Peek Inside Past Property Management Deals

What Sale Price Did Other PM Businesses Get?

A Look At Past Property Management Deals and Why They Don’t Tell The Whole Story

It’s one of the first questions I typically hear when meeting a property management professional who is giving some thought to selling their business. There is a natural curiosity.

What Do You Think My Business Is Worth?

There are literally dozens of factors that have positive and negative impacts on the value of your company. Valuation specialists utlitize the 3 approaches to value in drawing conclusions – the Asset, Market and Income approaches.

For management companies, the Asset approach is typically discarded. Ours are service-based businesses where the tangible assets rarely match the Market or Income approach values. The discussion here focuses on the Market approach to valuation and what other similar businesses achieved. Sales comps.

Unlike with residential or commercial real estate, sales comps are only employed as very loose frameworks in business valuation. The unique nature of each company makes apples to apples impossible.

We certainly can look at many years of transactions and find key reference points. These reference points are expressed as multiples. It can be a multiple of earnings. A multiple of gross revenue. A multiple of gross profit margin. A multiple of EBIT or EBITDA. A multiple of monthly management contracts.

An analysis of the last decade of property management transactions tells us a few things we likely could’ve assumed already:

  1. High revenue companies will achieve a greater multiple than smaller firms.
  2. Businesses showing a rapid or recent rise in revenues or earnings achieve higher multiples than companies showing flat or declining numbers.
  3. Management companies who’ve taken the time to highly automate their processes achieve higher multiples.
  4. Companies where the owner has little or no role in daily operations get a higher multiple.
  5. Businesses with more than 5 years of operations get higher multiples.
  6. Property management buyers rarely reach a purchase price equal to one year’s annual revenues. A $1 Million revenue company is not likely to get a $1Million purchase price.
  7. Companies with highly developed marketing processes and automations will get higher multiples than ones with lots of manual process.
  8. Businesses with strong balance sheets and little or no longterm debt get a higher multiple.


So what are the price ranges?

We did a review of almost 100 property management companies sold throughout the U.S. in the last decade. These comps include residential, commercial, HOA and vacation rental property management businesses. Real estate offices and brokerages were discarded. There were, by far, more comps reported in Florida than any other state. That’s partly due to the state’s very active vacation rental marketplace. It also points to the fact that Florida brokers, M&A professionals and sales associations are better about reporting transactions than other parts of the country.

Keep in mind, this analysis is limited to property management companies doing between $500,000 and $5 Million in revenues. We only included businesses booking at least half a million dollars in third-party management revenues.

Some median numbers we found in this analysis, for the 90-plus PM companies purchased:

  1. Median Gross Revenues – $797,080
  2. Median Seller’s Discretionary Earnings – $153,056
  3. Median Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA) – $66,697
  4. Median SDE Margins – 15.4% (SDE as a percentage of gross revenues)
  5. Median Purchase Price – $365,000

So here are some of the multiples which create the reference points in the sales comps.

  1. Median Purchase Price as a percentage of SDE – 2.5 times SDE. The 25th percentile businesses achieved 1.9 times SDE while the 75th percentile sales hit 3.1 times SDE.
  2. Median Purchase Price as a percentage of EBITDA – 5.0 times EBITDA. The 25th percentile businesses achieved 3.0 times EBITDA while the 75th percentile companies hit 11.6 times EBITDA.
  3. Median Purchase Price as a percentage of annual Gross Revenues – 41%. The 25th percentile businesses achieved 32% of revenues while the 75th percentile companies got 49% of revenues. The 90th percentile PM companies reached 73% of revenues.


Again, these numbers don’t tell the whole valuation story. They certainly shouldn’t be used as arbitrary conclusions of your company’s value.

First off, there are marketplace considerations which can drive values up or down. These figures are national. There will be state and regional variations in value. Companies with office locations in rural and small towns will see fewer buyers, and lower prices, than those in major metros.

