In the broader M&A market, news of mega deals hitting the headlines is signaling that companies are aggressively pursuing acquisitions with transaction activity reflecting a mix of corporate and private equity buyers and diverse industries. Deal value in February was up more than twofold from January levels with Heinz, Dell and Virgin Media among the billion-dollar-plus deals.
Local corporate buyers are also flexing their muscle. If February transaction activity is any indicator, momentum is building for what is expected to be an active year for M&A in 2013.
An M&A highlight in the health care arena, Cincinnati’s Catholic Health Partners Inc. announced a strategic partnership with Summa Health System Inc. of Akron, whereby it will acquire a minority ownership stake in the health care provider. The move is reflective of the broader consolidation trend taking place in hospitals and health systems in anticipation of changes from health care reform. Summa announced last July that it was seeking a potential partner as part of a three-year strategic planning process.
The combination brings together two regional leaders and expands CHP’s market share. With $5.6 billion in assets, CHP operates more than 100 health facilities, including 24 hospitals throughout Ohio and Kentucky, and is the largest health system in Ohio. CHP reported $3.8 billion in net operating revenue in 2012.
In a highlight for the industrial market, Beachwood, Ohio-based private equity firm Rockwood Equity Partners completed the acquisition of TIM-CO (aka CAL-RF Inc.), its first strategic add-on for portfolio company Astrex Electronics, which it acquired in 2008. TIM-CO is a distributor of electrical and electronic components and value-added assembler of coaxial connectors and cable assemblies with a focus on the commercial aviation, space, oil and gas, industrial, and military markets.
Also in the industrial segment, Timken Co. announced its second acquisition this year with Roller Bearing Industries Inc. Roller Bearing manufactures balls and roller bearings for the railway and automotive industries. Timken purchased the company from The Greenbriar Cos. Inc.
Deal of the Month
The health care industry garners the spotlight this month with the announced $2.1 billion acquisition by Cardinal Health of AssuraMed Holding Inc. of Twinsburg. AssuraMed distributes disposable medical products for the home health market, with a product range than spans more than 30,000 SKUs from ostomy, diabetic and respiratory supplies to wound care and insulin infusion products.
The acquisition gives Cardinal Health an entry into the growing home health market, adding an estimated $1 billion to the top line. The company estimates synergies from the combination to reach $50 million by 2016. Cardinal Health reported EBITDA of $2.3 billion on revenue of $104.8 billion in 2012.
AssuraMed is backed by private equity firms Clayton, Dubilier & Rice and GS Capital Partners, which acquired the company in 2010. During their ownership AssuraMed completed the acquisition of Invacare Supply Group, the domestic medical supplies business of Invacare, in a $150 million transaction.
Andrew Petryk is managing director and principal of Brown Gibbons Lang & Co. LLC, an investment bank serving the middle market. Contact him at (216) 920-6613 or email@example.com
When one company is acquiring another, the deal price is often the primary factor considered. Too many times, however, critical issues are overlooked, says Sean R. Saari, CPA/ABV, CVA, MBA, senior manager with Skoda Minotti’s Valuation and Litigation Advisory Services Group and Accounting and Auditing Team.
“Deals get started and then take on a life of their own. During the acquisition process, the company is often focused on negotiating and finalizing the deal. However, there are a number of valuation-related issues that can be important to consider, but which are often overlooked,” says Saari. “Some companies try to address these issues after the fact, but the earlier you’re able to get the valuation and accounting issues handled on the front end, the easier things are going to be on the back end.”
Smart Business spoke with Saari about the five things you need to know regarding business valuation before making an acquisition.
What is the appropriate standard of value to consider in an acquisition scenario?
