It is common knowledge why C-Corporation
stockholders want to sell stock when they are ready to sell their company. In short, they want to avoid the double taxation
that comes from selling C-Corporation assets and then having to distribute the
cash proceeds in the form of a dividend.
It is also common knowledge why most buyers prefer to purchase
assets. By purchasing assets, they avoid
any known or, more importantly, unknown liabilities of the selling corporation
and by purchasing assets, they can write them up to fair market value (FMV) and
depreciate them from the higher base.
Based on my experience, almost all purchasers
prefer to purchase assets and a significant majority will not even consider
purchasing stock. I have had very interested
and qualified purchasers walk away from deals when the seller insists on a
stock sale. C-Corporation stock sellers should
recognize that by insisting on a stock sale they are reducing the number of
potential purchasers and should expect the selling process to take longer, all
things being equal.
The key to selling C-Corporation stock is
to find the right buyer. So, what should
your investment banker look for in a purchaser in order to increase the likelihood of
finding this elusive purchaser, who is willing to buy stock. Whether the buyer is an individual or a
strategic corporate purchaser I believe the most important attribute is a buyer
who has had prior experience with a stock transaction either as a purchaser or,
even better, as a seller. The purchaser
also needs to be willing to take on some additional “controlled” risk to
complete an otherwise desirable transaction.
I say controlled because there are seller representations, warranties,
and indemnifications in the definitive purchase agreement that can help control
the liability exposure for the purchaser.
The other side of the transaction, the
seller, can also affect the likelihood of being able to sell stock. Are all sellers good candidates for a stock
sale? The simple answer is no. The selling corporation should have a history
of low risk from a litigation, product liability, environmental and employee
relations standpoint. It will be almost
impossible to sell C-Corporation stock if the selling company has a history of litigation,
environmental exposure, product liability claims or any type of employee
discrimination or harassment claims.
Most purchasers will have the expectation that these types of claims
will continue in to the future and some unknown claims may already exist, only to arise after
the transaction closes.
The selling shareholder(s) must also be
willing assume responsibility for any liabilities of the corporations, not
specifically assumed by the purchaser, that occurred prior to closing. This is
especially true of unknown liabilities that become known after the transaction
closes. This is accomplished through seller
representations and warranties in the definitive purchase agreement. The seller should expect these
representations and warranties to be more robust than in an asset sale
transaction. The selling shareholders
should also expect to indemnify the purchaser against these liabilities and the
purchaser may require that this indemnification be secured with some of the
sale proceeds for some period of time, post-closing. An indemnification is no good to a purchaser if
the seller making the indemnification is allowed to transfer all of their
wealth to a trust or other family members, thereby shielding it from purchaser claims.
Stronger representations, warranties and
indemnifications will help address a buyer’s aversion to the risk of unknown
liabilities in a stock purchase transaction but they do not help with the other
purchaser drawback, which is the inability to write-up the assets to FMV and
depreciate them from the higher value. Allocating some of the
purchase price to personal goodwill can help with this. Look for a future article that discusses the
use of personal goodwill in a stock transaction.
In summary, to sell C-Corporation stock
your intermediary will need to find a buyer that is experienced, sophisticated,
and willing to take some “controlled” risk and the seller will need to have clean history from an unexpected liability standpoint and be
willing to accept more robust representations, warranties and indemnifications.
Alan D. Austin, CFA
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