Even if you obtain an
indemnification letter from the seller stating that a full disclosure was made
at the time of sale, that is still small comfort a few years later when you are
sued for a defective product or discriminatory hiring practices prior to your
acquisition of the company.
Service businesses, however are often
bought with stock purchases simply because the potential liabilities (defective
products, hazardous materials, etc) are much lower and easier to deal
with. Also, an asset purchase for a service business may make little sense
as there are generally few assets of any value. Service businesses
typically maintain little if any inventory and do not require huge investments
in plant and equipment.
Tax Aspects Of A Stock Purchase
Even with all
of the potential liabilities involved in a stock purchase however, many sellers
are simply going to insist on a stock-only transaction. Why? Because
they can't afford the taxes they may be forced to pay on an asset sale.
If a C corporation sells its assets for substantially more than its basis in
those assets, it will likely subject the stockholders to a substantial amount of
corporation will have to pay taxes on the gains incurred from an asset sale and
then the stockholders may have to pay taxes again on the after-tax liquidation
distribution from the corporation. For this reason, you may find yourself
in the position of wanting to acquire the assets of a business only to have the
sellers insist that you reimburse them for the negative tax impact they will
face from an asset transaction.
Tax Aspects Of An Asset Purchase
Buyers typically insist on asset purchases not only for liability reasons,
but also because when stock is purchased, there is no step-up in basis for the
acquired assets. Let's take a look at an example:
John wants to buy Company X which manufactures widgets. Company X began
in 1950 and has been operating on the same property it acquired in 1950 for
$20,000. John, knowing that the property is now worth substantially more,
pays $4,000,000 for 100% of the Company X stock and then sells the property for
$2,000,000 to raise capital and move the plant to a more modern facility.
John will have to pay taxes on a $1,980,000 gain (assuming that John isn't our
client since we never would have allowed this situation to happen!). If
John had bought the assets of Company X instead of the stock, $2,000,000 of his
$4,000,000 purchase price would have been allocated to the property value at the
time of the purchase and he would have had no taxable gain on the land sale.
If you are on the buying end of a company purchase where the seller insists
on making it a stock transaction, we will need to adjust the value that we place
on the company's stock for the potential taxes you may be forced to pay upon a
sale of assets. Even if John had intended to keep the property in the
above example, he still would have been unable to take depreciation on the 1950
Most likely, the plant was fully depreciated by the company many
years ago. Since John would get no step-up in basis from a stock
acquisition, he would not be able to assign a new value to the plant and
depreciate a portion of his investment.
The important things to remember when buying or selling a company is
"always be flexible" and "everything is negotiable."
If you do have negative tax implications arising from a stock or asset
transaction, it does not necessarily have to be a deal breaker. Taxes are
an important part of any company-level transaction, but they should never be
considered the most important part.
Our office can easily assist you with the tax ramifications of a potential
transaction, but business strategy, personal goals and marketing plans are among
the considerations that are typically much more critical to your