Structuring a Partner M&A Sale: Asset or Stock?
Deciding on the best deal structure for an M&A transaction requires careful evaluation. Here are a few things partners should look out for.
- By Reed Warren
- December 21, 2017
In any M&A transaction, one of the first questions we get from involved parties is how the deal should be structured: asset sale or stock sale?
The answer is...complicated. The parties benefit from opposing structures, so what's good for the buyer is generally poor for the seller, and vice versa. Typically, buyers prefer asset sales, whereas sellers prefer stock sales.
To be clear, we're not providing legal or tax advice here, but do want to provide an understanding of the differences. Every business transaction is unique, and buyers and sellers should always engage attorneys, accountants and M&A advisors when considering a business sale.
A stock sale is the purchase of the owner's shares of a corporation, whereas an asset sale is the purchase of individual assets and liabilities. While there are many things to consider when negotiating the type of transaction, tax implications and potential liabilities particularly around contracts and agreements are the primary concerns.
In an asset sale, the seller retains possession of the legal entity and the buyer purchases individual assets of the company, such as equipment, licenses, goodwill, intellectual property, trademarks, patents, telephone numbers and inventory. Asset sales typically exclude any cash and the seller typically retains the long-term debt obligations. This is referred to as a cash-free, debt-free transaction.
For the buyer, the asset sales allow them to "step up" the company's depreciable basis in its assets. The buyer can gain substantial tax benefits that reduce taxes sooner and improve the company's cash flow during the critical early years of the acquisition. In addition, buyers prefer asset sales because they typically avoid inheriting potential liabilities, such as product or service liability, contract disputes or employee lawsuits.
For sellers, asset sales tend to generate higher taxes because while intangible assets, such as goodwill, are taxed at capital gains rates, other "hard" assets can be subject to higher ordinary income tax rates. If you're a C corporation, you likely face double taxation. If you're considering selling the firm in a few years, consider switching to either an S corporation or LLC, but be aware that there are look-back periods for the conversion.
In a stock deal, instead of choosing specific assets and liabilities to acquire, the buyer purchases an ownership stake in the entire business. In effect, the buyer acquires the entity instead of acquiring the business from the entity. Assets and liabilities not desired by the buyer will be distributed or paid off prior to the sale.
Stock sales are a mixed bag for the buyer. The cons are clearly the loss of the ability to gain a stepped-up basis in the assets, which can result in higher future taxes. Additionally, buyers may accept more risk by purchasing the company's stock.
In spite of the cons, the buyer might find a stock purchase advantageous if the seller has a large number of copyrights or patents or if it has significant government or corporate contracts that are difficult to assign or that require consent by the holder of the contract.
From a seller perspective, the stock sale tends to favor the seller because the proceeds are taxed at a lower capital gains rate, and in C corporations the corporate-level taxes are bypassed. Also, sellers tend to mitigate their risk against future liabilities, such as product liability claims, contract claims, employee lawsuits, pensions and benefit plans.
Deciding on the best deal structure for an M&A transaction requires careful evaluation. The optimal structure for your professional services firm should be made as early as possible, as the decision will impact virtually all the transaction documents.
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Reed Warren is vice president of Revenue Rocket, an IT services growth consultancy and M&A adviser. You can reach him at firstname.lastname@example.org.