Negotiating a stock sale of your business

When a company is sold, a buyer usually wants to buy the company's assets rather than the stock. The seller wants to sell stock, if possible.

The most common advice given to buyers of closely held businesses is that purchasing a company's assets is better than buying its stock. Two main reasons:

1. When you purchase a company's stock, you get all of its attributes, including its liabilities. Although the company's financial statements disclose known liabilities, it's the unknown liabilities that may cause concern. Assurances and indemnification from the seller can be unsatisfactory recourse if the unknown liability is great.

2. A buyer of stock is not able to deduct, depreciate or amortize any portion of the purchase price unless some portion is allocated to contracts with the selling owners, such as non compete covenants. When assets are purchased, most of the purchase price will be written off within 15 years. This creates a tax benefit that will not be realized for quite some time for the purchaser of stock.

Since the repeal of the General Utilities Doctrine in 1986, the sale of assets of a C corporation has significant potential of a double tax to the seller. When the assets are purchased, the C corporation seller has gain on the sale of the assets, which is taxed to the corporation.

When the shareholders of the selling corporation take the money out, either by liquidating the company or as a dividend, the shareholders are taxed again on the same proceeds. This extra tax can cause the proceeds of the sale of the business's assets to be taxed at a 50 percent tax rate or more.

Generally, S corporations, partnerships and limited liability companies (LLC) don't face a double tax as C corporations do. These factors generally drive negotiations in structuring a sale and purchase of a closely-held business. It is also the reason why many companies in the United States start out or become S corporations or LLCs.

Buyer's perspective

Recently, the number of deals where stock was purchased instead of assets has increased. This is partly because many of the buyers are large businesses buying smaller entities, and it doesn't affect them whether the purchase is of stock or assets.

When the buyer is an individual or another closely-held concern without deep pockets, the above considerations will usually be compelling enough to convince the buyer to buy assets. Even when the buyer is not concerned about the purchase price, the buyer is less likely to buy stock than assets.

In fact, the Tax Court recently acknowledged that the value of stock of a C corporation was reduced by the potential for double tax to the buyer when the assets in the corporation will ultimately be sold. The court reasoned that a willing buyer would pay less for the stock than the assets because of double tax and liability issues.

Seller's perspective

To avoid double tax, owners of C corporations have been known to go to great lengths to sell stock. To avoid the liability issues and inheriting the double tax problem, buyers have been known to go to great lengths to buy assets. Sellers need to know how to bridge the gap without giving up too much in the way of sales price. Sellers need to educate buyers that other issues favor a stock purchase.

The equalizer in some transactions is state and local taxes. Most states have sales and property taxes in some form. These taxes have a large impact on the sale of assets. They usually are not applicable to stock sales.

If a buyer wants the assets of a company, the purchase of those assets often causes taxes on transfer based on the value of the assets. Where the buyer is buying vehicles that are used in the business, not held for resale, there is often a sales or use tax that applies to the purchase. While the question of who will pay the tax is negotiable, the fact is someone will pay it and the transaction will be more costly.

Some states have a property tax on the value of inventories or furniture and fixtures owned by a company. In most cases, these property taxes are based on the cost of the assets. In a stock purchase, the cost of the property is never stepped up. Therefore, the property tax is paid on the depreciated cost or the original cost of the assets.

In an asset purchase, the amount allocated to the fixed assets typically exceeds the book value of the assets and the property tax goes up immediately. The property tax cost increase is often more than enough to offset any benefit derived from allocating purchase price to assets that can be quickly written off.

More than a few buyers have been stunned to find out that the asset purchase that they engineered with the help of their advisers has a high cost in the form of state and local taxes. Sellers know the tax laws in their state and can educate the buyer in such a way that the purchase of stock can become quite attractive. If successful, the seller can get full or near full value for the sale of stock and no double tax on the sale.

If you are planing to sell your family business we can help you structure a transaction that gives you and the buyer the best deal for the money.

Melvin J. Van de Ven, CPA, CVA is a partner in the certified public accounting firm of Schott & Van de Ven in Cape Girardeau. (email at mvandeven@schottvandeven.com)