clients, and as well as, I was on the buying side and the selling side of a professional hockey team. Some of the, some of the things like that, that get really interesting. It was, hundreds of millions of dollars.
But even for the small guy, there are huge implications to this. I actually just saw one in the last week where somebody was actually looking at buying one and they provided their jobs and they were showing, that they were going to make 30 to 50 percent profit on these jobs that were coming in, but they’d been losing their butts for five years straight.
[00:09:28] Stephen Brown: Mm hmm.
[00:09:29] Wade Carpenter: The gross profits were not even close to what they were showing on that. And so nobody believed that.
[00:09:36] Stephen Brown: From a seller’s standpoint, you’re saying, this is what I want you to believe. Look at my financial information. And from a buyer’s standpoint, you’re saying, how do I know this financial information is accurate? You can’t depend on the seller to provide the forensic accounting information that you need to make a decision.
But you got to start somewhere, right?
[00:09:58] Wade Carpenter: Right. So let’s talk about the asset sale and then we can maybe deep dive into some of these other things.
Asset sale from a seller’s perspective
[00:10:02] Wade Carpenter: An asset sale from a seller’s perspective, they may have to do a little more work about proving, buildings and things like that, you can get a value. And you may have to get some kind of valuation on equipment or inventory, that kind of stuff. You know, you’ve got inventory or machinery and you’re trying to get as much value as you possibly can. So it’s usually a process going through and trying to document everything.
But again, from their perspective, a seller may have to be paying more taxes on an asset sale because possibly some of it will be capital gains taxed, but there’s a lot of it that could be taxed as ordinary income or even short term capital gains, which doesn’t get as favorable tax treatment.
So, we are talking about higher taxes in almost all cases, if you’re doing an asset sale.
[00:10:55] Stephen Brown: Okay.
[00:10:56] Wade Carpenter: Again, with an asset sale, usually you’re retaining the liabilities of that company. So you got to take that into an account.
[00:11:02] Stephen Brown: So, you’re still retaining the liabilities on an asset sale.
[00:11:06] Wade Carpenter: Unless the buyer agrees to take something over and, maybe they are buying trucks or whatever your equipment is and they have some loans on it that they possibly could assume some of that stuff, but it’s not really included unless you specify it.
[00:11:21] Stephen Brown: Okay. So, just to make it clear, an asset sale is a term of purchasing a company like a stock sale. It’s a methodology. It’s not like a corporation or a company is selling off some of their assets to someone.
[00:11:37] Wade Carpenter: Well, it is, I mean, for an asset sale that you are selling and a lot of times, even though you’re not selling the company per se, you may be keeping a trade name or something like that, but you’re not keeping the exact same company or starting something new or rolling it into your thing. So you can buy a name or you can buy a website or, stuff like that.
Asset sale from a buyer’s perspective
[00:11:59] Wade Carpenter: Let me talk about it real quick from the buyer’s perspective. Again, whether you can figure out the deal or not, buyers can choose which assets they want to acquire and they gives them a little more control over what they are buying. Sometimes it’s got to be give and take because if you don’t strike a deal, there’s nothing to buy.
The other thing is again, looking at What the composition of assets are and whether they truly are valued the way they should be and whether they can be written off immediately or they’re going to be able to be written off over five years or 15 years.
It’s still a benefit over a stock sale, but the longer the term, the less attractive it is. Again, while still complex, the due diligence doesn’t necessarily have to be as in depth, but you still need to watch where you walking there. The valuation is going to be based on the assets that are required.
[00:12:54] Stephen Brown: Okay.
I guess what I’m trying to wrap my mind around is all of the different tax implications that you have to take into account whether you’re a buyer or seller. And then as a general rule, what’s better for a buyer or seller? And like you said, it just depends on what you’re buying.
And then what does it take to dissolve a corporation? A corporation can go on forever. You assume filing their corporate papers, a corporation is an entity unto itself, and you’re buying that entity. So, you’re in charge of it, and you’re steward of it until you end it or sell it to someone, right?
[00:13:30] Wade Carpenter: Right.
