Primary tax and legal considerations in stock purchases vs asset purchases

December 28, 2018

by an investor from Western Washington University in Key West, FL 33040, USA

I'm currently negotiating the form and structure of an LOI with a seller. The business' customers generally sign contracts and pay large (typically 50%) deposits 6-12 months in advance of services rendered. This is due to the business' very seasonal nature with the key operating season only lasting 3-4 months every year. This revenue visibility helps offset the risks of having a short operating season and provides the business with a significant amount of negative working capital. I'm currently looking at buying the business in the off/pre-season.

The business already is nearly fully contracted/booked for the upcoming season and has a very significant amount of deposits received as a result. The business owner has also prepaid a number of expenses (such as workers' comp insurance) and purchased a number of supplies for the upcoming season that he would like to be reimbursed for. I realize that deposits paid, prepaid expenses, and supplies can all be accounted for in the working capital peg. However, my concern is that these customer contracts and prepaid expenses for items like workers' comp are none transferable and thus the acquisition may need to be structured as a stock purchase instead of an asset purchase? The business also has no real liabilities and seemingly very low risk of any unknown/undisclosed liabilities popping up that couldn't be address with representations/warranties/indemnifications that could be offset against a large proposed seller note?

(1) Are there any searchers or advisors who have experience with a stock purchase instead of an asset purchase? What are the main legal and tax (both short-term and long-term) implications to be aware of? How do these factors typically impact valuation?

(2) Do any legal and/or insurance experts have any guidance on the transferability of customer contracts/pre-bookings and prepaid expenses such as workers' comp? Thanks in advance!

Reply by a professional
from University of San Francisco in San Francisco, CA, USA

There's usually quite a few different things to consider. Initially, the accountants should make a determination of what structure is best for you, which, often for a buyer is an asset acquisition for tax purposes since you get a stepped up basis in the assets acquired. The asset acquisition could be disadvantageous to the seller, however, since it could lead to 2 levels of taxation, one at the seller entity level and one at the shareholder level. An accountant can accurately advise based on a detailed look at your situation and possible elections and structuring solutions. Then there are the legal considerations. In a stock sale, all of the assets of the business transfer, including customer contracts, but there could be a change of control clause in the customer contracts that could still trigger consent even in a stock sale. In an asset sale, the assignment of the customer contracts may require consent depending on the assignment clause. As you point, out only acquired assets transfer in an asset sale, whereas all liabilities transfer in a stock sale. Hope this is helpful as a starting point, please send me a message if you would like to discuss further.

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

Hi Ben, I did a 338(g) election with a stock acquisition in order to treat it as an asset purchase from a tax perspective. The difference between a 338(g) and 338(h)(10) comes down to the corporate structure of the target.

One of the big reasons we did it was to preserve the existing contracts of the target: in our case the company had ~300 active contracts at the time of sale and all of them would have required consent to transfer to a new company (i.e. NewCo) if we structured the deal as an asset sale.

The other thing to consider is that the seller might be able to take advantage of the Sec###-###-#### Small Business Stock Capital Gains Exclusion in a stock deal. In our case, we were able to negotiate the 338(g) with the seller because he was having all of his capital gains wiped out at the shareholder level.

Given that your close getting an LOI in place it might be worth engaging with an accounting firm to do post-LOI quality of earning work... they might throw in the structuring advice for free.

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