Timing also plays a role. There was a record number of property management companies sold in 2018. As we work through our post-COVID futures in 2020, the multiples are likely to get  pushed down. The typical timeframe to sell a PM business is between 6-12 months.

With these comps in mind, our business valuation experts will then examine the 8 key drivers of your company value to refine the pricing. Included in those calculations is your personal readiness to sell the business.

So these sales comps are good tools as a starting point in the valuation process. But you’d make a big mistake in presuming these are how much your business is worth.

That’s why we encourage you to sign up for a ManageVisors business valuation. It’s free and takes a much deeper dive into the factors that determine the pricing of your company. We also offer fee-based certified valuations, recommended when making decisions related to stock purchases, estate planning and legal matters.

This post intended for informational purposes only. It is not intended to constitute legal, tax or investment advice. There is no guarantee that any claims made are accurate or will come to pass. ManageVisors does not warrant the accuracy of the information. Consult a financial, tax or legal professional for specific information related to your own situation.


How To Accurately Peg Your PM Company’s Earnings

How To Accurately Peg Your PM Company’s Earnings

Addbacks – How To Calculate Your Management Company’s Earnings

It’s Actually Pretty Easy To Figure Out Your Cash Flow – Here’s How

It’s a pet peeve of mine. Business brokers and M&A advisors absolutely love making the business valuation process seem complicated and difficult. I guess we’re always looking for ways to justify our fees.

Well guess what? It isn’t really all that difficult to determine your earnings. If you’ve got accurate financial statements (a BIG if) you should be able to knock this out in 90 minutes or so.

There are three common ways to measure a company’s cash flow when selling a property management business. All three have distinct advantages and purposes.

  1. Seller’s Discretionary Earnings – SDE is the most common number in small business sales. It will almost always be employed when valuing companies with less than $5 Million in revenues. That’s because smaller company’s are usually owned by an individual or couple as owner/operators rather than a corporation with multiple shareholders. It answers the question “what is the total return of cash and benefits flowing to the owner?”
  2. Earnings Before Interest, Taxes, Depreciation & Amortization – EBITDA is used for valuating a company based on the return on investment. It answers the question “what is the return to the owner for a cash purchase of the business, after a market rate of compensation for work that the owner performs in the business (or for hiring someone else to perform those functions) has been subtracted?”
  3. Discounted Cash Flow – DCF analysis uses the “time value of money” concept to determine company value based on future income streams. It is typically used to measure the attractiveness of much larger companies, say with revenues of $100 Million or more.

All three methods pull numbers from your Profit & Loss Statements. We valuation specialists also look critically through your Balance Sheets and Cash Flow Statements to reach value conclusions but those are not directly utilized in our earnings calculations.

Unless your management company is doing $25 Million or maybe $50 Million in revenues, you’ll want to focus exclusively on figuring out your SDE. It will be the broadest and most favorable calculation available. Your earnings for SDE will be larger than your earnings for EBITDA so it makes your company look better to investment buyers.

Don’t be confused by various terms people throw around for Seller’s Discretionary Earnings.  It can be called recast earnings, normalized earnings, seller’s discretionary cash flow, adjusted cash flow or adjusted net income. SDE is the official terminology advocated by the International Business Broker’s Association (IBBA).


SDE Definition

The IBBA has defined how SDE is to be calculated. A business’s overall SDE is calculated as an average of the SDE for the 2 or 3 most recent full years, plus the current year in progress. If there is a strong trend in the earnings (up or down), much more weight will be placed on more recent years.