[00:13:32] Stephen Brown: Okay, so, so anyway, I was thinking about all the tax implications that you were talking about, or complications. That might be a good way to describe it. And what would, and–
[00:13:43] Wade Carpenter: –taxes, if something comes back on a year, you get audited on a year that maybe they cheated on their taxes or something like that, you as the new owner, if you did a stock sale, you’re liable for all that.
[00:13:56] Stephen Brown: If you’re buying a company that does installation of glass roofing work and so forth, sometimes you have extended warranties that come from the manufacturer and also that you’ve taken on. So you have roof leaks, you have installation problems, and it’s, I followed the terms of our contract, it’s on you. It’s gotta be fixed and that cost has to come out of your pocket.
The Asset Acquisition Statement
[00:14:19] Stephen Brown: You know, we were talking about the acquisition statement before the podcast. Is it time to talk a little bit about that? Cause I was very interested in–
[00:14:28] Wade Carpenter: That’s a great thing we need to bring up since we’re talking about the asset sale. When you do an asset sale, there’s a IRS form 8594, the Asset Acquisition Statement. There’s a lot of people actually out there that never file these things. I’ve had business brokers that didn’t know you’re supposed to file these things.
But what this statement does, is that we’ve got to report what the sales price of the company was and the breakdown of how we split up the assets. So if you’re acquiring the majority of a company, you are supposed to file this for the acquisition. The buyer is supposed to file it, and the seller is supposed to file it. If one person files it and the other one doesn’t, the IRS is going to pick it up. If the . Reports it one way for the classes of assets in different numbers, and it doesn’t agree to what the seller turns in, if they turn it in at all, then the IRS is going to be reaching out to one or both of the buyer or the seller.
[00:15:30] Stephen Brown: So at the time of sale, both of them have to file the 8594 form with the IRS. And it could create problems if you’re not in agreement on that, right?
[00:15:39] Wade Carpenter: Well, you really need to get with the seller and agree on all that. And I’ve–
[00:15:45] Stephen Brown: you buy the company, yeah.
[00:15:47] Wade Carpenter: Yeah, I’ve actually gone to almost the closing, and the business broker didn’t know you were supposed to do this, and the attorney that was leading all this didn’t know you were supposed to do that. So I was like, well, we’re going to specify in this agreement, the classes of the assets.
The seven classes of assets and their tax treatment
[00:16:02] Wade Carpenter: There’s seven different classes of assets, and that’s where I want to tell you about the differences in the tax treatment here.
[00:16:08] Stephen Brown: Okay.
[00:16:09] Wade Carpenter: Class number one is the cash and cash equivalents. You’ve got cash in the bank, it is what it is. Money market. The lower classes are the ones that you’re going to pay ordinary income on and a gain on.
The next class is things like investments, certificates of deposits, government securities, investment assets. They’re sometimes easier to value, not as liquid as cash, but again, you’re looking at ordinary income tax rates.
Class 3 is accounts receivable. Again, that’s usually straightforward. That comes in, it’s profit, and the seller has got to pick up some income on it.
Class 4 is the inventory. Same thing. It’s an ordinary income item. So, whatever that valuation of the inventory is, that is going to be where– some of these things were as we get in the higher, this is where we end up negotiating what the differences are and how we’re going to put things. So, the value we’re going to put on the inventory, and usually you can get valuation done on something like that.
Same as class 5, which is for lack of a better name, I would say is basically all other assets not included in these other classes, which is things like the furniture and fixtures, your vehicles, I mean it could also be like patents or copyrights, those kind of things, where we could have some short term capital gain treatment, but some of these things still will get less favorable tax treatment than they would. But the problem is for furniture and equipment, we can still depreciate that stuff over a shorter period of time.
So, from the buyer’s standpoint, at least they’ve got something to write off.
[00:17:48] Stephen Brown: Okay.
[00:17:49] Wade Carpenter: Class six is the intangible assets, things like a customer list, license, covenant not to compete, those kind of things.
If you’ve got a covenant not to compete, or if there’s a continuation agreement, those are going to be ordinary income to the seller. For the buyer it’s going to be longer term assets that we’ve got to write over a longer term period of time. Usually we get into the 15 year property, so it takes longer to recoup your money that you put into it.
