We recently closed the second sizable C-Corp. stock sale this year. They are not easy, but are kind of fun and are certainly a challenge.
Here is the basic deal on a C-Corp. stock sale. For about the same price you can sell the assets (basically equipment and goodwill) or you can sell the entire thing – stock. The entire thing means everything – assets, liabilities, bank accounts, etc. Say you have a C-Corp. and you ask your CPA and attorney what you should do. Your CPA says, “Sell the stock! You’ll have mainly favorable capital gains tax that way. ” Your attorney says, “Sell the stock! You will get rid of the entire thing and it will be less likely to come back and bite you”.
A buyer that may be interested in your C-Corp. business will ask his CPA and attorney. The buyer’s CPA will say, “Buy the assets! You’ll get a step up in basis on the hard assets and get more favorable tax treatment in the short run, when you’ll need it.” The buyers attorney says, “Buy the assets! If you buy the stock, you’ll assume undisclosed and unknown liabilities. Whatever you do, DON’T buy the stock”.
It can be a tough situation to resolve, but often we’ve been able to help stake out a middle ground stock sale that provides the seller tax breaks, but also gives the buyer some tax writeoffs and other benefits.
One strategy we’ve used is Personal Goodwill. Personal Goodwill is purchased directly from the seller by the buyer, not from the corporation, and it can be written off by the buyer (unlike the stock price). It is still favorable capital gains to the seller so the seller is happy.
However the IRS tends to challenge Personal Goodwill cases. Why? Because in most transactions, if the negotiations on price allocation swings toward the buyer, the buyer loses, the seller wins and the IRS wins. If the seller makes a concession, the seller loses, the buyer wins and the IRS wins. So the IRS doesn’t really care about price allocations because they get their money no matter what. The IRS always wins – sounds familiar doesn’t it?
But in the case of Personal Goodwill, the seller wins, the buyer wins and the IRS loses. Because neither buyer or seller has a monetary incentive to minimize Personal Goodwill, the IRS tends to want to see validation. So the key to a Personal Goodwill transaction is to carefully document, use the appropriate agreements, and keep the money flow separate. We have collected some Personal Goodwill court cases that show how it has been upheld in court. Unfortunately it isn’t for everyone since there truly has to be a compelling case for Personal Goodwill.
We have also used earnouts and royalties in order to construct a deal where the seller demands a premium price for future growth. The key to these transactions is keep them as simple as possible.