SDE is calculated for each year based on information from the business tax returns, the profit and loss statements and owner estimates. All of the following categories are added together in the SDE calculation. Here is what it includes:

  • Pretax net income. This is the bottom line number on your P&L. PLUS…
  • Owner’s total compensation. This includes one or two salaries paid to the owner plus profit sharing income paid to all the owners. If there is a second salary being paid to a spouse or family member, you must subtract whatever salary amount would be needed to replace his/her workload. WARNING: These salaries must be stated incomes appearing on your P&L and tax return. They can not be funds sucked out of the business through draws and distributions. PLUS…
  • Employer portion of payroll taxes paid based on the W2 salary of one owner. PLUS…
  • Business interest expense (because business debt is a “non operating expense” and assumed to be paid off). Do not plug in expenses for mortgage interest. PLUS…
  • Depreciation and amortization (non cash expenses). PLUS…
  • Discretionary expenses or personal perks paid by the business but which really benefit the owner. Common examples include the owner’s health insurance, personal use of automobiles, personal travel, personal meals and entertainment, etc. PLUS…
  • Adjustments for extraordinary, non recurring expenses or revenue (e.g., expenses incurred in a one-time lawsuit or damage from flood or fire would be added back. Revenue and expenses from a major discontinued product would be removed. PLUS…
  • This can get tricky. If you are enjoying rental income that your buyer will not, you must make a negative adjustment and subtract it from earnings. If a new owner’s rent will be different from yours, you must make an adjustment, either positive or negative. For example, if your business currently has two leased locations but only one is necessary to run the company, you can addback the rent you’re paying on the second office. On the flip side, if you’ve been operating from a home office and the business cannot reasonably be run without a physical space, you’ll need a negative adjustment for a fair market rent expense.


What Precisely is a Discretionary Expense?

Discretionary expenses are defined to be ones that the business paid for but are primarily of a personal benefit to the owner.  Typical expense categories (places to check on your tax returns/ P&Ls) are owner medical or life insurance, travel, automobiles, meals and entertainment, dues and memberships.

To qualify as discretionary, each expense must meet all 4 of these criteria:

1)  Benefit the owner(s)

2)  Not benefit the business or the employees

3)  Are paid for by the business and expensed on tax returns and P&Ls

4)  Be documented and verifiable by a prospective buyer as discretionary.

Illustrative examples of expenses that would NOT qualify would include:

  • Medical benefits for an employee
  • Counting all meal & entertainment expenses as discretionary even though dining with clients is a critical way of building relationships
  • Counting all travel as discretionary, even though some travel is necessary for business (such as to a trade show)
  • Counting all auto expenses as discretionary even though the vehicles are used to deliver products or by employees
  • Any marketing or promotion related expense even if it “didn’t work and it wouldn’t be done again”
  • Expenses for a Rotary or club membership if any clients are gained through such memberships
  • Counting unreported cash sales unless the buyer has a straightforward means to verify such sales
  • Counting dozens of personal purchases on a credit card where the card is also used for business purchases, or where the expenses are buried in a much larger expense category or several expense categories and therefore nearly impossible for a buyer to verify.

It is better to be conservative in your estimates than aggressive.  If buyers believe you are exaggerating the discretionary expenses, they will conclude you are untrustworthy and likely making other misrepresentations. Worse, if they purchase the business based on your misrepresentations, you may be guilty of fraud.


So What Are Non-Operating  & Extraordinary Expenses?

Extraordinary expenses are defined to be ones that 1) the business paid for 2) are truly unusual or exceptional in nature and 3) documented and verifiable as extraordinary.  By their nature there are no “typical” extraordinary expenses.  Examples might include expenses associated with natural disasters, a move of location, or a lawsuit out of the ordinary course of business.

Examples of expenses that would not qualify would include a marketing campaign that failed, headhunter fees to replace a manager that quit, research and development of a product or service that was later scrubbed. Keep in mind, most businesses list nothing in this category so you need to be conservative and cautious in your calculation.

Non operating revenue is unrelated to the business operations, such as interest revenue, rent from a property owned through the business or sale of equipment or part of the business.  Non operating expenses might include those to repair or fix up a building owned by the business.


The Question To Ask Yourself

In trying to figure out addbacks and adjustments to reach an accurate earnings number, ask yourself this question – if another guy owned my business right this minute, and operated it in the exact same way, in the same place, with the same employees and clients, what income and expenses would be different for him? Those are the adjustments you need to make to your net income figure on the profit and loss statement.

