Taking the Acquisition Route

Road sign with 2 arrows pointing in different directions

An acquisition of a target company's stock or assets can help your business expand its operations while maintaining control of the company.

With taxable direct purchases, the buyer simply pays cash or issues debt (or a combination) in exchange for the target corporation's stock or assets. This compares to a merger where the buyer generally issues stock to the target company's shareholders, which means they wind up owning part of the merged company.

Here are some key factors to keep in mind when evaluating a taxable asset or stock purchase:

ASSET Purchases

In most cases, this transaction would be in the buyer's best interest because it will provide the corporation with several benefits, including:

  • A taxable asset purchase allows the buyer to "step up," or increase, the tax basis of the acquired assets to reflect the purchase price. This gives the buyer bigger post-purchase tax write-offs for depreciation, amortization, cost of goods sold and so forth. (Get a professional appraisal to establish the values of the purchased assets for tax basis purposes.)
  • The buyer can avoid any liabilities associated with the target business, unless the company expressly agrees to assume some, such as existing real estate mortgages with favorable terms.
  • The buyer can potentially structure the deal as an installment payment arrangement thus stretching out the purchase price over a number of years, and,
  • The buyer can avoid taking on additional shareholders. The existing ownership base of the corporation can continue without adding any new owners from the target corporation.

The buyer may have to engage in some give-and-take with the seller regarding valuation amounts. There are obviously two perspectives in these types of negotiations:

1. The buyer's side. A corporation probably wants to allocate more of the total purchase price to short-lived assets such as inventories, receivables, and other assets that can be depreciated or amortized relatively quickly under the income tax rules.

2. The seller's side. The target, depending on its tax situation, might want to allocate more of the purchase price to lower-taxed capital gain assets such as intangibles, buildings and land.

STOCK Purchases

While a taxable asset purchase is probably in the buyer's best interests, the seller may prefer a taxable stock sale for both tax and non-tax reasons.

The seller's profit will generally be treated as a long-term capital gain taxed at a maximum federal rate of 15 percent, provided the selling shareholders are individuals.

Because the target corporation continues to own its assets, no tax is triggered at the corporate level. A taxable asset sale, on the other hand, may trigger double taxation — once at the target corporate level and again at the shareholder's level when sales proceeds are paid out to them.

There are also positive aspects for the buyer:

  • It may be much easier legally to simply buy the target corporation's stock rather than having to transfer title to a large number of purchased assets.
  • A stock purchase may allow a buyer to gain control over valuable non-transferable assets owned by the target corporation, such as leases and licenses, that could not be acquired with an asset purchase.

However, there can be drawbacks for the buyer too:

  • The buyer will generally become responsible for the target's liabilities, whether known or unknown.
  • A stock purchase will generally not allow a buyer to step up the tax basis of the target corporation's appreciated assets (unless the transaction qualifies for a special election under Section 338 of the Internal Revenue Code).

If your corporation is considering purchasing stock or assets of a target company, carefully evaluate the tax and non-tax factors. Before completing a transaction, get professional tax and valuation advice. For a stock purchase, a due diligence study is recommended to avoid being harmed by unanticipated target corporation liabilities.

A Side-by-Side Comparison

Merger: May be tax-free | Acquisition: Taxable consequences

Merger: Dilution of ownership by adding more stockholders. | Acquisition: Taxable consequences.

Merger: No cash exchange. | Acquisition: Requires cash, debt, or both.

Merger: Can be slow and cumbersome. | Acquisition: Generally can be completed quickly. (Although asset purchases can be slower and more complicated than stock purchases.)

Points to Remember

These factors dictate an asset purchase:

The buyer wants a stepped-up tax basis for appreciated assets the target owns.

The buyer wants to avoid becoming responsible for the target's liabilities.

The seller can accept the income tax consequences, including possible double taxation at both the corporate and shareholder levels.

These factors dictate a stock purchase

The buyer is not concerned about getting a stepped-up tax basis for assets owned by the target corporation.

The seller insists on a stock sale to avoid double taxation or other adverse tax consequences.

The buyer doesn't want the expense and hassle of transferring legal ownership of the target's assets.

The target owns valuable non-transferable assets that the buyer couldn't acquire in an asset purchase.

The buyer can accept responsibility for the target's liabilities.

The buyer doesn't want to take on additional shareholders from the target business.

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