In an asset sale, the buyer purchases the business’s equipment, contracts and other assets, and the seller formally closes the LLC after the sale. In a membership interest sale, the buyer purchases the owners’ membership interest (also sometimes called “units”), and the LLC keeps operating with its contracts and liabilities intact.
If you own a Tennessee LLC and have a buyer at the table, one of the first decisions is how to structure the deal. The choice between an asset sale vs. a membership interest sale affects which liabilities follow the business, whether your contracts transfer smoothly, how the proceeds are taxed, and what paperwork remains after closing. Those questions are much easier to settle before you sign a letter of intent than after.
What Is the Difference Between an Asset Sale and a Membership Interest Sale?
In an asset sale, the LLC sells what it owns, such as equipment, inventory, customer lists, intellectual property, goodwill and any contracts the buyer agrees to take on. The seller’s LLC keeps the proceeds along with any obligations the buyer did not assume, and the LLC is wound up and terminated once its affairs are settled.
In a membership interest sale, the owners sell their membership interest in the LLC itself. The company keeps its name, tax ID, bank accounts, contracts and history. Only its ownership changes.
Asset Sale vs. Membership Interest Sale: The Pros and Cons
Liability Exposure
Asset buyers can generally choose which liabilities they assume and leave the rest with the seller, which is a major reason buyers tend to prefer asset deals.
A membership interest buyer steps into the LLC as it stands, including debts, pending claims, and potential undiscovered problems. Buyers manage that risk with representations and warranties, indemnification provisions, and sometimes an escrow holdback, which can leave individual sellers exposed long after closing.
Contracts, Leases and Licenses
Asset sales require the seller’s LLC to assign its contracts to the buyer. Many commercial leases, vendor agreements and customer contracts include anti-assignment clauses that require the other party’s consent, and some permits and licenses cannot be transferred at all.
Membership interest sales often avoid this problem because the contracting party is still the same LLC. Some agreements, however, contain change-of-control provisions that treat a sale of ownership like an assignment, so every agreement deserves a close read by an experienced contract law attorney.
Tax Considerations
The tax implications of an asset sale and a membership interest sale can differ significantly depending on the circumstances of the transaction. Buyers and sellers should consult with their respective CPAs or tax advisors to understand the potential tax consequences before proceeding.
Closing Paperwork and Costs
Membership interest sales are often more straightforward and less expensive to close because ownership of the LLC changes hands without requiring the separate transfer of each business asset. This can be particularly advantageous when the business owns numerous assets, has existing liens, or owns real estate.
Asset sales generally involve more closing documents, including bills of sale, assignments of contracts and leases, lien releases, and, when real estate is involved, deeds and other property transfer documents. Depending on the number and types of assets involved, these additional requirements can increase legal fees and other closing costs.
However, either type of transaction can become more complicated when the buyer finances part of the purchase price through the seller. Promissory notes, security agreements, and related documents can add to the cost and complexity of closing regardless of the transaction’s structure.
Every transaction is different, and the simplest structure is not always the best one. Buyers and sellers should consult with an experienced business transactions attorney to determine how best to structure the sale based on their particular circumstances.
Weighing the Trade-Offs
Every business sale is different, and each party has its own priorities, whether those involve minimizing closing costs, limiting liability exposure, simplifying the transaction, or achieving favorable tax treatment. The best structure depends on the particular circumstances of the deal and the goals of the parties involved. Buyers and sellers should consult with an experienced business transactions attorney to understand their options and determine which structure best serves their interests.
How Membership Interest Transfers Work Under Tennessee Law
Tennessee LLCs are governed by the Tennessee Revised Limited Liability Company Act, Tenn. Code Ann. §§ 48-249-101, et seq. The Act separates a member’s financial rights, meaning the share of profits, losses and distributions, from governance rights, such as voting and participating in management.
Financial rights are generally transferable unless an operating agreement or other written agreement restricts them; however, someone who receives only financial rights does not become a member. Governance rights are more tightly controlled. Under Tenn. Code Ann. § 48-249-508, a member may transfer governance rights to another existing member, and a sole member may transfer freely. Most other transfers of governance rights require the unanimous approval of the remaining members.
Many operating agreements add their own approval requirements, rights of first refusal or buy-sell terms, so review yours before you agree to sell your membership interest.
Closing the Shell After an Asset Sale in Tennessee
Selling the assets does not end the LLC. In Tennessee, closing a company is a two-step process of dissolution followed by termination, and the Tennessee Department of Revenue must issue a tax clearance certificate before the Secretary of State will terminate it. Until termination documents are filed, the LLC must continue filing annual reports and paying taxes.
For an LLC that has accepted contributions from its members, the process generally looks like this:
- File a Notice of Dissolution with the Secretary of State.
- Wind up the company’s affairs by collecting receivables, paying creditors and distributing what remains to the members.
- File a final franchise and excise tax return and obtain a tax clearance certificate from the Tennessee Department of Revenue.
- File Articles of Termination with the Secretary of State.
Asset Sale vs. Membership Interest Sale: How the Same Deal Can Play Out Two Ways
The following scenario is a hypothetical example to illustrate how each structure works. Imagine a Tennessee commercial cleaning company owned by two members. The LLC leases its warehouse, holds service contracts with local businesses, owns a fleet of vans and is defending a customer’s damage claim. A regional competitor wants to buy it.
As an asset sale, the buyer purchases the vans, equipment, customer list, and trade name. If the buyer wants to take over the warehouse lease, it may need the landlord’s consent. It may also need consent from any customers whose contracts prohibit assignment. The damage claim generally stays with the selling LLC, which must resolve it before winding up and terminating the LLC.
As a membership interest sale, the buyer purchases the owners’ membership interests, and the LLC continues operating with its existing assets, contracts, and liabilities (including the vans, service contracts, leases, and pending damages claim). The buyer would thus inherit the damage claim, so the buyer may negotiate an indemnification provision requiring the individual sellers to cover certain losses or arrange to hold back part of the purchase price in escrow until the claim is resolved. The sellers therefore do not have to wind up the LLC, but they still may remain individually financially responsible for the claim under the terms of the sale agreement.
Which Structure Is Right for Your Tennessee Business?
When comparing asset sale vs. membership interest sale, the right structure depends on how much liability risk each side will accept. The size of the deal, how many contracts require consent, the tax picture and what the buyer prefers also influence the structure of the deal.
Buyer preference often carries significant weight, but a seller who understands the trade-offs can negotiate price and terms to account for them. Because the letter of intent usually fixes the structure and key economic terms, the time before you sign it is the most valuable time to get advice.
If you are considering selling your business, the business transactions attorneys at Hudson, Reed & Christiansen can review your operating agreement, contracts and potential liabilities, then work alongside your CPA to recommend a structure that protects you through closing and beyond. Contact our office to schedule a consultation before you sign a letter of intent.