There are two different standards to keep in mind — fair market value and strategic value. Fair market value represents the value of the business if it were to be sold to an unrelated third party and it sets the floor value to what an acceptable purchase price may be. Fair market value is typically most appropriate when financial buyers are involved because they don’t really have any synergies to squeeze out of the company, they simply want to purchase the business ‘as-is’ and continue its operation. However, if the potential acquirer is in the same industry as the target company and the deal is a strategic acquisition, it is important to consider the ‘strategic value’ of the business. Under this standard of value, the acquirer considers the impact of certain redundant expenses that may be eliminated. The elimination of certain expenses may allow a strategic acquirer to pay a price that is greater than fair market value while still receiving an appropriate return.
Can the structure of an acquisition impact the price paid for the target company?
There are competing benefits between structuring a deal as a stock or an asset deal, which can impact the purchase price of an acquisition. Generally, sellers prefer stock deals because their proceeds are taxed only once as capital gains. In stock deals, however, the buyer cannot pick the assets and liabilities that it would like to assume, all unknown and contingent liabilities must be assumed by the buyer and the buyer gets no step up in the basis of the assets purchased. Therefore, buyers typically prefer asset deals because they can pick the assets and liabilities they want and they get a step up in the basis of the assets acquired. This step up, typically for fixed assets and intangible assets, creates additional depreciation tax deductions for the buyer, which can allow them to pay more than they would under an asset deal. This is particularly true when fixed assets with little carrying value are purchased or when intangible assets make up a significant portion of the purchase price. Sellers can be averse to asset deals, however, because contingent and unknown liabilities existing as of the purchase date typically are retained and the sale proceeds can be subject to double taxation.
How are earnouts accounted for?
Earnouts can be an effective tool to bridge the gap if the owner and the seller can’t agree on price. In an earnout, the buyer and seller agree that, after the transaction has closed, there may be additional payments to the seller based upon company performance. It allows the buyer to compensate the seller if certain levels of activity are achieved or to keep the purchase price lower if the targets aren’t met.
However, while it is a great tool, there are some accounting issues that the acquirer is often not aware of.
When an earnout is present, generally accepted accounting principles require the buyer to record the fair value of the earnout as a liability on its books. This is based on the likelihood of the earnout being paid and how much the earnout payment might be. Buyers often don’t realize they have to carry that extra liability on their books and that the balance has to be adjusted every reporting period until the earnout is settled, with the changes in value being reported in the income statement.
What other accounting requirements must be addressed when an acquisition is made?
When making an acquisition, consider the post-acquisition purchase price allocation, in which the purchase price is allocated to the various assets acquired. In many cases, the purchase price exceeds the value of the tangible assets acquired. Accounting rules require that the purchase price in excess of the tangible asset value be allocated to the intangible assets purchased, such as trademarks, customer relationships, technology and non-competition agreements. Any unallocated purchase price left after the intangible assets have been valued is assigned to goodwill.
Determining the fair value of intangible assets acquired is a complex process and typically involves the use of a third-party valuation expert to develop a supportable valuation analysis that will withstand scrutiny from the acquiring company’s auditors.
What are the potential issues if you overpay for an acquisition?
If an acquirer overpays, it results in a lower return on their investment or possibly the loss of a portion of the investment.
From an accounting standpoint, if an overpayment has occurred, it’s likely that goodwill and certain intangible assets may need to be impaired, which can result in a significant charge to the company’s earnings in the period of impairment. Assistance from a third-party valuation expert is often necessary when goodwill or intangible asset impairment is present to determine an appropriate amount that satisfies the company’s auditors.
Sean R. Saari, CPA/ABV, CVA, MBA, is senior manager with Skoda Minotti’s Valuation and Litigation Advisory Services Group and Accounting and Auditing Team. Reach him at (440) 449-6800 or firstname.lastname@example.org.
Insights Accounting & Consulting is brought to you by Skoda Minotti
When Punit Shah saw that people were no longer paying premiums for completed real estate development projects in 2008, he knew that his company needed to get out of the construction business.
“We saw where the market was going and we had to take reactive measures to make sure that our future was protected and the future of our employees was protected,” says Shah, the president and COO of Liberty Group of Cos., a Clearwater, Fla.-based real estate company with 400 employees.
