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The Impact Of The C Corporation Structure In A Sales Transaction

Sep 16, 2008

Acquisition Value and Corporate Structure

Is There A Relation?

I have been on the buy side of over 100 small to mid-sized business acquisitions. In my experience, the purchase of a C-Corporation business structure has a lower return than that of a LLC, S-Corporation, partnership or sole proprietorship. Another way of saying this is that buyers will pay more money for a non C-Corporation business to get the same financial performance.

Don't get me wrong, the C-Corporation structure has many advantages and is very useful if applied properly. However, for the small to mid-sized business, the advantages of a C-Corporation may not outweigh the purchase price differential that will occur when the business is sold.

The one major reason for this has to do with the way a C-Corporation is taxed. The factor that causes a lower price on C-Corporation purchases is the loss of tax deductibility of the acquisition purchase price. A non C-Corporation (such as an LLC or Subchapter S-Corporation) transaction can be structured to treat the acquisition as an asset purchase on the acquirer's financial statements and tax returns with little or no adverse impact to the seller. Recording the acquisitions as an asset allows the acquirer to write off a significant portion of the purchase price thus reducing the tax expense.

However, in order to record the C-Corporation acquisition as an asset purchase, a significant gain on sale will be incurred at the time of the acquisition. This gain will result in a current tax liability thus decreasing the net working capital position of the seller and resulting in a significant reduction in the net purchase price. The impact is so damaging that most sellers will not allow for a step up of assets in a C-Corporation transaction. However, in order to compensate for the lost value of the tax write off, a discount is taken on the purchase price. While the actual discount is dependent on the transaction in question, I have seen discounts between 10% and 20%.

For example, if a business is throwing off free cash flow of $1 million in an industry where the typical acquisition valuation is 5X of cash flow, the seller would receive $5 million plus the net working capital position less any debt assumed by the acquirer. Assuming the hard assets are on the books for $1 million and are equal to their fair market value, the goodwill and other intangible asset value is $4 million. Based on the tax rates and internal rates of return of the acquirer, the C-Corporation discount would be around 10%.

If you are considering selling your business in the future, contact your B2B CFO partner for a review of your corporate structure and how it affects your selling price. We are experts who can help you plan and manage your corporate transition. Planning ahead will assure you get the most cash for your business at the closing table.

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