Very often, addbacks are not 100% of an expense category. For instance, your company’s annual automobile expenses may be $10,000. The business does own a couple cars but you also run  your personal car’s gas, repairs and licensing through the company. So you’d call that a 25% addback, or $2,500. Maybe you expense $15,000 for bookkeeping and accounting but included in that is your own personal returns and tax help. That could be a 50% addback. Do your best in making an accurate estimate of what is a personal benefit to you versus a business benefit to the company.

Once you finally have an earnings number for each year, the fun starts. You now have choices to make. Do you claim your management company has an SDE based on last year’s numbers? Or do you use an SDE that’s averaged over three years? Or do you use a 3-year weighted average, where last year’s earnings are given greater weight than those from two and three years ago?

Depends on who’s asking. Most will rely on a Trailing 12, an SDE calculation based on the last 12 months in which monthly reconciliations were completed. They will compare the Trailing 12 performance to previous years and draw opinions about how to treat it.

One reason the property management industry is very popular with business buyers is that revenues are typically rather consistent, without roller coaster rides seen in many other industries. Even if their clients’ properties are struggling with vacancy, maintenance or delinquency issues, the management company’s revenue will remain pretty consistent. New clients come, old clients go but the income stream is often stable.

If there isn’t a great deal of difference between your Trailing 12 and last year’s P&L, lenders and valuators will use last year to calculate the SDE number. Lenders always go back to the tax returns to underwrite a deal.

Once you have your earnings number, now you need to figure out how to use it in calculating the value of your company and the price a buyer may be willing to pay. That’s the next part of the valuation game. Check our site to pick up the process from here.


This post intended for informational purposes only. It is not intended to constitute legal, tax or investment advice. There is no guarantee that any claims made are accurate or will come to pass. ManageVisors does not warrant the accuracy of the information. Consult a financial, tax or legal professional for specific information related to your own situation.

Don’t Be A “Hub and Spoke” Property Manager

Don't Be A Hub Spoke PM Owner

10 Warning Signs You’re a Hub-and-Spoke Owner

Fix These Issues and Watch Your Company’s Value Soar

Picture a bicycle wheel. On the outside is the rubber wheel affixed to the metal frame. Then you have dozens of spokes leading from the frame to the center. The hub is where all the stability and balance comes from. The wheel is nothing without the hub.

This hub-and-spoke image is one of the most popular concepts used in John Warillow’s Value Builder System. For millions of business owners, it’s also the most critical key to improving operations and increasing company value.

The wheel is only as strong as the hub. The moment the hub is overwhelmed, the entire system fails. In business sales, the owner is the hub. Everything else in the company are the spokes and wheel.

You want to do everything in your power NOT to be a hub-and-spoke owner. When daily operations are so completely dependent on the owner, the enterprise value nosedives. You’ve probably heard the phrase “the owner is the business.” Don’t let that be you.

Business buyers have very little faith in these businesses because they understand how dangerous it is. When the owner leaves, so much can go with him – clients and key relationships. Employees. Vendors. Financing sources. You name it.

Most property management companies start small, so there are many pitfalls. It’s easy to become a hub-and-spoke owner and often tough to recognize. But if you want to scale your company and improve its value with an eye toward selling, you need to see the signs. Then do something about it.

Here are 10 warning signs to guard against, along with some fix-it suggestions.

You sign all of the checks

Most business owners sign the checks. But what happens if you’re away for a couple of days, or a couple weeks, and an important supplier needs to be paid? Consider giving an employee signing authority for checks up to an amount you’re comfortable with. Then change the mailing address on your bank statements so they are mailed to your home (not the office). That way, you can review all signed checks and make sure the privilege isn’t being abused.Having statements go to your home is also a good anti-theft practice.


