Structuring for a Smooth Business Transaction

When selling or buying a business there is virtually an infinite number of ways in which a transaction can be structured. One of the most important considerations in structuring an acquisition is whether the transaction will be a sale of stock or assets. Both stock and asset deals have their advantages and disadvantages, depending on the facts and circumstances surrounding each deal. The buyer and seller should consider the following factors in determining the structure of the transaction.

Asset deals

In an asset deal, individually identified assets and liabilities of the seller are sold to the buyer. The buyer can choose, or “cherry pick,” which assets or liabilities it wants to purchase, which allows the buyer to avoid unwanted assets or liabilities for which it does not wish to assume responsibility. The asset purchase agreement between the buyer and seller will include all the assets and liabilities that are involved in the transaction and will also assign value to them.

Seller’s perspective

From the seller’s standpoint, asset sales generate higher taxes because the transaction generates various kinds of gains or losses to the seller based on the classification of each asset.

For example, if an asset has a higher step-up basis than the seller’s tax basis, the seller will be taxed at ordinary gains for the difference between the step-up basis and tax basis. Additionally if the seller’s business is structured as a C corporation the seller faces double taxation. The corporation is first taxed on the sale of the assets. The corporation’s shareholders are then taxed when the proceeds from the sale are transferred to the shareholders.

Buyer’s perspective

Generally buyers prefer an asset sale because it allows them to step up the basis of the assets to its fair market value. By allocating a higher value for depreciable assets the buyer may benefit from incremental tax benefits. Additionally, the buyer can amortize any goodwill from the transaction over 15 years.

Recent tax legislation has also provided a greater advantage to buyers in asset transactions. The Tax Cuts and Jobs Act allows buyers to immediately deduct some or all of the nongoodwill portion of the purchase price.

Other advantages for the buyer include the ability to “cherry pick” the assets or liabilities of the seller, the fact that buyers are generally free from any undisclosed or contingent liabilities and that buyers are generally not liable for the seller’s liabilities unless specifically assumed under the contract.

Stock deals

In a stock sale the buyer purchases the seller’s corporate stock and the buyer obtains ownership in the seller’s legal entity. The assets that the buyer obtains in a stock purchase are similar to that of an asset purchase. Assets or liabilities that the buyer does not desire are typically distributed or paid off prior to the sale. Stock purchases also do not require the process of identifying each asset because the title of each asset lies within the corporation.

Seller’s perspective

One of the biggest advantages for a seller is that all proceeds are taxed on the sale of stock. This usually means that any gains or losses from the sale are capital in nature. Sellers are also able to pass obligations (i.e., disclosed, not disclosed, unknown and contingent) and nontransferable rights to the buyer.

However, the purchase agreement in a transaction can shift some of these responsibilities back to the seller. Some disadvantages of stock sale for a seller include not being able to choose the assets to be retained and the loss of any net operating loss or credit carryforwards to offset a gain on the sale.

Buyer’s perspective

When a buyer purchases the stock of the seller the buyer perseveres the right to use the seller’s name, licenses and permits. In situations where the seller holds a large number of copyrights, patents, permits, or government or corporate contacts, a stock sale may be preferred by the buyer. The buyer is also able to save time and money from the tedious valuation of the seller’s individual assets and liabilities because the transaction is inherently simple.

The biggest disadvantage for a buyer in a stock sale is that they lose the ability to step up the assets of the target. The basis of the assets at the time of sale is the depreciation basis for the buyer. The buyer may also be liable for unknown, undisclosed or contingent liabilities. However, the representations, warranties and indemnifications in the stock purchase agreement can help mitigate potential liabilities.

Example

Company ABC enters into an agreement with Company XYZ to purchase Company XYZ for $100. At the time of sale Company XYZ’s assets have a tax basis of $25 with a fair market value (FMV) of $50. The shareholder’s basis in Company XYZ is $25.

STOCK SALE				ASSET SALE
Purchase price		$100		Purchase price	$100
Less: Shareholder’s basis		$25		Tax basis of assets	$25
Capital gain on stock sale		$75		Gain on sale	$75
				Less FMV of assets	$50
				Ordinary gain	$25
				Gain on sale	$75
				Less ordinary gain	$25
				Capital gain	$50
Seller’s taxable gain				Seller’s taxable gain
Capital gain		$75		Capital gain	$50
Ordinary gain		—		Ordinary gain	$25
Total gain		$75		Total	$75
Buyer’s depreciable basis in assets				Buyer’s depreciable basis in assets
Tax basis of asset		$25		FMV of assets	$50
Buyer’s basis in XYZ stock				Goodwill (amortized over 15 years)	$50
Carryover basis		$100		Total	$100

Conclusion

Navigating the structure of a transaction, for both buyers and sellers, can be a difficult and time-consuming process. It is important that buyers and sellers know the implications of how a deal is structured. Assembling an experienced deal team of investment bankers, lawyers and accountants can help navigate and negotiate the obstacles of structuring a transaction.

For more information or to better understand your options related to structuring a transaction, please contact Brock Childers, analyst, at bc@taureaugroup.com or any member of the Taureau Group team at 414-465-5555.