Note: The “Tale of Two Deals” series explores different aspects of two deals that we closed recently in the same week.
There are two basic types of acquisition structures: the asset sale and the stock sale. With the two deals I completed recently, one was an asset sale where specific operating assets were sold to the buyer and other was a stock sale where the stock of the corporation (and therefore the entire company) was sold to the buyer. This blog entry describes the stock sale.
A stock sale is what many naturally believe happens in an acquisition. Similar to buying a house and obtaining a deed that proves ownership, a business buyer buys the stock that proves ownership. The buyer pays the seller, and the seller gives the buyer the keys to the company – the actual shares of stock. The corporation continues, now under a different owner. It is not that simple since there are exceptions to the “everything goes” concept of a stock sale and there are invariably some changes that will occur on the change in ownership.
Why Structure as a Stock
However, as I wrote about last time (The Asset Sale), most buyers prefer an asset sale, both to avoid being stuck with undisclosed liabilities, and for tax and cash flow reasons. So most of the time our acquisitions are structured as asset sales, but there are a few reasons why a stock sale is used, the two most common being:
- There are too many customer contracts or there are a few large customer contracts that you don’t want to mess with. With a stock sale, the contracts continue with no change (unless the contracts contain a specific “change of ownership” clause). With an asset sale, the contracts need to be changed or assigned to the new company that purchased the operating assets and often (e.g. large government contracts) it can be difficult to get them assigned in a reasonable amount of time.
- If the company being acquired is a C-Corporation, then a stock sale can avoid the double taxation issue of an asset sale. With a C-Corporation acquisition structured as asset sale, the proceeds from the sale of the assets flow into the C-Corp. Corporate taxes are paid, but the net proceeds are still stuck in the C-Corp. To get them out, the owners have to take wages or dividends, and thus paying taxes again. It is a painful way to sell a business.
Our Recent Stock
In the recent deal we structured the transaction as a stock sale because our client was (still is) a C-Corporation. By the way, not all C-Corps can be sold as a stock sale. If there is a history of lawsuits, if the owners played fast and loose with the finances, or if there is an inherent problem with potential liability (e.g. the company installs asbestos floors), then many buyers will just plain refuse to execute a stock sale.
Note to owners of C-Corporations: I try not to audibly groan when a new client tells us they are a C-Corporation. Unless you have a large number of shareholders there are very few reasons to still be a C-Corporation. Visit your attorney and elect to be an S-Corporation. It takes 10 years to become 100% free from the pain of double taxation, but every little bit helps.
Our client ran a clean company, but it still took some negotiations to get the stock sale agreed to. I had dealt with this buyer on a previous acquisition, an asset sale, and right from the start I told him this needed to be a stock sale. His reply was, “Ney, you know us, and you know we do only asset deals”. The key was that another strategic buyer also was extremely interested in our client, and within a week both of these buyers had agreed to a stock sale (after consulting their legal counsel).
This intense competition also kept the price up. It isn’t uncommon for the price to go down during negotiations for a stock sale, because the buyer is sacrificing cash flow (they lose depreciation on the stepped up value of the assets) and their return-on-investment projections go down.
Getting to the Close
There is always some challenge to close. In this case our client had been notified that they had been awarded a government contract, and that they should expect deliver of the actual contract at any time. The moment the stock deal was signed it was possible that our client would no longer meet the terms and conditions specified in the contract, so he preferred waiting and signing the contract before close. Similar to our deal in The Asset deal (but for different reasons), we were stuck waiting on a contract.
We finally closed the deal after a few weeks of waiting. By chance the other deal had also been waiting on a contract, and we resolved that issue at the same time. It looked like both would close on the same day which would have been interesting. As it was both deals closed on consecutive days, which was still a lot fun.