2. Your mobile phone bill is over $200 a month

If your employees are out of their depth a lot, it will show up in your mobile phone bill. Staff will be calling you to coach them through problems. Ask yourself if you’re hiring too many junior employees. Sometimes people with a couple of years of industry experience will be a lot more self-sufficient and only slightly more expensive than the greenhorns. Also consider getting a virtual assistant (VA), who can act as a first line of defense in protecting your time. I’ve had great luck with offshore VA’s based in the Philippines or Malaysia who have excellent language skills and can perform key accounting, database and marketing functions.

3. Your revenue is flat when compared to last year’s

Flat revenue from one year to the next can be a sign you are a hub in a hub-and-spoke model. Like forcing water through a hose, you have only so much capacity. No matter how efficient you are, every business dependent on its owner reaches capacity at some point. Consider how you can reduce the number of time-consuming tasks or technically complex duties. Focus on reducing your personal involvement by 50% in some key areas. You don’t need to give up total control. Just find a happy medium in your daily tasks.

4. Your vacations suck

If you spend your vacations dispatching orders from your mobile phone, it’s time to cut the tether. Start by taking one day off and seeing how your company does without you. Build systems for failure points. Work up to a point where you can take a few weeks off without affecting your business. We often refer to the “3-Week Vacation Test.” If your business runs fine while you’re in the Bahamas, you’ve done it right.

5. You spend more time negotiating than a union boss

If you find yourself constantly having to get involved in negotiating with property owner/clients or vendors, you are a hub. Consider giving at least one staff member a platform where they have your approval to negotiate. You may also want to tie any employee bonuses or leasing commissions to their ability to solve problems and work through complex matters independently.

You are the last one out the door every night

If the clock strikes 5 every night and you’re the only one behind a computer, then you are very much a hub. If you don’t trust others to close out your management software, lock the doors and set the alarm, you’ve got some work to do. The solution may start with SOP’s. When owners take the time to write out simple-to-follow operating procedures, life gets a lot better. Maybe put together an employee manual of basic procedures. Then get to the ne.

7. You have given all your PM clients your mobile number

It’s good to have the pulse of your property owner/clients. But you’ve got serious problems if they’re calling you rather than the office for routine matters. It can be a delicate balance for property managers. On the one hand, you want your clients to know you are keeping their needs and issues very top-of-mind. On the other, you don’t want them to think you’re the only solution. Avoid having your personal relationship be the glue that holds your business together..

8. You get the tickets to the game

Clients, vendors and contractors sometimes want to show their appreciation by giving you free tickets to sports events or concerts. That’s great. But if you are the only one at the company they consider, that’s not a good sign. They have pegged you as the only one worthy of their generosity. Try integrating one or two people into more of your.

9. You get cc’d on more than five e-mails a day

Employees, clients and vendors constantly cc’ing you on e-mails can be a sign that they are looking for your tacit approval. Or maybe that you have not made clear when you want to be involved in their work. Start by asking your employees to greatly reduce the number of times you’re copied in e-mails. Ask them to add you only if you really must be made aware of something – and only if they need a specific action from you.

10. You have not taken the time to automate

Automation is so important in property management companies. Rent collections, maintenance requests, invoicing, accounting, marketing, you name it. The more that gets automated, the less the business is about you. And the less the business is about you, the greater the value to a potential acquirer.

When To Tell Employees You_re Selling

When To Tell Employees You_re Selling

When To Tell Employees You’re Selling The Company

It’s Easy To Commit A Major Mistake – Don’t Have “The Talk” Too Early


A huge part of any exit strategy is properly planning for that moment in time when employees find out the business is for sale or, preferably, has already been sold. Your workers have been kept in the dark for as long as possible. Some won’t be a bit surprised. Others may be devastated.

In almost all cases, a property management owner should delay the news as long as possible. There is usually very little to be gained by “getting the word out.” Thousands of business owners can relay stories about the damage to their business or the emotional trauma that accompanied a premature release of the information. Don’t inform employees what’s going on until the transaction has closed. Or at minimum, the buyer has removed all contingencies and there doesn’t appear to be any major roadblocks to the finish line.

