How is the purchase of a C-Corp different from an LLC?

October 29, 2018

by a searcher from Harvard University - Harvard Business School in Grand Rapids, MI, USA

Has anyone purchased a C-Corp or have working knowledge of the difference between a C-Corp and an LLC? How is the value of the C-Corp different due to the corporate structure? Has anyone purchased a C-Corp then converted the company to an LLC -- what were the headaches and tax implications?

From my research, the value of a C-Corp is lower because depreciation cannot be reset upon acquisition; therefore available cash to service debt is lower. The seller of the C-Corp also wants a stock sale (not an asset sale) because the proceeds of the purchase are taxed at long-term capital gains. It seems this is a recipe for a painful negotiation... and once acquired, the C-Corp will continue being a less efficient 'double tax' structure.

Any advice would be appreciated.

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Reply by an intermediary
from State University of New York at Stony Brook in Boynton Beach, FL, USA

I am neither a CPA nor an attorney. My opinions on this subject are based upon years of experience acting as an M&A intermediary. Unless there is a license involved that is tied to the seller’s entity and cannot be transferred, I have seen very few other compelling reasons to buy either the stock of a seller’s corporation or interests of a seller’s LLC. The typical practice is for the buyer to set up a new entity that fits the buyer’s needs. Through the terms of an asset purchase agreement, all assets related to the operating business would be transferred into the new entity. Should the parties agree that the seller will retain equity in the business, the buyer will simply provide either shares or membership interests of the new entity to the seller. Leaving behind the seller’s entity prevents any hidden liabilities in that entity from being carried forward. There are always exceptions, such as student loans from private, for-profit schools or retail sales taxes. However, aside from some unique exceptions, hidden or unknown liabilities become a non-issue. Leaving the seller’s shell entity behind also avoids additional due diligence expense to search for any hidden skeletons in that entity.

Now, regarding the tax ramifications (again an intermediary’s opinion), when an asset sale occurs there is a negotiation between buyer and seller as to how the various classes of assets are allocated. Each class of assets has differing tax ramifications. Both buyer and seller each report on IRS form 8594 the allocation of sold assets. During negotiations, the buyer and seller should act in good faith to agree upon an allocation of assets to fairly minimize taxes for both parties. By discussing and agreeing upon this allocation early in the process, it provides more comfort and certainty, especially to the seller. I have seen several deals blow up in the very late stages of the transaction because of a big “surprise” to the seller who suddenly learns about a large post-sale tax bill. So, get that discussion out of the way early on, preferably at the LOI stage. This will save considerable legal fees and a lot of stress.

One final note: the IRS compares the two respective form 8594 filings to ensure they agree. If they do not, one or both sides of the transaction may be hit with an additional tax bills and penalties.

Reply by a searcher
from Harvard University in Minneapolis, MN, USA

I recently purchased a C-Corp. The seller and I originally negotiated an asset sale (as most buyers would want since it allows for the step-up of basis in assets). However, we wound up switching to a stock deal for a couple reasons, one of which was the Section 1202 Small Business Stock Exclusion which would allow the seller to have all of his capital gains wiped out. Because he was receiving this benefit he agreed to a 338(g) election which allowed us to still get the step-up in basis. In the end it worked out well for both parties.

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