Every business acquisition is either an asset purchase or a stock purchase. This single structural choice affects your tax basis, your inherited liabilities, your ability to use SBA financing, your employees' benefits continuity, and potentially the economics of the entire deal. Most ETA buyers default to an asset purchase — and for most deals, that is correct. But understanding why, and when stock purchases make sense, is fundamental knowledge.
What an Asset Purchase Is
In an asset purchase, you buy specific assets of the business — equipment, inventory, customer contracts, intellectual property, goodwill, trade names — and assume only the specific liabilities you agree to assume. The legal entity (the corporation or LLC) stays with the seller. You form a new entity or use an existing one to hold the acquired assets.
The primary buyer benefit is liability separation. Undisclosed pre-closing liabilities — lawsuits, tax assessments, environmental obligations, employee claims — stay with the seller's entity. You are not inheriting a corporate history you did not create. The SBA strongly prefers asset purchases for this reason; it reduces lender risk significantly.
The second major buyer benefit is tax basis. In an asset purchase, your cost basis in the acquired assets is your purchase price, allocated across asset categories per IRS Form 8594 rules. This stepped-up basis means you can depreciate and amortize assets at your acquisition cost — which is almost always far higher than the seller's depreciated basis. This reduces your taxable income in years one through fifteen, which is real cash.
What a Stock Purchase Is
In a stock purchase, you buy the shares of the corporation from the selling shareholders. The legal entity — with all its history, contracts, liabilities, and tax positions — transfers to you intact. You inherit everything: the good (transferable licenses, existing contracts, long-standing supplier terms) and the bad (contingent liabilities, historical tax positions, pending claims you may not know about).
Sellers generally prefer stock purchases because it gives them capital gains treatment on the entire proceeds (versus asset sales, where some proceeds may be taxed as ordinary income for certain asset categories). In an asset sale, the seller's corporation sells the assets and recognizes gain, and then the seller winds down the corporation — potentially triggering a second level of tax. In a stock sale, selling shareholders pay capital gains rates on their stock proceeds with no entity-level tax.
The Tax Basis Problem for Stock Buyers
In a stock purchase, you inherit the seller's tax basis in all assets — not your purchase price. If the seller has fully depreciated their equipment (basis of zero), you also have a basis of zero. You cannot depreciate the equipment again, even though you paid full market value for it. This eliminates a significant tax benefit and creates a meaningful economic difference between asset and stock deals. For ETA deals in the $2M–$10M range, the present value of the depreciation and amortization difference between an asset deal and a stock deal is often $200,000–$800,000 depending on the asset mix.
The Section 338(h)(10) Election: Having Both
A Section 338(h)(10) election is a joint election between buyer and seller that allows a stock purchase to be treated as an asset purchase for tax purposes. The buyer gets a stepped-up basis in the assets (the asset purchase benefit), and the transaction mechanics are those of a stock deal (the seller's benefit of single-level tax treatment in some cases, and cleaner contract transfer). The election is only available for S-corporation targets or subsidiary stock purchases — not C-corporations selling to unrelated buyers.
For S-corp sellers, the 338(h)(10) election is worth discussing with your tax advisor. It bridges the gap between what sellers want (stock deal simplicity) and what buyers want (asset basis step-up). Whether it actually makes sense depends on the seller's specific tax situation and the asset composition of the business.
Practical SBA and Lender Considerations
SBA 7(a) loans strongly favor asset purchases. The SBA's standard operating procedure (SOP 50 10 7.1) requires that for stock purchases, the lender must conduct additional due diligence on the target entity's contingent liabilities. Many SBA preferred lenders simply decline stock deal financing for this reason. If your deal is SBA-financed — which most ETA deals are — structure it as an asset purchase unless there is a compelling reason not to.
The one scenario where stock deals become necessary even with SBA financing: businesses with licenses or contracts that cannot be transferred. Healthcare practices, professional service firms (where the license belongs to the entity), government contractors with non-assignable contracts, and businesses with lease agreements that prohibit assignment may require a stock purchase. In these cases, your SBA lender must approve the structure, and you should obtain specific reps and warranties covering known liabilities.
Negotiating the Structure with the Seller
Most sellers prefer stock deals for tax reasons. Most buyers prefer asset deals. The gap is often negotiable through price. Calculate the tax benefit difference to the seller between a stock deal and an asset deal — the additional taxes they would pay on an asset sale. Then calculate your tax benefit as a buyer from the stepped-up basis. If the buyer's benefit exceeds the seller's tax cost, there is room for a price adjustment that makes both parties whole while structuring as an asset deal. Your tax advisor and the seller's tax advisor should run this analysis jointly.