The way the
transaction is structured – specifically, whether it is a stock sale or asset
can have material implications to the cash realized by the business owner
With respect to the sale of a business, the
negotiated sales price is not the only determinant of the economic benefits to
be ultimately realized by the seller. The way the transaction is structured –
specifically, whether it is a stock sale or asset sale – can have material
implications to the cash realized by the business owner when all is said and
It probably goes without saying that the optimal
deal structure will vary for each proposed transaction and will depend on the
specific circumstances of the buyer and seller. Each business owner and buyer is
unique, and each will have their own tax situations and goals with respect to
the business sale or purchase. However, it is a general rule that stock sales
are preferred by sellers, while asset purchases are preferred by buyers.
A seller prefers a stock sale, especially for a C-corporation, because there is
only one level of tax (which is imposed on the difference between the
transaction price of the stock and the seller’s tax basis in the stock).
Additionally, if the seller has held the stock for more than 12 months, the gain
will be taxed at the more favorable long-term capital gains tax rates.
The buyer, on the other hand, generally prefers an
asset purchase for tax reasons, as well as to avoid any unknown corporate
liabilities of the selling corporation. If the cost of the assets to the
purchaser is greater than the tax basis of the assets, there is a step-up in the
tax basis of those assets. The buyer fares better in the transaction, as the
purchase price of furniture, fixtures or equipment can be deducted for tax
purposes relatively quickly through depreciation expense. The asset purchase
also will often result in the creation of goodwill, which can be amortized for
tax purposes over a 15-year period. Unlike a stock purchase, the ability to
depreciate and amortize these assets generates increased income tax deductions
in the future, creating a lower tax liability. The stepped-up basis can result
in significant economic benefit to the purchaser, which may allow the purchaser
to pay a higher price.
If the sale of the business is structured as an
asset sale, one strategy that may be available to the seller is to sell his or
her personal goodwill as a separate asset. In other words, the overall tax
liability can be reduced if a portion of the sales proceeds are allocated
directly to the shareholder rather than to the corporation. In this manner, the
seller avoids the double taxation normally present on the sales of assets of a
C-corporation (the double tax involves a tax on the gain on the sale of the
asset and a second tax when the remaining proceeds are paid in dividends to the
shareholders). By allocating a portion of the sales price to be paid directly to
the shareholder for personal goodwill, the selling shareholder pays only the tax
on the realized gain on that asset.
Personal goodwill may be present, depending on the
circumstances with respect to the business and its owner, and certain factors
may support the existence of personal goodwill. These factors include that the
should be directly involved in the operations
of the business,
makes all of the day-to-day management
is highly visible to the customers or clients
of the business.
personal goodwill indicators
Small entrepreneurial business is highly dependent on the
employee-owner’s personal skills and relationships. In the June 2003 edition of the
"Tax Adviser," authors Darrell V.
Arne and James R. Hamill provide a checklist for allocating a portion of the
purchase price to personal goodwill:
There is no pre-existing
covenant not to compete and/or employment agreement between the selling
company and the employee-owner.
Personal service is an
important feature in the company’s products or services.
There is no significant
capital investment in either tangible or identifiable intangible assets.
Only employee-owners own the
In the end, determining the
structure of the deal is an integral part of the overall negotiating
process, and the financial and tax advisors of both parties should
be intimately involved throughout the process. With each major
revision of the transaction terms, these advisors should apprise
their clients of the ultimate cash flow ramifications.