Family Business

Tax Planning Can Make, or Break, a Sale Transaction

By Christian Schiller and Bryan Jaffe September 7, 2011

When an owner sells their business the transaction generally take one of two forms:

a) A stock transaction, wherein the buyer purchases the capital stock of the business inclusive of any liabilities (contingent or otherwise, current, future or historical); or
b) An asset sale, wherein the buyer purchases the assets of the business and leaves behind the liabilities.

The form a transaction takes has meaningful implications on the taxes paid by the selling stakeholder at close and upon the buyers in future periods. Unfortunately, this is often a zero sum game — what is good for the buyer is often adverse for the seller, and vice versa. This will be a substantive part of the negotiation, wherein sellers will seek more consideration from buyers in exchange for agreeing to tax structures that put them at a disadvantage.

From a tax perspective, sellers tend to favor stock transactions, where, in most cases, any taxable income is subject to capital gains treatment, as long as the stock was held for at least 12 months. Buyers, especially when capital intensive businesses are involved, prefer asset transactions because they can step up the basis of any assets acquired to fair market value, providing them a shield from future taxes due to increased depreciation. Further, while the likelihood that the buyer inherits unknown obligations of the seller is virtually eliminated in an asset sale,, asset transactions can result in double taxation for sellers, depending on the legal entity structure of the company, wherein the corporation is taxed on the gain on sale, and then shareholder proceeds are taxed as income.

While the above tension has been historically well documented, we have increasingly seen tax considerations placing undue tension on deal dynamics after the recession of 2008 – 2009. During this period many business sought to minimize their own cash taxes, in order to preserve cash flow, by making discretionary accounting choices. As example, a number of companies with whom we have relationships took accelerated depreciation expenses during this period to shield income from taxes; however, at the time of sale, this depreciation is subject to “recapture”, which is made at the ordinary income tax rate for equipment. This realization often leads to some difficult discussions with sellers, who are often managing their expectations to a bottom line number.

Given these realities, we believe that investing time, and money into tax analysis prior to making a decision as to whether to sell your business is prudent. A small up-front investment of time and potentially advice of a third party accounting firm can pay significant dividends later in sale process.

To this end, it is our advice that sellers and their agents market the business for sale under a specific transaction structure that has been vetted with the key selling shareholders and is known to be both viable and efficient based on their input and feedback. While this limits downstream surprises for key stakeholders, it also has the benefit of ensuring that any bids received are readily comparable from a tax perspective. This allows sellers to avoid the prospects of a difficult renegotiation, or even an abandonment of the process, once the tax implications of a buyers offer are revealed post business diligence, which can be especially problematic in a sale to a strategic buyer.

While as a general rule we counsel sellers to limit their time and capital commitment to a sale process prior to determining that an efficient market is open to them, this is one instance where an ounce of prevention is worth a pound of cure.

Bryan Jaffe and Christian Schiller are managing directors at Cascadia Capital, a Seattle-based boutique investment bank serving companies in diverse industries, including information technology, sustainability and middle market.

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