This is the second article of a three-part series outlining the basic considerations for both business acquirers and sellers when conducting a small business transaction. This article focuses on transaction structuring. If your business is looking to enter into a transaction, Stanton Law offers its services to both the buy side and the sell side of a transaction. Importantly, we offer the experience and resources required to complete a successful transaction.
There are two basic ways a business can be acquired: a stock purchase or an asset purchase. Both the target company and the acquiring company want to maximize tax benefits and avoid assuming additional liability.
Stock Purchase: In a stock purchase, the shareholders sell their interest in the target to an acquirer. The acquirer then assumes ownership of the target’s assets and liabilities. Additionally, things like leases, permits, and contracts are automatically transferred to the acquirer, but so are liabilities, including any unknown and contingent liabilities.
Asset Purchase: In an asset sale, the target remains the legal owner of the entity, and the acquirer purchases individual assets of the company, such as equipment, inventory, net working capital, and customer lists. In this type of transaction, the acquirer has more discretion regarding which assets and liabilities it wants to assume.
Tax Implications of Structuring a Transaction:
Non-Corporations: If the target company is a sole proprietorship, partnership, or LLC, the sale is typically treated as an asset purchase. Alternatively, these entities could sell their membership interests to an acquirer. In the case of an asset purchase, many of the assets will be subject to a lower tax rate, but some assets, such as inventory, will be taxed as ordinary income. In this respect, there is an inherent conflict between the parties: the target will want to allocate much of the purchase price to capital gains assets, while the acquirer will want to allocate the purchase price to depreciable assets. It is important to understand the tax implications of a specific transaction in order to facilitate a fair negotiation. Other things that can usually be negotiated are any outstanding liens as well as any current and future tax debts the company may be liable for as a result of filing tax returns.
Corporations: If the target company is a corporation, the parties can decide between a stock purchase or an asset purchase. The target’s stockholders will generally prefer to structure the transaction as a stock sale rather than a purchase of the company’s assets so the gain on the transaction is taxed only once. Additionally, the gain from a stock sale is usually classified as a capital gain, which is subject to a lower tax rate. In a stock sale, the acquirer will retain the target’s tax attributes such as transferable capital loss. On the other hand, the acquirer will usually prefer to structure the transaction as an asset purchase, because this will ultimately reduce the taxable gains due to the step-up basis taken in the target’s assets. Importantly, the acquirer does not automatically assume the target’s tax attributes. This structure may be less favorable for the target because the transaction may be subject to additional tax on both the sale of assets and the final liquidation of assets not purchased by the acquirer.
Stanton Law has a team of experienced attorneys who provide advice and structure transactions to get the best outcome for their clients. The next article will discuss some of the key consequences of a transaction and the tools that can mitigate these risks.