To keep the company profitable, Shah has implemented a new business strategy to grow through aggressive acquisition of existing properties.
Smart Business spoke with Shah about the keys in investing in growth through acquisitions.
What is your approach to new acquisitions?
Any acquisition that we’re buying has to have a value-add component to it and have a big upside that we can conservatively rely on to have a long-term gain in.
One thing that really makes us different is our ability to analytically look at every piece of information upfront. That makes it a lot easier for us on the back end, because we know what we’re getting into and we know how to proactively deal with whatever is coming our way.
So it’s something that we think may tie up equity or capital for a really long time and then have minimal returns, we usually pass on that deal, because we want to make the most and highest return that we can on our equity. We also want to make sure that it’s a safe investment, because right now is not the time to be making risky investments. Now is the time to be making investments that you are 100 percent confident in and that you’ve got a reasonable return on the money that you are putting at risk.
We’re not forecasting tremendous numbers with a forward-looking basis. We’re buying what we deem to be profitable as-is right now. As the market improves overall, as the economy improves, as our management team goes in there and adds more professionalism in overall management of the asset, we see that all as value-add opportunity.
What criteria do you use to evaluate investments during due diligence?
The most primary thing is location and demand generators. We want to be conservative and consider all different options, whether if there is a terrorist attack, what that would do to the core business of the hotel, during recessions, what happens during peak periods. So we look for diverse demand generators. We look for location of course. Then we look at the physical plans of the hotel or whatever the asset is. We look at the long-term intrinsic value of the asset itself but also the submarket and the overall region. We want to know if this is something that is going to be sustainable and is there going to be a demand generator for this property 10 years from now. As far as my ranking, it would go in that order.
We’re looking just for the best products that we can find, and we’re filtering out anything that doesn’t meet our core criteria. We’ve been very diligent about establishing that criteria upfront and knowing what we’re pursuing.
What mistakes can you make when pursuing acquisition opportunities?
The biggest thing anyone can do if they’re getting involved in what we’re doing is make sure they spend the time, money and resources on the due diligence. It’s almost turning into the height of the market again on a different scale, because people are just buying things sight unseen, guns blazing and not necessarily knowing what the repercussions are because there are a lot of legal complexities when dealing with distressed assets. I’ve seen a lot of people who are just jumping in all at once without understanding the risks involved with those investments. The other thing is real estate and cash-flowing businesses are still businesses and you have to have great management and employees to make those investments profitable. You can’t just buy an assisted living facility or hotel and expect just because you got a good deal on it, it’s going to turn profitable. It’s not like land. There is an inherent business component to it, and a lot of people fail to realize that when they are looking at these types of deals.
How to reach: Liberty Group of Cos., (727) 866-7999 or www.libertyg.com
If you’re thinking about selling your business, there are a lot of factors to consider before making that decision.
“First and foremost, you need to determine whether it is a good time as it relates to you, as the business owner, to help meet the goals and objectives of the business life cycle,” says Albert D. Melchiorre, president of MelCap Partners, LLC, a middle market investment banking firm. “Other factors include trends in the business and the industry, and economic trends.”
Smart Business spoke with Melchiorre about how to evaluate whether now is the right time to sell your business.
How can a business owner begin to evaluate whether selling is the right decision?
Beyond whether it’s a good time for the business owner and current trends, do you have a successor in place? Are you aging and considering a sale because you’re 75, or are you 55?
Is it a good time as it relates to trends in your specific business? Is the business performing at high levels, with the added opportunity for further growth? Is it a good time in your industry? You may be performing, but if your industry is declining rapidly, is the business’s performance sustainable based on what’s going on in the industry?
Also consider whether it is a good time from a mergers and acquisitions perspective. Is capital plentiful? Are there plenty of potential buyers?
It’s good to have all of these factors lined up. Historically, it’s rare, but in the current economic environment, for a lot of business owners, they are lining up.
How can the current mergers and acquisitions market impact the decision to sell?