Wait Until The Wire Has Landed

Resist the excitement and temptation to share your secret. It may even seem dishonest to keep employees in the dark about the sale. But not only could it cause disruption to the business, it could cause unwanted worry with your buyer about the potential for a smooth transition. 

Telling your employees too soon could also decrease the value of your business. Anxious workers may decide to leave before the deal is done, which can have devastating consequences. The last thing you want is to create a panic while you’re still involved in daily management.

There will be some circumstances which dictate telling a worker ahead of time. The most common is when owners need the cooperation of employees to prepare financials, orchestrate tours, or provide information that the owner cannot.

The other important consideration (which deserves an article all its own) is your “key employees.” Many businesses have one or several critical workers who deserve special attention or retention strategy planning. In all cases, you should emphasize repeatedly the importance of confidentiality in the process.

When Is The Right Time?

Many owners stress about how to break the news. Managing the messaging is critical. In today’s smartphone universe, it’s a mistake thinking you can get the word out in several stages. News will travel instantly among your people. Use that to your advantage. Do it once and do it well.   

Try to bring together as many employees at the same time. Teleconference the announcement if needed. Do not bring the new owner, or representatives, to the initial announcement, unless there is an unusual circumstance. You’ve got to be ready for all types of reactions. It’s best to limit the emotions to existing personnel.   

Challenge your employees to take complete ownership of their work and assure them their jobs are secure. Invite them to become actively involved in the transition, within limits.  Keep it short but informative. Be honest and comfortable in telling them the circumstances behind your selling. Emphasize this will be a win-win-win for you, the employees and the new owner. Calmly convince them the company will go on without you.

Be ready for all types of reactions. Don’t be surprised if someone tells you, to your face, they’re glad you’re leaving. Try to soften the blow with your words and actions.

Keep things upbeat and honest. Don’t dwell on the experience, merits or background of the new ownership. Selling that comes later. Let them know they are among the reasons the new owner is so excited about the purchase. Ask employees to keep the news within the company until you’ve had a chance to contact property owner/clients, vendors, and maybe the media.

Spell out briefly how you envision the transition to work. Emphasize that you’re going to be actively involved through the process and can be contacted. No one likes change. But remaining forthright, calm and supportive can go a long way toward a comfortable handoff of ownership.



Stock vs Asset Sales – Advantages Disadvantages

Stock vs Asset Sales - Advantages Disadvantages

Asset Sales vs. Stock Sales: What’s The Difference?

Advantages and Disadvantages for Property Management Deal Structures


Deciding whether to structure your property management disposition as an asset sale or a stock sale is complicated because the parties involved benefit from opposing structures. Generally, buyers prefer asset sales, whereas sellers prefer stock sales. This article highlights some primary differences between the two structures.

An asset sale is the purchase of individual assets and liabilities, whereas a stock sale is the purchase of the owner’s shares of a corporation. While there are many considerations when negotiating the type of transaction, tax implications and potential liabilities are the primary concerns.

If the business in question is a sole proprietorship, a partnership, or a limited liability company (LLC), the transaction cannot be structured as a stock sale since none of these entity structures have stock. Instead, owners of these entity types can sell their partnership or membership interests as opposed to the entity selling its assets. If the business is incorporated, either as a regular C-corporation or as a sub-S corporation, the buyer and seller must decide whether to structure the deal as an asset sale or a stock sale.


Asset sales

In an asset sale, the seller retains possession of the legal entity and the buyer purchases individual assets of the company, such as equipment, fixtures, leaseholds, licenses, goodwill, trade secrets, trade names, telephone numbers, and inventory. Asset sales are almost always completed on a “cash-free, debt-free” basis. The sale does do not include cash and the seller retains the long-term debt obligations. Normalized net working capital is also typically included in a sale. Net working capital often includes accounts receivable, inventory, prepaid expenses, accounts payable, and accrued expenses.