And then the last class is the goodwill and going concern, which is another intangible, but that definitely gets the 15 year treatment right now, so it’s a longer term write off.
[00:18:29] Stephen Brown: When you say 15 year treatment, what do you mean?
[00:18:31] Wade Carpenter: So just like furniture and fixtures or machinery or a truck, we’ve got to write it off over a certain period of time.
[00:18:38] Stephen Brown: Okay.
[00:18:39] Wade Carpenter: For Goodwill, we can write it off, but it takes 15 years to write it all off. So you put money up front where, you’re not going to be able to at least get some kind of value to write off of that until many years later.
So that’s why it makes a lot of difference between the buyer and the seller how we classify these things. And where we get into the higher classes where the value is not necessarily set on the customer list versus goodwill, you know those kind of things, getting into the gray areas, and that’s where you may have evaluation done, but you also may have some negotiation back and forth between the buyer and seller because depending on which side you’re on it can make a huge difference on the tax treatment of it.
[00:19:25] Stephen Brown: Okay. I always thought of goodwill as something that was so intangible, all it did is increase the potential value of your company if you had it and you can prove it. But from an accounting standpoint, it’s a real thing, huh?
[00:19:38] Wade Carpenter: is a real thing that we can put on the books in certain cases. Especially if you bought the goodwill, you’ve got something to write off, but–
[00:19:46] Stephen Brown: Then it has a value, because that’s what you were willing to pay for it?
[00:19:50] Wade Carpenter: Right, right. So again, I don’t know if you have any wrap up questions, but I would say, definitely get some qualified help on this.
[00:19:58] Stephen Brown: Now, this 8594 form that you have to fill out for the IRS. Do you have to fill that out if it’s either an asset or a stock sale?
[00:20:06] Wade Carpenter: Not for stock sales, only for an asset sale.
[00:20:09] Stephen Brown: For asset sales. Okay.
[00:20:10] Wade Carpenter: Where you’re essentially selling a company. If you were selling a truck, it doesn’t apply to something like that, but if you’re selling essentially the guts of the company in a sale, then that’s what we’re talking about here. So.
[00:20:24] Stephen Brown: Okay. All right. There’s a lot to think about. What should our listeners do as they’re listening to this podcast when they have more specific questions? Any idea? I know they can reach out to either one of us. We can try to steer them in the right direction. But do you still provide those services?
[00:20:43] Wade Carpenter: We will help our own clients. Like Eric Wilkinson, that’s part of what we were originally hired to do. But we don’t get into the audit due diligence stuff anymore. We will do the due diligence but we’re not going to go on site and do that kind of stuff. And there are specialists in that.
I definitely can advise people, but one of the messages of this is don’t walk into buying or selling the company before you understand the major differences in how these are going to be treated. I’ve seen people, they got some money held back and they’re going to buy a company and they think they’re going to be set up, and then they walk in and they don’t realize what they’ve walked into.
So before you sign that contract, talk to somebody about this that is qualified to help you.
[00:21:28] Stephen Brown: Okay. Also your lawyer can help steer you in the right direction. At least the paperwork from the buy sell is done by a lawyer’s standpoint. And then we talked about the business brokers. In our earlier podcast that was mentioned, business broker may be anything from a glorified real estate agent to someone who really knows their stuff and helps you maximize the value of the company that you’re selling or buying.
[00:21:53] Wade Carpenter: Right, well, going back to what you said about the lawyer, not all lawyers know this stuff, and you really do need to get somebody that is well versed in doing this. I’ve had real estate attorneys and bankruptcy attorneys trying to do stuff like this and it’s unfortunate. Let’s just leave it at that.
Buying a company that received an ERC
[00:22:11] Wade Carpenter: I really liked our conversation a week or two ago when we were talking about the Employee Retention Credit. So I do think that’s worth bringing up as we wrap this one up.
