Sunday, February 5, 2017

Yes, You Can Sell C-Corp Stock – It’s Just Harder

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

No comments:

Post a Comment