Buyer’s Viewpoint

Within IRS guidelines, asset sales allow buyers to “step-up” the company’s depreciable basis in its assets. By allocating a higher value for assets that depreciate quickly (like equipment, which typically has a 3-7 year life) and by allocating lower values on assets that amortize slowly (like goodwill, which has a 15 year life), the buyer can gain additional tax benefits. This reduces taxes sooner and improves the company’s cash flow during the vital first years. In addition, buyers prefer asset sales because they more easily avoid inheriting potential liabilities, especially contingent liabilities in the form of product liability, contract disputes, product warranty issues, or employee lawsuits.

However, asset sales may also present problems for buyers. Certain assets are more difficult to transfer due to issues of assignability, legal ownership, and third-party consents. Examples of more difficult to transfer assets include certain intellectual property, contracts, leases, and permits. Obtaining consents and refiling permit applications can slow down the transaction process.


Seller’s Viewpoint

For sellers, asset sales generate higher taxes because while intangible assets, such as goodwill, are taxed at capital gains rates, other “hard” assets can be subject to higher ordinary income tax rates. Federal capital gains rates are currently 20% and state rates vary (Missouri is currently 6% and Kansas is 6.45%). Ordinary income tax rates depend on the seller’s tax bracket.

Furthermore, if the entity sold is a C-corporation, the seller faces double taxation. The corporation is first taxed upon selling the assets to the buyer. The corporation’s owners are then taxed again when the proceeds transfer outside the corporation. In addition, if the company is an S-corporation that was formerly a C-corporation, and if the sale is within the 10-year built-in gains (BIG) tax recognition period, the S-corporation’s asset sale could trigger corporate-level BIG taxes, under IRS Sec. 1374.


Stock Purchase

Through a stock sale, the buyer purchases the selling shareholders’ stock directly thereby obtaining ownership in the seller’s legal entity. The actual assets and liabilities acquired in a stock sale tend to be similar to that of an assets sale. Assets and liabilities not desired by the buyer will be distributed or paid off prior to the sale. Unlike an asset sale, stock sales do not require numerous separate conveyances of each individual asset because the title of each asset lies within the corporation. A stock purchase is simpler in concept than an asset purchase. Few distinctions (between wanted and unwanted assets or between assumed and un-assumed liabilities) need, or can, be made.

The Acquirer buys all the stock of the Target and takes the corporation as it finds it. All of the target corporation’s assets remain subject to all its liabilities. Most contracts, lease, and franchise rights and permits remain in place (and in effect transfer automatically), although some sophisticated pre-existing agreements with third parties may require their consent to continuation after a transfer of control of the corporation.


Buyer’s Viewpoint

With stock sales, buyers lose the ability to gain a stepped up basis in the assets and thus do not get to re-depreciate certain assets. The basis of the assets at the time of sale, or book value, sets the depreciation basis for the new owner. As a result, the lower depreciation expense can result in higher future taxes for the buyer, as compared to an asset sale. Additionally, buyers may accept more risk by purchasing the company’s stock, including all contingent risk that may be unknown or undisclosed. Future lawsuits, environmental concerns, OSHA violations, employee issues, and other liabilities become the responsibility of the new owner. These potential liabilities can be mitigated in the stock purchase agreement through representations and warranties and indemnifications.

If the business in question has a large number of copyrights or patents or if it has significant government or corporate contracts that are difficult to assign, a stock sale may be the better option because the corporation, not the owner, retains ownership. Also, if a company is dependent on a few large vendors or customers, a stock sale may reduce the risk of losing these contracts.


Seller’s Viewpoint

Sellers often favor stock sales because all the proceeds are taxed at a lower capital gains rate, and in C-corporations the corporate level taxes are bypassed. Likewise, sellers are sometimes less responsible for future liabilities, such as product liability claims, contract claims, employee lawsuits, pensions, and benefit plans. However, the purchase agreement in a transaction can shift responsibilities back to a seller.

The deal structure of any transaction can have a major impact on the future for both the buyer and seller. Many other factors, such as the company’s structure and the industry, can also influence the decision. It is important for both parties to consult with their business intermediaries, legal counsels, and accounting professionals early in the process to fully understand the issues and reach a decision that will produce the desired results.


