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Business Sellers - Beware of the C Corp Asset Sale

Aug 17, 2007
We recently completed a Merger and Acquisition engagement to sell our client to a large publicly traded company. Our client had started her company 25 years ago and had set it up a C Corp. She never was advised to change that structure in preparation for a much better tax treatment on the sale of the business.

The buyer had an acquisition policy of only asset sales and no stock sales. The tax implications to our client were punishing. In a C Corp Asset Sale, there is no such thing as a long-term capital gain for the corporation. Since our client's basis (a software and consulting firm) was essentially $0, the entire sale amount would have been treated as ordinary income and would have been taxed at a rate of about 30%. Once taxes are paid by the corporation and a distribution is made to the stockholders, the stockholders are then taxed at the 15% individual long-term capital gains rate.

Let's say that the purchase price was $5 million. With an asset sale, the Corporation would first pay 30% of $5 million, or $1.5 million. On the distribution, the shareholders would pay 15% of the $3.5 million distribution or $425,000. The total tax paid is a whopping $1,925,000. Net proceeds to the seller are $3,075,000. A stock sale, on the other hand is far superior for this C Corp. A stock sale is not taxed at the corporate level, so the gain of $5 million is taxed only once at the shareholders' long term capital gain tax rate of 15%, for a total tax of $750,000. Net proceeds to the seller are $4,250,000, an improvement of $1,175,000.

We simply had to turn this into a stock sale. Our approach was to use this issue as a negotiating point to bridge the valuation gap. The seller wanted more and the buyer wanted to pay less. We had pushed the value as far as could with the buyer, but our client still wanted more. We suggested to the buyer that if they were willing to do a stock sale we may be able to get our client to accept their current offer.

We argued that since this was a technology and services firm, the risk of any environmental or product liability was minimal. We proposed that they cover any perceived risks with stringent Reps and Warranties language in the purchase agreement. Finally, because a significant portion of the transaction value was an earn out, they had a built in escrow account. It worked! Our client was able to realize an additional $1,175,000 through a stock sale and we were able to bridge the valuation gap between buyer and seller.
About the Author
href="http://www.midmarkcap.com/" target="_blank">Dave Kauppi is 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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