What is an asset sale?

Takeaway: An asset sale is a type of acquisition structure in which a startup sells some or all of its assets (e.g., intellectual property) to the acquiror.

An asset sale is a type of business transaction wherein a company sells specific assets (and often liabilities too) to another party. This can include physical property like real estate, equipment, inventory, or intangible assets such as software, patents, trademarks, customer lists, and other intellectual property.

In the context of startups, an asset sale is often an exit strategy used when the company itself may not be profitable, but it possesses valuable assets that other companies might find attractive. This could be innovative technology, a strong customer base, or even the team's expertise.

In an asset sale, the buyer purchases individual assets of the company, not the company itself. This means that the seller retains the legal entity, along with any assets and liabilities not expressly transferred in the sale. It's worth noting that in an asset sale, the buyer can pick and choose the assets they want to acquire and leave behind any that they find undesirable or risky.

Buyers like asset sales because they can pick and choose specific assets and liabilities that they want to purchase. This can help limit their exposure to the unwanted liabilities of the seller's business and ensures they only pay for what they want to buy. Unless specifically included in the sale, liabilities remain with the seller. The buyer acquires the assets free and clear of liens and encumbrances, which can make this a safer option for buyers.

Sellers (i.e., startups) often prefer stock sales because, in asset sales, (i) sellers are left with the assets and liabilities the buyer did not want and (ii) sellers usually receive better tax treatment (e.g., long-term capital gains) in stock sales.

However, an asset sale can be more complicated than a stock sale (where the buyer purchases the entire company, including its liabilities). Each individual asset may need to be transferred according to its nature and the laws governing such transfers. For example, intellectual property would need to be assigned, real estate would need to be deeded, and contracts might require the consent of the other parties to be transferred. Asset sales are typically more logistically complicated than stock sales because assigning assets to the buyer requires certain formalities, which often include getting third party consents.

From a tax perspective, an asset sale can be more beneficial for buyers, as they get a “step-up” in the tax basis of the purchased assets, which can lead to future tax deductions. Sellers, on the other hand, may face a higher tax bill as the sale of certain assets can lead to ordinary income, which is taxed at a higher rate than long-term capital gains.

In conclusion, an asset sale is an important tool in the M&A toolkit. For startups with valuable assets but perhaps without profitability, an asset sale can be an attractive exit strategy. However, as with any significant business decision, both sellers and buyers should seek legal and tax advice before proceeding with an asset sale.