Ratio of asset sales to stock sales

How common are asset sales versus stock sales? Based on an analysis of marketplace transactions from the Pratt’s Stats database, approximately 30% of all transactions were stock sales. However, this figure varies significantly by company size, with larger transactions having a greater likelihood of being stock sales.


Advantage of Asset Purchase over a Stock Purchase


  • A major tax advantage is that the buyer can “step up” the basis of many assets over their current tax values and obtain ordinary tax deductions for the depreciation and/or amortization deductions. For example, if the seller has equipment worth $500,000 but the equipment is fully depreciated for tax purposes, a transaction that is treated as a stock sale cannot “step up” the basis to $500,000 for tax purposes since the seller has already depreciated the equipment.
  • Goodwill, which is the amount paid for a company less its tangible assets, can be amortized on a straight-line basis over 15 years for tax purposes in an asset transaction. In a stock deal, just like if you were buying shares of a company like IBM, the goodwill cannot be deducted until the stock is sold by the buyer.
  • The buyer can dictate what, if any, liabilities it is going to assume in the transaction. This limits the buyer’s exposure to liabilities that are either unknown or not stated by the seller. The buyer can also dictate which assets it is not going to purchase. This is often advantageous if the seller has a lot of accounts receivable that the buyer does not believe will be collected.
  • Because the exposure to unknown liabilities is limited, the buyer typically needs to conduct less due diligence.
  • Minority shareholders that don’t want to sell may be forced to accept the terms of an asset sale.
  • The buyer can select which employees they want to offer jobs without impacting their unemployment rates.


Disadvantages of Asset Purchase Compared to Stock Purchase
  • Contracts – especially with customers and suppliers – may need to be renegotiated and/or novated.
  • The tax cost to the seller is typically higher, so the seller may want a higher purchase price.
  • Assignable contract rights could be limited.
  • Assets may need to be retitled.
  • In California and most other states, the seller should obtain a bulk sales certificate. Otherwise, the purchaser could become liable for any unpaid taxes.
  • Employment agreements with key employees may need to be rewritten.
  • The seller still needs to liquidate any assets not purchased, pay any liabilities that have not been assumed, and negotiate any leases that need to be terminated.


Advantages of a Stock Purchase
  • The acquirer doesn’t have to bother with costly valuations and retitles.
  • In most cases, buyers can assume non-assignable licenses and permits without consent.
  • Buyers may also be able to avoid paying state and transfer taxes.
  • More simple and common than an asset acquisition. For example, hedge funds are known for conducting M&A transactions, particularly in the form of a simple stock purchase.


Disadvantages of a Stock Purchase


  • The main disadvantage is that an acquirer receives neither the “step-up” tax benefit nor the advantage of handpicking liabilities.
  • All asset and liabilities transfer at carrying value.
  • The only way to eliminate unwanted liabilities is to contractually sell them back to the target.
  • Securities laws can complicate situations involving a large number of shareholders.
  • It may be difficult to convince some stockholders to sell their shares.
  • Goodwill is not tax deductible.


IRC Section 338 allows the buyer to purchase the stock but the transaction is taxed as if it were an asset purchase. However, the seller has to pay the tax bill that arises from the step-up on the basis of assets, which occurs under asset purchase transactions. We often see this election used in purchases of service companies where the customer contracts may be difficult to novate or where the seller has leases and/or other contracts that the buyer does not want to renegotiate.

As you can see, there are many factors to take into consideration when weighing your acquisition method and the decision may not be an easy one. An advisor who is experienced with mergers and acquisitions can assist the buyer and/or seller throughout the process and help provide clarity.


This post intended for informational purposes only. It is not intended to constitute legal, tax or investment advice. There is no guarantee that any claims made are accurate or will come to pass. ManageVisors does not warrant the accuracy of the information. Consult a financial, tax or legal professional for specific information related to your own situation.