Although some areas of the economy are still struggling, other industries are doing very well. As a result, the earnings of corporations remain strong, giving strategic buyers the financial resources to be able to buy companies. Right now, there are trillions of dollars sitting on corporate balance sheets resulting in an incredible amount of liquidity from a strategic buyer’s perspective.
In addition, although the availability of bank debt to lower- and middle-market companies remains tight, overall, banks are beginning to lend money again. And with lower interest rates, the cost of capital remains low and there are a lot of private equity dollars looking to invest in good, quality companies.
So if your business has performed well and has good prospects for growth, the trends in your business are positive, and it’s personally a good time for you, it may be a good time to consider a sale.
How could the potential end of the Bush-era tax cuts impact a decision?
Nobody has a crystal ball, but in all likelihood, the extension of the Bush-era tax cuts will come to an end this year. Whether or not new tax cuts go into effect, there is a strong likelihood that taxes will be going up for businesses and that you will pay more next year on the sale of a business.
I would look at that as the tipping point. I don’t think it’s necessarily a primary driver in determining whether it’s a good time to sell, but it may be a secondary driver if everything else lines up for you.
How can an outside expert help you through the process to maximize your return on a sale?
For most business owners, this is a once-in-a-lifetime event, the most significant liquidity event in their lives. Business owners should focus on what they do best and let investment bankers focus on their expertise. The role of the investment banker is to help business owners maximize the value of their business to allow them to reach their goals and objectives in the sale of their business.
The investment banker will also work with the business’s other advisers, such as an attorney, an accountant and financial advisers. While the investment banker may be leading the charge, it is clearly a team effort.
How can a business owner’s decision about whether to stay with the business after the sale impact that transaction?
Some business owners, especially if they are the founder, may be key to the continued success of the business. But many just want to sell the business and walk away today.
If you’ve taken the step of bringing in key managers or finding your successor, you’re more likely to be able to exit the business at sale. But those who have not taken those steps from a succession standpoint will find it much more difficult to exit upon sale, because if you are still very key to the business, that will have a negative impact on the value of your company if you were to leave upon a sale.
How far in advance of a sale should a business owner begin to prepare?
It varies from owner to owner, but you should begin thinking about it years in advance. This is not a decision any business owner should take lightly, just suddenly deciding, ‘Today, it’s time.’
Having an early conversation with an investment banker can help you think through the process and evaluate where you are with the business today, what you can expect to receive and provide you with an overview of the process. It’s a very good exercise to get the input, advice and assistance of someone who can help you execute on that transaction.
Because this may be a once-in-a-lifetime event, you need to make sure it is the right time for you before moving ahead.
Albert D. Melchiorre is president of MelCap Partners, LLC. Reach him at (330) 239-1990 or email@example.com.
Insights Mergers & Acquisitions is brought to you by MelCap
Bill Sasser created The Management Trust in late 2005 as part of an industry rollup, merging six companies to form an employee share ownership plan, or ESOP. The community association management company is owned by its 700 employees, but it is Sasser’s job as chairman and CEO to provide value and profitability for the company’s employee-owners. As part of that, he has helped to spearhead a growth-by-acquisition strategy that has helped the company broach new markets and new lines of business.
Smart Business spoke with Sasser about the acquisition strategy at The Management Trust – which is the DBA name of The Management Association Inc. — and how to effectively implement an acquisition strategy at your company.
At the outset, what was the process like to roll all of the companies together to start The Management Trust?
We really invoke the ESOP culture quite a lot in just about everything we do, and probably our biggest cultural difference between an ESOP company and a nonemployee owned company is the degree to which we engage our employee owners. That really kind of changes the dynamic considerably. What we've done is we operate with a high degree of transparency for all of our employee owners, because they are our shareholders.
In doing so, they understand the good, bad and ugly of what our strategic vision is, what our financial performance is, all of those sorts of things. So as we are going through the post-merger integration issues, which is compounded by the recession, we would share with them the challenges we’re having. What we have found, and this is the beauty of an employee ownership culture, is even when you are sharing with them news that is not entirely positive, they feel honored and respected for being given the information at all.
