Asset Purchase v. Stock Purchase

Like any other business, an optometry practice can be owned in any one of several forms. In a sole proprietorship the practice is owned by the individual doctor. This is the simplest business form of ownership. Whatever the "business" owns, the doctor owns because the doctor and the business are one and the same. A sole proprietorship reports his/her business income on a personal tax return, Schedule C. If you file a Schedule C with your 1040 tax return for your optometry practice, you are a sole proprietorship. 

Similarly, in a partnership the practice is owned by two or more individual doctors, but, again, whatever the partnership owns, generally speaking, the individual partners own. If the partnership is sued, both of the partner-owners are potentially liable for any judgment. A partnership is not a separate legal entity and does not file its own tax return, exactly. It files a Form 1065, Information Return (a U.S. Return of Partnership Income). This form reports the partnership’s total income, deductions, and other financial information for the year. The partnership does not pay tax on this income. Instead, the partnership issues a K-1 to each partner showing the partner's earnings and they then pay taxes on their own tax return on a Schedule E. 

This is important because, in the case of both a sole proprietorship and a partnership, the individuals own the assets and if the practice is selling, it will be selling those assets. There is no choice or other option. Its an Asset sale.  

However, the individual or individuals that own the practice may choose to own and operate it as a distinct and separate entity, either as a corporation or as a limited liability company (LLC) (for purposes of this discussion, the two forms are interchangeable). This concept confuses many people, but it shouldn't. The corporation issues shares of stock to the individual owner(s), and that is the only thing the individuals own -- shares of stock in the corporation. Everything else, e.g. the equipment, the inventory, etc., is owned by the corporation, not by the shareholders.

Thus, if a sole proprietorship optometry practice purchases a new OCT, it is the doctor that owns the practice that is buying and that owns the OCT. Legally speaking, "title" to the OCT is held in the name of the individual that owns the practice. If that person dies, ownership of the OCT passes to his or her heirs just like everything else that the deceased doctor owned.

In contrast, if a corporate optometry practice purchases the same new OCT, the OCT is owned by the corporation, and title to the OCT is held in the name of the corporation. The individual doctor(s) that are the shareholders of the corporation do NOT own the OCT. They have no ownership interest in any of the "things" (the assets) that the corporation owns. The shareholder's (or "members" in an LLC) own the entity (the corporation or the LLC), and the entity owns everything else. The OCT is an "asset" of that corporation, which increases the value of the shares of stock held by the shareholders, but the OCT is not owned by the shareholders themselves. If the shareholder dies, the OCT continues to be owned by the corporation. It is only the shares of stock in the corporation which pass to the heirs of the deceased doctor, and those heirs become the shareholder(s).

So, what happens when someone wants to buy an optometry practice?

That depends on whether the practice being purchased is individually owned, or owned in the corporate or LLC form.  If the practice is individually owned, the transaction is simple: the owner sells the various assets of the business (e.g. the inventory, goodwill, equipment, furniture, etc.) to the buyer.

But, there are two ways to purchase or sell a business that is a corporation (or LLC). One way is to purchase the corporation's stock (or shares, or membership interests in the case of an LLC) from the current shareholder(s). This is accomplished through a Stock Purchase Agreement. The owner or owners of all the outstanding shares of the corporation's stock are sold to the buyer, and the buyer then owns the corporation. There is no change in the ownership of any of the assets of the corporation, no change in the corporation's tax ID number, account numbers, etc. The corporation is unchanged. It just has a new owner.

The upside to this, for a seller, is that the profits from the sale are typically going to be taxed as a long-term capital gain, which has favorable tax rates. And if the corporation is an "S" corporation (as is usually the case) there is no risk of a corporate/double tax. All the profits of the sale pass thru to the shareholders as long-term capital gain. Also, for the buyer, with no change in the accounts, tax ID, etc., the transfer is relatively easier. (However, contrary to the belief of some, the new owner must still engage in credentialing with third party payers.)

The problem or downside with a stock purchase for a buyer is two-fold. First, because there is no change in the ownership of the business' assets, there is also no change in the responsibility for its debts and liabilities (both known and unknown liabilities, such as a potential lawsuit which has not yet been filed). Second, the buyer loses the ability to write-off or depreciate the business from his/her taxes. For these reasons, in most cases, the buyer of a corporate optometry practice will purchase the corporation's assets from the corporation, not the shares of stock in the corporation. By purchasing the assets from the corporation (not from the doctor/shareholder) the corporation continues to "own" its debts and liabilities. Typically the seller will collect the accounts receivable, pay off all remaining debts, then dissolve the corporation. 

Thus, the second way to purchase a corporate optometry practice, and the more common way, is through an Asset Purchase Agreement. In an asset purchase the buyer (which can be an individual or a buying corporation) purchases and acquires title to the assets of the selling business, but none of its debts or liabilities except for those debts or liabilities that are explicitly identified and assumed by the buyer. Typical language you'd see in an asset purchase agreement looks like this:

The "assets" being purchased include the goodwill, furniture, fixtures, equipment, inventory, and everything else of value to the business. As a practical matter, in most cases the selling corporation retains its cash and accounts receivable, so it doesn't sell ALL its assets, and the purchaser typically agrees to purchase and be responsible for some of the liabilities, such as an ongoing equipment lease or the website and URL. But in an asset purchase agreement, unlike a stock purchase agreement, the buyer can choose exactly what it is buying and what it is not buying. That offers the buyer substantial protection from acquiring unknown or undisclosed debts or liabilities. In addition, there are signficant tax advantages to the -buyer- of the assets: stepped-up basis and the ability to obtain a depreciation write-off. These tax benefits do not exist when buying the shares of stock in the corporation. 

ADVANCED TIP: There is, however, a third way. Utilizing an IRS Section 338(h)(10) election, one can purchase the stock of a corporation (provide the corporation is a subchapter "S" corporation) but obtain some of the benefits of an asset purchase (stepped-up basis for greater depreciation). This is a fairly complex procedure and is generally reserved for only larger purchases where the sale price is over $1M. To read more about this option, click HERE. 

There are, of course, many subtitles in this big-picture explanation. These require the help of an experienced attorney, and accountant, to be sure the transaction does not create unintended consequences for either party. Sales need to be structured to be tax-efficient, and to protect the interests of both the Buyer and Seller after the sale closes.