Acquiring A Business         

Whenever one our clients is looking to sell his or her corporation, we often encourage them to seek a stock transaction with the potential buyer if at all possible.  On the other hand, when we have a client considering the purchase of a small business, we almost always advise that they buy only the assets of the company and not the stock.  

Why this seeming paradox?  Two reasons really - taxes and potential liability.  


The Liability Involved In A Stock Purchase

If you acquire the stock of another company, you are acquiring both the assets and the liabilities - including those you may not know about!  While all acquisitions should come with some degree of good faith and due diligence on the part of the buyer and seller, there is always the potential for nasty surprises such as unpaid taxes, environmental hazards, defective products, etc that may appear down the road.

If you acquire the stock of another company, you are acquiring both the assets and the liabilities


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 double-taxation.

The C 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 plant. 

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 decision-making.