Moving forward, what has been your growth strategy?
Historically, we have relied heavily on the homebuilders to fuel our growth. Obviously, over the last five years, there has not been a lot of home development. So we really found ourselves in the position of needing to reinvent the company. What we have done is a couple of things: No. 1, we realized we needed to find recurring nonvolatile revenue streams that are predictable, as opposed to the volatility of the real estate market. We went about doing that, creating some proprietary programs and so forth, and in so doing, we built a model that became scalable. So once we realized that we had built a strong business model that could prosper even in a difficult economic time, and had recurring predictable revenue streams, that is what then gave rise to the acquisition strategy.
What makes for a good growth opportunity in your situation?
I think it is a couple of things. First of all, every company's long-term strategy is going to be somewhat different. My job description is very simple: the creation and preservation of ESOP share value for our employees. That is really what I do. Parenthetic to that is a lot of different things. But as it relates to the acquisition opportunities, we look for three different things. We look for companies that are either strategic markets, meaning markets that we know we need to be in to grow this company into a national presence. We look for companies that have what we call a strategic skill set, which may be a particular area of expertise that we can leverage throughout all the positions of the management trust. Again, with the idea that we want to create a business model that is scalable. Thirdly is simply tuck-unders, where we just acquire a focused business and fold them into an existing office of the national trust. The most important criteria that we look at when we are exploring a potential acquisition opportunity is where we can create value.
What would you tell other business heads about developing an acquisition strategy?
I think if I had to identify a couple of key points for somebody considering acquisitions, the first point would be to find a point of differentiation between your company and other acquirers in that business space. If the company is simply trying to compete on price while not considering other factors, a bidding war is going to ensue, and that is not going to work. Sellers want to find a company that is going to be a good fit. So any way you can differentiate yourself from your competitors is better. I think that culture is critically important in any acquisition strategy. You need to find a company that is going to fit.
How to reach: The Management Trust, (714) 285-2626 or www.managementtrust.com
When you’re considering buying a company, it’s not just a matter of locating a target and writing a check. There’s a lot that goes into doing proper due diligence, and if you fail to do it right, the transaction could be disastrous, says Thomas Vaughn, member, Dykema Gossett PLLC.
“From the purchaser’s perspective, conducting an effective due diligence process is critical to maximizing value from your acquisitions,” says Vaughn.
Smart Business spoke with Vaughn about why due diligence is critical to ensure a successful acquisition.
When considering purchasing a business, what is the first step?
Start by assembling a team of in-house and outside lawyers, inside and outside financial professionals, and possibly experts in various areas impacting the target. In the due diligence process, it is the job of the buyer to learn and understand everything it possibly can about the prospective target, and that requires a very deep dive by the due diligence team.
What is the next step?
The team should develop a due diligence strategy, and one of the most important components of that is to agree on the purpose of the due diligence effort.
From a buyer’s perspective, due diligence can be a very expensive process, so it is typically done in stages to keep costs down until the buyer is certain it is going to complete the transaction. As a result, in the preliminary due diligence, you are trying to determine the target company meets your investment parameters. You’re looking for ‘go, no go factors.’
The early stages of due diligence are very financial and operations oriented. For instance, making sure the financial statements and projections accurately represent the company’s business prospects and that there aren’t any major customer problems or potential defections are critical elements of due diligence.
From a legal standpoint, you look for high-dollar legal issues, like pending litigation or claims, or legal impediments to completing a deal, such as regulatory issues.
Also determine that the value you see in the company is an accurate perception of its true value. As part of that, identify and confirm synergies. All of these efforts will help you negotiate the purchase price and other deal terms.
Once you are satisfied with value and have signed a letter of intent, you can conduct the detailed part of the due diligence process.
How do you proceed with the detailed due diligence?
