Did you ever consider that the structure of your deal could mean the difference between it successfully closing or going stale? As we mentioned in the first article of this series, EBITDA Considerations and Its Impact on Deal Value, there are a number of factors that can influence your deal. In this article, we will discuss another significant deal influencer: the structure of your deal.
Overview of Basic Deal Structures
There are two main deal structures that we will explore: Stock vs. Asset. A stock deal is the purchase of the entire entity—all of the shares of stock, assets, liabilities and operations of the business are transferred from the seller to the buyer. An asset deal is the purchase of only the assets and liabilities that are specifically identified in the agreement. The seller retains ownership of the stock and any business assets or liabilities that are not identified in the agreement. Regardless of which type of deal structure one is considering, both the buyer and the seller should consult a tax advisor to evaluate the tax implications before agreeing to the terms of the deal.
So which type of deal structure should you pursue? While there are a multitude of variables that go into deciding which structure is more advantageous for your specific deal, here are a few factors that should always be considered.
From The Sellers Perspective:
The following are some considerations for a seller in an asset deal:
- Potential post-deal liabilities. It’s important to remember that in an asset structure the company is still a viable entity post-deal and any liabilities not included in the transaction remain the responsibility of the seller. For example, if the company failed to properly file sales tax returns in certain jurisdictions the seller could potentially be on the hook post-deal.
- Double taxation. From the seller’s perspective, an asset deal will be subject to double taxation—first at corporate rates and then again at income tax rates for dividends. Therefore, sellers may want to consider raising the sales price to minimize the effect of the increased tax.
The following are some considerations for a seller in a stock deal:
- Capital gains tax treatment. Since the seller is selling the stock of the company, the seller will be able to take advantage of capital gains tax treatment in the deal.
- Greater deal complexity. At the close of the deal, all of the liabilities of the company are transferred to the buyer, essentially wiping the slate clean for the seller. However, because all of the liabilities are being assumed, the terms of the purchase and sale agreement may become more complex. As a result, sellers should be prepared for a lengthy due diligence process brought on by the buyer.
From The Buyers Perspective:
Buyers typically tend to lean toward making asset acquisitions for two main reasons:
- Clearly defined assets and liabilities. In an asset deal, the buyer is able to focus solely on the assets that will be acquired and liabilities that will be assumed. Due diligence activities in this case will mainly focus on acquired assets and completeness of assumed liabilities as well as quality of earnings.
- Tax advantages. If the buyers purchase price is in excess of the fair value of the net tangible assets acquired then the resulting goodwill will be deductible for tax purposes.
In a stock purchase the buyer’s main consideration is typically the potential for unrecorded liabilities such as unpaid income or sales tax. Due to these possibilities, there are a few things that a buyer should keep in mind when considering a stock offer:
- Extending due diligence procedures. Although due diligence is a major factor in any deal, extra emphasis should be placed on the target company for any potential unrecorded liabilities.
- Give extra attention to the Purchase and Sale Terms. Extra legal attention should be paid to the terms contained in the purchase and sale agreement, specifically the representations and warranties, as they should clearly define the liabilities identified by the sellers.
- Consider a 338(h)(10) election. A buyer can make a 338(h)(10) election to treat a stock deal as an asset deal for tax purposes which allows for potential beneficial tax treatment. However, there may be additional tax considerations to this election which should be evaluated by a tax professional.
What Else Can Influence Your Deal Value?
As we have discussed in this and our previous Deal Influencers article, there are numerous items that can impact the value and ultimate sale price of a company. In the final article for this series, we will examine other considerations that we routinely see having an effect on deal value such as working capital adjustments and earn-outs.
If you would like to further explore the ideas we have presented, please do not hesitate to contact us.