Whether you are buying or selling your business, we can help you structure, negotiate and fully document your transaction. We are experienced in assisting our clients in successfully negotiating and closing their mergers and acquisition transactions.
If you are thinking about buying or selling a business, you should consider talking to an experienced business attorney before you sign a letter of intent or start negotiating the transaction price or structure. Complex corporate, tax, employment, and employee benefit laws can affect the price, structure, documentation, and closing date of an M&A transaction. Whether the deal is a stock sale, a merger transaction or a purchase and assumption transaction, there will be legal issues that will crop up that have not been considered by the parties during their initial acquisition discussions. Consequently, it is not unusual for business executives to come to a verbal agreement on a deal, and then have to significantly renegotiate it after consulting with their attorneys.
Here are four important issues that should be discussed with your attorney at the beginning of the acquisition process:
Issue 1: Letter of Intent. The buyer and seller should consider negotiating and signing a non-binding letter of intent before going through the time and expense of completing the buyer’s due diligence and negotiating the detailed provisions of a definitive purchase agreement. The purpose of this non-binding document is to set the expectations of the parties with respect to purchase price, transaction structure, timetable for completion of buyer’s due diligence, and timetable for negotiation of a definitive agreement. The buyer may also wish to add a binding “no-shop” exclusivity provision to the letter of intent, to stop the seller from negotiating with other parties for a set period of time after the signing of the letter of intent.
The specific wording of the contract language on purchase price, transaction structure and post-closing indemnification provisions can sometimes be subject to extensive negotiation. If you are concerned as to whether there is truly a meeting of the minds on these points, you should consider having the letter of intent include the precise wording of these provisions that you would like to see in the definitive agreement.
Issue 2: Due Diligence. The buyer should conduct a thorough due diligence of both the proposed purchased assets and assumed liabilities of the business. The due diligence should include a careful review of all of the assumed liabilities, including the customer contracts, vendor contracts, and lease agreements. In a purchase and assumption transaction, an important issue is whether customer or vendor consent will be needed in order to assign vendor contracts to the buyer. If commercial real estate is being purchased, in addition to a building inspection, the buyer should consider doing at least a Phase I environmental site assessment. The buyer should also review the records of the seller’s employees the buyer intends to continue to employ after the consummation of the acquisition. If the transaction is a merger or stock purchase transaction, the buyer should have an attorney review all of seller’s ERISA plan documents, along with a copy of the IRS Form 5500 (Annual Return/Report of Employee Benefit Plan). The buyer should also confirm as to whether any lawsuits or government investigations are pending against the seller.
Issue 3: Employee Issues. The resolution of certain relevant employee issues, such as employment agreements, non-competition agreements, and the termination or assumption of seller’s employee benefit plans, should be specifically included as part of the definitive purchase agreement. Employment and non-competition agreements with key individuals can either be signed on the closing date or at the time of the signing of the definitive agreement (with the employment agreements being contingent upon the closing occurring).
Issue 4: Tax Treatment of the Transaction. The financial implications of the tax treatment of the proposed transaction need to be understood. There are two types of tax basis: (i) inside basis and (ii) outside basis. The “inside basis” is the tax basis that a company has in its assets. The “outside basis” is the tax basis that a stockholder has in the shares of a company. The basis to be used in calculating the income tax payable by the seller depends on how the transaction is structured.
For corporate M&A transactions, in a taxable stock acquisition, the buyer acquires stock from the selling corporation’s stockholders, who are taxed on the difference between the purchase price and their outside basis in the selling corporation’s stock. In a taxable asset acquisition, the selling corporation is taxed on the excess of the purchase price over its inside basis in the assets sold, and the selling corporation's shareholders are taxed on the distribution of sale proceeds.
For an asset sale, the seller and buyer must allocate the purchase price among the assets acquired by filing a Form 8594 Asset Acquisition Statement with the IRS as part of their federal income tax returns. As the IRS expects the buyer and seller to file consistent allocations, the classes of asset allocation should be a negotiated provision in the definitive agreement. As the buyer usually wants to be able to deduct as much of the purchase price as quickly as possible, the buyer usually prefers to allocate as much as the purchase price as possible to inventory and equipment, rather than goodwill (which usually has to be amortized over 15 years).
The primary differences among the tax structures of taxable asset, stock, and hybrid Section 338 elections are set forth below.
|Structure||Merger/Acquisition||Tax Effects on Seller and Buyer|
|Asset||Asset Purchase or Forward Merger||Seller generally pays capital gains tax on goodwill, and ordinary income tax on “hard assets,” such as buildings and equipment. In addition, if a Subchapter S corporation is sold within five years after making its Subchapter S election, a special entity level “built in gains” tax is imposed. Buyer is able to deduct the purchase price over several years by depreciating the assets with a stepped-up basis. Buyer can also amortize good will over 15 years.|
|Stock||Stock Purchase or Reverse Merger||Seller pays the capital gains tax on the difference between the purchase price and seller’s basis in the stock. Buyer inherits seller’s cost basis and depreciation on tangible assets. Buyer cannot amortize good will.|
|338(h)(10) Joint Election||Stock Purchase or Reverse Merger||The Section 338(h)(10) election is a joint election of the buyer and seller that is frequently used for the stock sale of an S corporation. Seller pays the capital gains tax on the difference between the purchase price and seller’s basis in the stock. Buyer is able to deduct the purchase price over several years by depreciating the tangible assets with a stepped-up basis. Buyer can also amortize good will over 15 years.|
|338(g) Buyer Election||Stock Purchase or Reverse Merger||The Section 338(g) election is a unilateral election (for a deemed asset sale) made by a buyer after consummation of the stock purchase of a C corporation. In making the election, the buyer steps up the basis in the assets and is taxed on the gain in basis. This election is usually only done for domestic corporations in the rare event that the selling corporation has substantial net operating loss or tax credit carryovers that the buyer can use to offset any taxable gain triggered by the deemed asset sale. Seller pays the capital gains tax on the difference between the purchase price and seller’s basis in the stock. Buyer pays a tax that is based upon the recognition of gain on a deemed post-acquisition sale of assets. Buyer is able to deduct the purchase price over several years by depreciating the tangible assets with a stepped-up basis. Buyer can also amortize good will over 15 years.|
If a portion of the purchase price being paid to the seller’s stockholders is the stock of the buyer, then it may be possible to structure the transaction so that the seller’s stockholders are not taxed on the shares of buyer’s stock at the time they receive them. Instead, in a “tax free reorganization,” the seller’s stockholders will defer payment of any taxes on the shares of buyer’s stock until the date in which such shares are sold. The seller stockholders would still pay taxes on any cash that they receive in the transaction.
In a tax free “A Reorganization” (such as a forward merger), at least 40% of the value of the total purchase price must be in the voting or non-voting stock of the buyer. In a tax free “C Reorganization” (such as a purchase and assumption transaction for substantially all of the assets of the seller, followed by the liquidation of the seller), at least 80% of the value of the total purchase price must be in the voting stock of the buyer.
It should be noted that if the buyer does not have publicly traded stock, the stock will need to be conveyed to the seller’s stockholders in accordance with the requirements and restrictions of an applicable private securities offering exemption. This will usually require the preparation of a private placement memorandum and related securities documents.
This website provides general information about legal issues and developments in the law. Such materials are for informational purposes only and may not reflect the most current legal developments. These informational materials are not intended, and must not be taken, as legal advice on any particular set of facts or circumstances. You need to retain an attorney for advice on specific legal issues.