So you’ve decided to sell your business, but what structure is right for the transaction?’
Buyers and sellers often prefer different structures due to various factors which change based on the structure and which have different impacts on the parties.
Generally there are three (3) categories of factors that drive the eventual structure of a deal: (1) business issues, (2) assignments and consents, and (3) tax issues.
In an asset acquisition, the buyer purchases specific assets (and sometimes certain liabilities) of the target company. After the closing, both buyer and seller maintain their own corporate existence and structure, with a shift in the owner of the operating assets.
Business Issues. When purchasing a business, buyers typically prefer asset deals mainly because (i) they can pick and choose which assets they wish to purchase and (ii) the risk of assuming undisclosed/unknown liabilities is lowered. In an asset deal, buyers can essentially take what they want (operating assets) and leave what they don’t want (liabilities).
Assignments and Consents. Asset deals can be more complicated depending upon the business. If a business has many valuable contracts and licenses, the seller may need to obtain third party consents to assign the contracts and licenses, which can cause considerable additional work and delay.
Tax Issues. Often, the predominant driving factors in deal structure are tax issues.
- Buyers often prefer asset acquisitions because they will get the cost basis (based on purchase price) for the acquired assets, allowing them the benefit of depreciating the assets at a stepped-up basis. Essentially, the buyer would have a greater stream of deductions to use over time to off-set the income of the company. In a stock deal, the original basis is simply inherited, leaving less depreciation deductions for the Buyer over time.
- In contrast, Sellers often prefer a stock deal over an asset deal, because in an asset deal, the seller/target company will recognize taxable income/gain on the sale of its assets. If the target company is a C-corporation, the target company’s shareholders will also be taxed when the proceeds are distributed to them. (In the sale of an S-corporation, partnership or LLC, the taxable gain or loss flows through to the owners, avoiding the taxation at the company level.) In a stock acquisition, only the shareholders of a C-corporation recognize any gain. There is not taxation at the company level, so there is only one layer of taxation.
In a stock acquisition, the buyer acquires the stock of the target company directly from the selling owners. The buyer therefore acquires all of the assets, liabilities and rights of the target company.
Business Issues. While buyers cannot pick and choose assets, sometimes purchasing the company’s stock makes for an easier transition if the buyer desires to continue the business with little disruption. The liability issue typically will drive buyers to an asset deal; however, additional protections, including indemnity provisions, can be used in stock deals to ease the concerns of the buyer.
Assignments and Consents. Typically a stock deal will involve much less complexity as you do not have to move the entire business into a new entity. That said, there still will likely be certain required consents to the transaction. Many contracts and licenses that form a significant part of a business will have a consent requirement, or maybe just a notification requirement, upon a change of control or sale of stock. Barring a change of control provision in contracts and licensure issues, third party consents are generally not needed in a stock deal.
Tax Issues. The target company’s basis in its assets will be unchanged in a stock deal, as the basis is “inherited,” i.e. the same in the hands of the buyer as it was in the hands of the seller. The buyer in a stock deal will receive a stepped-up basis in the stock of the target company equal to the purchase price, but generally, the buyer would prefer the step up to be in basis of the assets to allow for more depreciation.
In a stock deal, the seller will recognize gain on the sale of their stock (primarily capital gain) resulting in only one level of tax, sometimes at a lower rate.
Selecting the best structure when selling or buying a business is often critical to the success of the deal itself and it will often have lasting impact on the future of the business. Accordingly, these considerations must be weighed against the desires of the parties, requiring creativity and planning, so that buyer and seller can reach a mutually beneficial result.
- Selling A Business: Asset Acquisition vs. Stock Acquisition - October 14, 2014
- Should You Use a Letter of Intent (LOI)? - June 17, 2014
- Indemnification Provisions of a Purchase Agreement - March 14, 2014