Mark: One of the main considerations in any sale process is transaction structure. And oftentimes it needs to be agreed upon between the parties because of its impact on tax issues and other issues right from the outset of the term sheet stage. The two main transaction structures are either a stock purchase, in which the buyer is acquiring 100% equity ownership of the target company, or an asset purchase where they're simply buying agreed assets and assuming certain agreed liabilities.
What are the differences between those two structures in terms of the tax implications?
Eric: Sure. For the selling shareholders, generally a stock sale is preferable because they are only taxed once on a sale of that stock. It's generally eligible for capital gain treatment. And in some cases, 100% exclusion from tax as qualified small business stock, or QSBS.
On the other hand, in the case of an asset sale, there is generally two levels of tax. The corporation has to pay tax on its sale of the assets, and then the shareholders pay tax again when those proceeds are distributed up to the shareholders. But there is some misalignment between the buyer and seller in this case because the buyer actually prefers an asset purchase. It gets a basis step up in those assets that can be used to shelter future income.
However, on balance, we find that often these transactions are structured as stock sales because the tax benefits of a stock sale to the seller are more significant than tax detriments to the buyer of that stock sale.
Mark: If the consideration is all cash, those different tax implications are triggered upon the receipt of the cash. But what if you have a deal that is either all stock or part stock? I hear talk about, you know, ensuring that the transaction is structured as a tax-free reorganization. What is that all about?
Eric: Yes, when some or all of the consideration is equity of the buyer, it is critical to ensure that the selling shareholders are taxed not when they receive that buyer equity, but later when they dispose of it. And in order to accomplish that, generally you need to structure it as a tax-free transaction of some sort. There are various different ways to do that depending on the nature of the buyer as well as the transaction structure.
Mark: And so different structures lend themselves to qualifying for that tax deferral based on different mixes of cash and stock. And there's rules, complicated tax rules, the dictate them on all of that.
So, the key takeaway is right from the outset when you're considering a sale process, bringing your tax professionals, get the structure right, and be able to explain the tax implications to all of your constituencies.