Most sellers know that preparing for a sale requires certain homework, such as cleaning up business and corporate records, and considering key employee retention arrangements. Another important way to prepare for a sale is to be ready to negotiate deal structure.
Essentially, a sale of a business can be structured as a stock transfer (whether as a stock sale or a merger) or an asset sale. They each have their own pros and cons.
Normally, a seller will prefer a stock transfer. In a stock transfer, (1) all liabilities are transferred to the buyer, (2) there can be less need to obtain third party consents to transfer important contracts, and (3) there is only one level of tax for the seller. The seller is taxed at the shareholder level.
On the other hand, a buyer will often prefer an asset purchase. In an asset sale, (1) assets can be “cherry picked,” (2) liabilities are retained by the seller unless they are assumed, and (3) the buyer can obtain a “stepped up” tax basis in the acquired assets. In an asset deal, a corporate seller is taxed at both the corporate level and the shareholder level (unless the corporate seller is an S corporation).
However, it would be an oversimplification to say that all sellers should insist on stock deals. Here is an example.
Assume that a buyer would be prepared to pay $100M in a stock deal.
- If the deal is structured as a stock deal, the buyer will acquire assets at their carrying values on the seller’s tax balance sheet. Any goodwill in the company that is reflected in the purchase price will not be amortizable by the buyer for tax purposes.
- If the deal is structured as an asset deal, the buyer will receive a stepped-up tax basis in the acquired assets. This means that the acquired net assets will be written up to fair value on the buyer’s tax balance sheet. A higher tax basis will reduce taxes on any gain on the future sale of those assets. Plus, depreciable assets such as machinery and equipment can be depreciated by the buyer based on the higher tax basis, and even goodwill and other intangibles acquired in the asset purchase will be amortized over fifteen years, and that amortization will be tax-deductible. Even on a net present value basis, the value of the future deductions is often significant.
- A buyer may be prepared to pay more in order to induce the seller to agree to an asset purchase. Studies show that asset deals tend to be priced at a premium to stock deals. In addition, the additional tax burden of an asset deal on a seller may be mitigated if the seller has significant net operating losses that it can use to offset gain at the corporate level.
- So if a seller is otherwise comfortable with potential retained liabilities and a more involved third party consent process, the seller could be better off positioning the company for a $120M asset sale, as compared to a $100M stock sale, and that positioning could be attractive to a buyer due to its ability to “write off” much of the purchase price.
Determining the ideal structure for a deal requires a careful analysis of applicable facts. There is no one-size-fits-all formula. (In fact, there is a hybrid alternative where an acquisition of the stock of an S corporation or of the subsidiary of a consolidated group can be treated as an asset deal for tax purposes.) But one thing is certain. Carefully considering and preparing for negotiation of deal structure can be a key to unlocking significant additional value.