The purchase or sale of a business is a major decision for both buyers and sellers. Such a transaction can be accomplished through the purchase of the company stock (if a corporation) or the membership interests (if a limited liability company). Alternatively, the buyer may purchase substantially all the assets of the company without purchasing the stock or membership interests. Normally, the buyer utilizes a new entity for the asset purchase transaction. A hybrid approach is a merger transaction (particularly with corporations involved), which will not be further addressed in this blog.
So, what are some considerations relevant to determining whether an equity purchase or assets purchase is best? Generally, equity purchases are often used when purchasing a very large company, a highly regulated company, a company that is heavily reliant on contractual relationships, which would require a contract assignment or when the seller of the business is insistent on obtaining capital gains treatment on the sale. Asset deals are common where the buyer wants a stepped-up cost basis in assets acquired and/or is fearful that there could be undisclosed liabilities with the company being acquired, which presents an unacceptable risk in the buyer’s mind. The following are some further considerations and comments in determining how to structure:
EQUITY INTEREST (STOCK OR MEMBERSHIP INTEREST) PURCHASE:
- There is no need to determine purchase price allocation among assets.
- The selling shareholders will pay capital gains tax recognized from the sale of their stock, thereby avoiding the prospect of double taxation if a C-corporation is involved.
- The buyer gets a stepped-up tax or cost basis for the stock or membership interest acquired, but the seller’s basis for the assets of the company carries over to the buyer.
- With a company that has numerous or substantial-value contracts, an equity transaction should eliminate the need for obtaining contract assignments, which could be difficult to obtain.
- Limited liability companies can elect to be treated either as C- or S-corporations rather than as partnerships for tax purposes.
- Each class of assets acquired is assigned a negotiated portion of the purchase price, resulting in many cases with a stepped-up cost basis in each asset for the buyer.
- Asset sale by a C-corporation followed by a liquidation of seller corporation could result in double taxation or two layers of taxes to the seller and seller shareholders.
- Because the seller could have a higher tax burden for ordinary income assets sold and the buyer may realize a tax benefit by acquiring amortizable assets, the seller should carefully consider the potential income tax consequences before doing a letter of intent or otherwise committing to the purchase price as once a price is on the table and somewhat agreed to, it is very difficult for the seller to try to raise the purchase price at that juncture.
At the end of the day, there are many factors that need to be taken into account in deciding which approach is best for the buyer and which is best for the seller in any particular transaction.
Patrick J. Van Zanen
Disclaimer: This blog is for information purposes only. Legal advice is provided only through a formal, written attorney/client agreement.