class 19: deal structuring & closing the transaction

asset sale - buyer’s perspective

• buyer directly purchases specific, individual assets of the business and assume only the liabilities they explicitly agree to

• pros:

  • liability protection

  • selective acquisition

  • stepped up basis allowed, allowing the buyer to step up the cost basis of the assets to the purchase price, allowing for higher depreciation and amortization deductions in the future

• cons:

  • complexity - you must transfer the title for each individual asset

  • higher closing costs because of more complex legal work and filings

  • organizational continuity is at risk because there may be contract which are non-assignable, requiring re-negotiation in some cases

stock sale - buyer’s perspective

• buyer purchases the shares (stock) of the selling company; the buyer acquires the legal entity, including all of the its assets and liabilities, known and unknown

• pros:

  • simplicity

  • continuity for existing contracts, licenses, permits and customer relationships

  • carry forward losses which can be leverages to shield future income from tax liabilities

• cons:

  • inherited liabilities

  • no stepped up basis - assets retain their historical cost basis

asset sale - seller’s perspective - seller’s disadvantage - goal is to minimize tax burden and transaction complexity

cons:

• double taxation if seller structured as a c-corp

• complexity associated with managing the sale of individual assets and the subsequent dissolution of the company

stock sale - seller’s perspective - seller’s preferred structure

pros: single-level taxation; the gain from the sale typically taxes at the personal level as a long-term capital gain, avoiding the double-taxation problem of an asset sale

earnouts

• contractual provision in an acquisition that makes a portion of the purchase price contingent on the target business achieving specific financial or operational milestones after the deal closes

• the problem it solves

  • valuation discrepancy

  • risk mitigation to ensure the buyer avoids overpaying for unproven future performance

• key components of an earnout agreement

  • metric - rev, ebitda, or net income

  • duration - typically 1-3 year; longer period can be risky for the buyer because it ties to the seller to the business for an extended time

  • payment schedule - payments can be made in lump sum or in installments as milestones are met

  • agreement must clearly define how the business will be managed during the earnout period

• pros for buyer:

  • reduced upfront cost

  • alleviates overpayment risk

  • seller retention - incentivizes the seller to stay involved and ensure a smooth transition

• cons for the buyer:

  • potential for dispute

  • operational constraints

Seller financing

when the business owner acts as a lender to the buyer, providing a loan for a portion of the purchase price

combining an earnout and seller financing: hybrid deal

• how it works: seller takes a seller note for a portion of the purchase price and also agrees to an earnout for a separate contingent portion

• advantage: creates a powerful alignment of interests; seller also received a predictable stream of payments from the seller note while also being incentivized to help the business grow to achieve the earnout; buyer gets the business with a lower initial cash outlay and the security of a holdback through the earnout