Stock Sale of a C-Corp

A 100% stock sale of a C-corporation is one of the most popular options for divesting a business and also one of the easiest to perform. Shareholders simply sell their stock in the seller entity to the buyer entity. In this scenario, the buyer simply becomes the new owner of the stock in the seller entity. The seller entity is not a party to the transaction itself, and thus recognizes no income when the deal occurs. The only income recognized for tax purposes in a 100% stock deal of this kind is the taxable capital gain event that occurs at the shareholder level. In this case the shareholders will be taxed at a capital gains rate for the excess over their basis held in the seller entity.

There are some downsides in this scenario. The buyer tends to lose the tax benefit of future tax write-offs because there is no basis step-up at the corporate level for the additional value paid by the buyer. From the buyer’s perspective, there is generally a basis loss that is accounted for as goodwill in this type of scenario. Because the buyer is the loser on a tax-basis in this type of scenario, the buyer will generally require a reduction in the price paid for shares in the transaction.

But consideration for how much of a haircut the buyer will require to be amenable in this type of transaction is not as cut and dry as it appears on the surface. There are several factors to consider. First, stock sales and asset sales have write-off periods that differ in length. So, while the 100% stock sale may not allow the buyer to write-off as much, such a deal would generally allow the buyer to front-load tax write-offs more quickly. In other words, tax benefits would come more quickly. This is especially difficult given that tax rates are always changing. I think we can safely assume that tax rates are more likely to increase than decrease. Some disagree, especially when it comes to corporate taxes. In any event, finding the after-tax benefit to the buyer will require using financial modeling to discount the amount owed to the present on both a stock and asset sale basis and then comparing apples to apples. In many cases, the present value of the lost tax benefits for doing an asset sale over a stock can be significant, even given the longer time horizon and discounts. In nearly every scenario, the seller will require the buyer to reduce the asking price by the difference in tax the seller will have to pay.

Many sellers need to be careful in thinking such a deal is bad for the seller and the seller’s shareholders. In many cases, a decrease in the price, but a change to an stock sale over an asset sale can still provide the shareholders with an increase over the asset option, even with the reduction in the closing price. Depending on the shareholders’ stock basis, the new closing price can often reduce the tax burden of the shareholders and bump up their net yield from the deal. In other words, both buyer and seller win.

Another key consideration in calculating the difference between asset vs. stock sale of a C-corp is in the event that the stock is owned by another C-corp and not individual shareholders. When this is the case it is important to note that sellers may not claim a 243 dividend received reduction (thus reducing the previously onerous tax burden). Unfortunately, because the transaction is an independent business purpose and would be used solely for tax avoidance, it is not allowed under the 243 reduction rule. The proceeds from a stock sale, even if the proceeds flow to another C-corp, will be treated as sales proceeds and not a dividend. The event would still trigger at tax at the C-corp level.

There are a myriad of creative techniques when it comes to getting a deal done in this type of scenario, which usually include purchasing only portions of the shareholder’s ownership in the selling entity. As in other merger opportunities, tax is a huge consideration, but often not the only consideration. When doing the deal, deal makers need to learn to see the forest through the tree. In this scenario, the complexities mount, but the core principles of basis and redemption for exchange and transfer remain. We’ll dive into more of this later when we discuss 388 elections in stock transactions.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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