When confronted with how to best structure the sale or purchase of a company, the process is further complicated because what is good for the seller, is very seldom good for the buyer. The structure of the sale is oftentimes driven by each party’s bargaining power over the other which will affect not only the form of the transaction, but also the price paid by the buyer and accepted by the seller. As a general rule, sellers prefer to sell the stock of their business and buyers prefer to purchase assets. This article highlights some of the basic differences between the two structures. Due to the limited scope, we will focus on regular C Corporation and Subchapter S Corporations in this article.
In an asset sale, the seller of a C Corporation generally faces “double taxation” whereby the corporation is taxed first on the sale of its assets to the buyer and the stockholders of the C Corporation are taxed again when the proceeds are distributed out of the C Corporation. Generally, an S Corporation avoids the double taxation issue since gains and losses flow directly to the shareholder. If the S Corporation was formerly a C Corporation, an additional built-in gains tax (BIG Tax) could apply at the S Corporation level due to the disposition of assets that had a fair market value greater than their basis at the date of the S Election. If these assets are sold within a 5 year recognition period beginning on the date of the S election, it could trigger a BIG Tax at the highest corporate rate (presently 35%).
An asset sale is beneficial to the buyer as it allows for a “step-up” in basis of depreciable assets assuming the purchase price exceeds the aggregate tax basis of assets acquired. By allocating a higher value to depreciable assets with shorter lives and allocating a lower value on longer amortizable assets (such as goodwill with a 15 year life), the buyer will obtain accelerated tax benefits. Buyers also prefer asset sales because they can choose which assets and liabilities to acquire and avoid inheriting contingent and/or unknown liabilities such as contract disputes, employee lawsuits, product liability and warranty issues etc. In an asset sale, ownership of assets and liabilities and any related contracts must be transferred to the seller. This can be a time consuming process for the buyer if there are numerous assets which need to be titled, such as vehicles.
In a stock sale, the seller of both C Corporation and S Corporation stock recognizes capital gain at the shareholder level. Sellers generally prefer stock sales due to the lower favorable capital gain treatment. From a non-tax perspective, sellers also prefer stock sales as this type of transaction generally affords them liability protection by relieving them of both known and unknown liabilities. A stock sale may also be preferable for the buyer when the target company has favorable contracts or permits that cannot be assigned to a new owner but would continue in force via a stock acquisition. On the other hand, with a stock sale, the buyer loses the ability to obtain a step-up in basis of appreciated assets acquired.
Stock and asset sales are beneficial over a tax-free reorganization when the seller does not desire to invest in the stock of the acquiring corporation because he either wants cash, no market exists for the stock of the acquiring company, and/or assumed liabilities could be an issue.