This is when the process starts in earnest. Have your team divide up responsibilities so that you’re not duplicating efforts and you are conducting the process as efficiently as possible. You want to make the process as smooth as possible for the seller. Due diligence is burdensome and time consuming for the seller. Don’t have multiple people asking the same questions or asking for the same documents.
One of the best ways to help this run smoothly is to present the seller with a detailed checklist. Often there is information listed on there that the company doesn’t have, but you can use the list to trigger the seller to think through the information documents the seller has and should be providing to you. Then keep the list updated to reflect documents received and make the list available to all team members
How is the due diligence information delivered?
Determine up front the deliverable to come out of the due diligence process. Is the expectation a written report from the accounting and legal staff? That is the most typical result, but there is an expense involved, so you have to determine if you want to incur that. You can also start with an oral report or short written report that notes red flags and items that are potentially problematic as a precursor to the full report.
That report should come with recommendations as to which problems can be potentially fixed and how to fix them, or whether the problem is so significant that it should have an impact on the purchase price or the decision to move ahead. Another outcome when due diligence identifies problems or uncertainties might be to have part of the purchase price paid as an earn-out. If certain things represented by the seller happen, you’ll pay the full price, but if they don’t, you won’t have to.
What are some red flags?
The biggest one is a very disorganized seller. In this case, the buyer needs to do very thorough due diligence. Lack of documents where you expect to see them, or poorly drafted documents or contracts, are also an issue.
Another red flag is a seller who provides you with certain due diligence but is slow providing other information. This may be an indication the seller is holding back bad news.
How does due diligence help in preparing schedules used in the typical acquisition agreement
The seller makes representations and warranties in the acquisition agreement and puts exceptions in the schedules. Then the buyer reviews them to get comfortable that nothing new has appeared in the schedules that was not disclosed in the due diligence process. It’s not unusual for new information to appear in the schedules, which can be a big problem.
If the buyer feels the seller intentionally didn’t disclose information until the last minute, it can have a very negative impact on completing the transaction and the ongoing relationship between the retained members of the management team and the buyer.
What kinds of things can show up at the last minute?
Usually it is a problem the seller was trying to solve before he or she has to disclose it, but can’t. The seller discloses it in the schedules just before the acquisition agreement is signed to avoid later indemnity claims. But doing so at the last minute is a problem in itself.
Thomas Vaughn is a member at Dykema Gossett PLLC. Reach him at (313) 568-6524 or TVaughn@dykema.com.
NEW YORK ? (Reuters) - VF Corp, owner of clothing brands such as The North Face and Wrangler jeans, said it would buy shoemaker Timberland Co for $2 billion to boost its outdoor and action sports business.
The deal values Timberland at $43 a share, a 43 percent premium to Friday's closing price of $29.99 on the New York Stock Exchange.
The companies expect the deal, which was unanimously approved by both boards, to add to VF's earnings per share by 25 cents in 2011 and by 75 cents in 2012, including acquisition-related expenses.
Timberland, home to its namesake label and brands such as Mountain Athletics and SmartWool, expects 2011 revenue of $1.6 billion, more than half of which is generated internationally.
The parties expect the deal to close in the third quarter and add about $700 million to VF's 2011 revenue.
VF said it aimed to boost Timberland sales by 10 percent annually by using its distribution channels in Europe, Asia and Latin America as well as by expanding Timberland's women's footwear and apparel business, among other measures.
VF plans to finance the deal through a combination of cash on hand, commercial paper and term debt.
Shares of Timberland were up 42.4 percent at $42.72 in premarket trading.
In today’s economy, news of mergers, spin-offs or reorganizations can energize businesses and financial markets. Small businesses can also take advantage of these techniques to merge with a complementary company, spin-off a high-flying division or reorganize their capital structure.
Smart Business spoke with David L. Musser, a partner with Nichols Cauley & Associates LLC, about how S corporations can grow their business through mergers, acquisitions or reorganizations and assess the best tax strategy to achieve this.
