Selling Your C Corp - Negotiate Hard for a Stock Sale Versus an Asset Sale

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Selling Your C Corp - Negotiate Hard for a Stock Sale Versus an Asset Sale

If you are the owner of a C Corp and are planning on selling your company, you must understand the ramifications of the stock sale versus the asset sale. Here is what happens when there is an asset sale of a C Corp. The assets that are sold are compared to their depreciated basis and the difference is treated as ordinary income to the C Corp. Any good will is a 100% gain and again is treated as ordinary income. This new found income drives up your corporate tax rate, often to the maximum rate of around 34%.

You are not done yet. The corporation pays this tax bill and then there is a distribution of the remaining funds to the shareholders. They are taxed a second time at their long term capital gains rate. This is often called the double taxation issue of a C Corp asset sale.

Compare this to a C Corp stock sale. The stock is sold and there is no tax to the corporation. The distribution is made to the shareholders and they pay only their long term capital gain on the change in value over their basis in the stock. The difference can be hundreds of thousands of dollars.

Most buyers have it drilled into their heads by their attorneys that they should not agree to a stock sale because the buyer will inherit all of the assets and all of the liabilities of the corporation, even the scary hidden liabilities. A second reason buyers want to do an asset acquisition is that they get to take a step up in basis of all the assets and can depreciate them at a higher amount than inheriting those assets under their current depreciation schedule.

Early in the process with the seller, communicate to them your desire for a stock sale because of the punishing double taxation you will face with an asset sale. You could give him two purchase prices, one for a stock sale and a much higher one (30% higher) for an asset sale. If you try to introduce this concept late in the process, you will find it very difficult to recover.

What can you do to convince the buyer to agree to a stock sale? If you are in an environmentally sensitive business or one with potential product liability issues, you may have a tougher time. One thought would be to agree to stringent reps and warranties and maintaining 10-15% of the transaction value in an interest bearing escrow fund pending any unforeseen issues. This delayed payment is a far superior result than immediately losing 34% of transaction value with an asset sale.

If you have a sale that is heavily weighted in good will and intellectual property as opposed to depreciable assets, step up in basis is less of an issue because the amortization schedules for good will in an asset sale are essentially the same as in a stock sale. If there are a lot of hard assets, the step up in basis is real tax savings for the buyer using an asset sale. You may counter with an offer that says you will lower your price by an amount that more than offsets his loss of step up in basis if he agrees to a stock sale.

Another approach you could use is to move a little more of the transaction value into an earn out, deferred payment, and or some seller financing. Your argument is that you will agree to stringent reps and warranties and the deferred payment component acts as a quasi escrow account. If something goes wrong for them, they still have a portion of your money.

The key here is to understand the net after tax effects of the C Corp asset sale and Stock Sale. Set your transaction value target based on the after tax proceeds you will recognize. Give the buyer one price for a stock sale and a 34% higher price for the asset sale and use this as a negotiation point. Introduce this concept to your buyer very early in the process and avoid trying to bring this issue up late in the process.

About the Author

Dave Kauppi is the editor of The Exit Strategist Newsletter, a Merger and Acquisition Advisor and President of MidMarket Capital, representing owners in the sale of privately held businesses. We provide Wall Street style investment banking services to lower mid market companies at a size appropriate fee structure.

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