So, you’ve crossed the mental Rubicon and identified a business to buy. Or decided to sell. Or both, perhaps. Congratulations!
As the process shifts from preliminary framework to written proposal or letter of intent, one wrinkle to iron out revolves around the legal transaction structure: Asset Sale or Stock Sale?
As part of an Asset Sale, the certain assets desired – e.g., inventory, fixed assets, and intangible assets/goodwill – are transferred, but interest-bearing liabilities are typically not. The seller may retain certain assets; will likely retain the interest-bearing liabilities, unless negotiated otherwise; and will retain the corporate or legal ‘existence’ of the business.
As part of a Stock Sale, all assets and liabilities (including any unknown liabilities) are typically transferred, and the corporate or legal ‘existence’ of the business changes hands.
- Of note here is the potential for a Stock Sale to be treated as an Asset Sale for U.S. federal tax purposes. An example of one such circumstance is a transaction carried out under Internal Revenue Code (IRC) Section 338(h)(10) – often referred to as “making a Section 338(h)(10) election.”
From a tax and business valuation perspective, it’s important to not lose sight of a key distinction:
- Under an Asset Sale, a buyer is able to ‘step up’ the tax basis of the assets acquired to reflect their costs as of the closing date. As a result, the associated future depreciation and amortization expense is typically higher than if based upon the assets’ historical costs, which will usually translate to a lower future tax liability.
- Under a Stock Sale, no ‘step up’ occurs, and the buyer effectively acquires the depreciation and amortization schedules that are in place as of the closing date. As a result, the buyer can deduct – for the calculation of taxes – only the depreciation and amortization expense associated with the assets acquired that is remaining as of the closing date. In addition, under this scenario, the buyer will inherit any historical net operating losses (NOLs) generated with the potential to use them to offset future operating income (and realize tax benefits), subject to limitations imposed by IRC Section 382.
Your CFGI team, consisting of valuation and M&A tax professionals, will work closely with you to identify the optimal transaction structure for your circumstances and to keep your pre-close planning on track.