How does this tax treatment work for businesses?
The reorganization provisions of the Internal Revenue Code, which are primarily located in the IRC Sections 354, 355 and 368, allow a variety of tax-free transactions in the form of combinations, divisions and recapitalizations. The tax-free treatment of these types of transactions is based on the theory that the corporation has essentially continued its old business within the corporate structure, without distributing boot or assets to the shareholders, despite the various implementing sales and exchanges.
Stated another way, the tax-free reorganization provisions of the Code are intended to recognize that in some cases there simply has not been a sufficient change in the economic circumstances of the corporation and its shareholders to justify the imposition of an income tax.
How can corporations realize tax-free transactions under the Internal Revenue Code?
The Code’s definitions are concerned with the form of the transaction rather than its substance. Accordingly, form plays an important role in achieving the desired tax result. This does not mean the economic consequences of a transaction can or should be ignored. Tests such as ‘business purpose,’ ‘continuity of shareholder interest,’ ‘continuity of business enterprise,’ and the ‘step-transaction’ doctrine can be applied to disqualify what otherwise seemingly qualifies, under the technical requirements of the Code, as a tax-free reorganization.
If the transaction meets the requirements for a tax-free reorganization, the property, stock and securities passing between corporations involved in the transaction and the stock and securities passing to shareholders of the corporations can be received without recognition of gain or loss. The price to be paid for tax-free (tax-deferred) treatment of reorganization exchanges is in the basis carryover and adjustment rules.
What other factors should a corporation consider when pursuing a tax-free reorganization/recapitalization?
A tax-free reorganization is only one way to acquire the assets or stock of another corporation. A major difference between a tax-free and taxable transaction is that stock of the acquiring corporation is the principal if not sole consideration that can be conveyed in a tax-free reorganization.
Some factors should be considered when deciding whether an S corporation should purchase the stock or assets of a target corporation, or combine with the target via a tax-free reorganization.
- The effect on the S election of the acquiring corporation
- Restrictions on what can be purchased
- Consideration conveyed to the target
- The effect of the target’s existence
- Recognition of gain or loss
- Basis and holding period
Corporations should also consider the following when determining whether to pursue a stock purchase, asset purchase or reorganization:
- Target shareholders often prefer stock sales due to capital gain and installment sales treatment. It may be difficult or impossible if regulatory approval is required. A stock sale avoids the reporting requirements that apply to asset sales (IRS Form 8594).
- S corporations may prefer an asset purchase because it allows new basis for depreciation and eliminates exposure to pre-purchase claims against the target. Paperwork needed to document the transfer of the assets can be burdensome. As with stock sales, regulatory approval may be required.
- In reorganization, the S corporation generally succeeds to the target’s earnings and profits, which can lead to liability for the tax on excess new passive income and termination of the S election after three years. S corporations may also be exposed to built-in gains tax for appreciation assets obtained from the target that are sold within 10 years.
- A method even exists to buy stock but, under IRC 338(h)(10), elect to treat it as an asset purchase.
Are there other options for corporations to limit their tax burden?
Corporations should also consider the introduction of qualified Subchapter S subsidiaries (QSubs). A QSub is a corporation 100 percent owned by an S corporation that has made a valid QSub election for that subsidiary. In addition to being 100 percent owned by an S corporation, a QSub must be a domestic corporation that otherwise meets the basic requirements to be an S corporation.
A QSub is technically neither a C corporation nor an S corporation. Instead, a QSub is not treated as a separate corporation for federal tax purposes (although it is still treated as a separate corporation for other purposes). A QSub’s assets, liabilities, and items of income, deduction and credit are treated as owned by the parent S corporation.
Whether acquiring a company or reorganizing, these tax techniques are highly complex, so it is imperative that you seek a tax professional before proceeding.
David L. Musser, CPA, CIA, CFP, is a partner with Nichols Cauley & Associates LLC. Reach him at firstname.lastname@example.org or (404) 214-1301.