Something like the Employee Retention Credit, there are people out there that legitimately should have gotten that credit. And then there were people all over the country saying, you qualify for this. It doesn’t matter what your CPA says. And there’s a lot of unscrupulous people because there was a lot of money to be made on this. And what if the IRS comes back and audits these?
There’s already been people that have been prosecuted for this and people going to jail for this. And I think they’re just beginning this. Because there’s a lot of fraud that was going on. And you may not even know the difference, you may have just walked in, these people told you you qualified. Hey, it’s free money in your mind, so why not?
[00:23:04] Stephen Brown: And you were excited about what you heard. This is a financial professional telling me this. However, I might point out that that financial professional was working on commission. I don’t know how many projects you do for clients on commission, Wade, but you know.
[00:23:19] Wade Carpenter: Well, ethically, we can’t.
[00:23:20] Stephen Brown: 10 percent of what they get back for you, that’s a big chunk of money.
[00:23:24] Wade Carpenter: Most of them are taking 20.
[00:23:26] Stephen Brown: Oh my gosh. So if they’re only taking 10, they’re pretty fair. I’m kidding. I don’t know.
[00:23:31] Wade Carpenter: Well, I saw some taking 15, but a lot of them were taking 20%, and don’t get me started on this particular topic.
[00:23:38] Stephen Brown: Well, why not take 50%? Was there some laws against that? I’m sorry. I’m–
[00:23:44] Wade Carpenter: It’s– but going back to the conversation of buying a company, what if you did a stock sale and you inherited that company and the IRS comes back and audits that? And, what if the IRS asked for the money back?
[00:23:56] Stephen Brown: Oh, I’m sure that financial group that advised you will pay that money back and refund their commission.
[00:24:02] Wade Carpenter: There were a lot of companies that were spun up to do specifically this, and they shut them down if an audit comes up. They will just fold them up and they’re long gone with the money.
But that was the conversation about your…
[00:24:16] Stephen Brown: Right. And we would always recommend that if you are buying a company that has an ERC, that you get a copy of the paperwork, who filed it, and you get the information to your accountant and your lawyer, right?
[00:24:29] Wade Carpenter: Right, and the paperwork is not, just filing the 941Xs to get the money back is nothing, but you need to understand the reasoning that they used to know if that’s a legitimate reason for asking for that ERC.
[00:24:45] Stephen Brown: Mm hmm. That’s right. Whoever’s looking at it may see a different perspective, but did you follow proper procedures? Will this hold up? That’s something that you do for a living with your numbers: will this hold up? That’s why I said send it to your CPA.
I suggest send it to your lawyer too, but, your CPA may be able to tell you better. I don’t know.
[00:25:07] Wade Carpenter: A lot of lawyers don’t know this stuff either, so.
[00:25:09] Stephen Brown: Okay.
[00:25:10] Wade Carpenter: A lot of CPAs don’t know some of these
[00:25:13] Stephen Brown: That’s right. You’re just hoping one of your two professionals catches it. I’m just saying you can always, Wade, I guess send it to you? How does that work?
[00:25:20] Wade Carpenter: Well, we’ll see. If they want to work with us, then, we can talk about it.
[00:25:24] Stephen Brown: Okay.
[00:25:25] Wade Carpenter: But I’m always glad to talk to anybody about this. I think you are too. We’re doing this whole podcast for educational purposes. I think there’s so much in construction that people just don’t know and people don’t want to say and they are afraid to say because they’re afraid they’re going to get sued and that’s why we put disclaimers all over this stuff.
But get qualified help on this stuff.
[00:25:47] Stephen Brown: Right. We just don’t want you to have a problem when you could have learned from something that happened to someone else. And that’s what we’re all about at the Contractor Success Forum. That’s why we started this, Wade. Just so our listeners might learn something that someone else had a pitfall that cost them their company, and best case scenario, a lot of money. Right?
[00:26:11] Wade Carpenter: Right, absolutely.
Thank you for listening to the Contractor Success Forum. If you’re listening on a podcast somewhere, check out the show notes at ContractorSuccessForum.Com or on the Carpenter CPA’s YouTube channel for more information. Consider subscribing to this channel and follow up each week as we post a new episode. We will look forward to seeing you on the next show.