In most acquisition transactions, one company will purchase the assets of another company. An asset deal has the benefit of allowing the acquiring company to select only those assets or lines of business of the target company that it wants to acquire. It enables the acquirer to recover its purchase price through depreciation and amortization, and it also allows the acquiring company to assume only those liabilities that are associated with those assets and that it affirmatively chooses to assume. For the same reason, an asset acquisition affords the acquirer the greatest flexibility in selecting the acquisition vehicle(s) – for example, a corporate subsidiary or a wholly-owned LLC  – and, so, the “residence” for the acquired business. 

 Stock Sales

Notwithstanding the benefits of asset sales, however, there are times when the acquiring company has little choice but to purchase all of the outstanding shares of stock of the target company, as where the target has difficult-to-transfer assets, where the acquirer wants to retain certain tax attributes of the target, or where the target’s shareholders insist upon a straight stock sale (and have sufficient leverage to extract it from the acquirer without a deemed asset sale election).

 How to Hold the Acquired Assets

Those situations sometimes prompt the readjustment of the ownership of some portion of the acquired company. For example, the target company may own assets that the acquirer does not want to keep, or the acquirer may determine that some portion of the target’s assets would be better housed in another entity controlled by the acquirer. The IRS recently addressed one such situation.

 Parent was the parent of a group of entities, including an affiliated group of corporations. Parent was directly engaged in Business A, Business B, Business C, and Business D.

 Subsidiary was a wholly-owned subsidiary of Parent that was acquired by Parent in a taxable transaction. Subsidiary was a holding company that owned all of the stock of Target, a subsidiary that was engaged in Business A.

 Following the acquisition of Subsidiary, Parent desired to integrate Target’s Business A with Parent’s Business A to achieve certain synergies expected from the combination.

 While Parent’s management worked to determine the best structure for permanent integration, Parent entered into certain Lease Arrangements with Target to lease the assets associated with Target’s Business A. Within a few months, the Lease Arrangements proved to be less than optimal.  As a result, Parent proposed to restructure the ownership of Target as a potential long-term solution for combining Target’s Business A with Parent’s Business A.

 In order to integrate Target’s Business A with Parent’s Business A, Parent proposed to form a new limited liability company (“LLC”) that would be disregarded as separate from its owner for federal income tax purposes. Pursuant to state law, Target would merge with and into LLC, with LLC surviving and with LLC receiving all the assets and liabilities of Target (the “Merger”). The separate corporate existence of Target would cease, and Subsidiary would receive solely Parent stock in exchange for its Target stock. The fair market value of the Parent stock received by Subsidiary in the Merger would be approximately equal to the fair market value of the Target stock surrendered in the exchange. Following the Merger, Parent would continue Target’s Business A and use a significant portion of Target’s historic business assets in such business.

 The IRS ruled that the Merger would qualify as a “reorganization” within the meaning of the Code. Consequently, no gain or loss would be recognized by:

–        Target on its transfer of its assets to Parent in exchange for Parent stock and Parent’s assumption of Target’s liabilities in the Merger;

–        Target on the transfer of Parent stock to its shareholder, Subsidiary, in the Merger;

–        Parent on the receipt of the Target assets in exchange for Parent stock in the Merger; or

–        Subsidiary on the receipt of shares of Parent stock in exchange for Target stock in the Merger.

 Other Post-Stock Acquisition Issues

The post-stock acquisition transaction considered in the above ruling was fairly straightforward. Other situations will present much more difficult issues. For example, how may the acquiring company dispose of unwanted assets that are owned by the target? A taxable sale of such assets is always possible, but it may generate significant tax liability. An immediate tax-free spin-off of the assets to the acquiring company’s owners will not be possible. The acquirer may try to isolate the unwanted assets in another entity (which amounts to kicking the can down the road).

 As always, in structuring and in pricing a stock transaction, the acquiring company has to consider the economic burden of not being able to recover its purchase price through depreciation. Less obviously, it should also consider the cost of having to subsequently adjust the holding structure for the indirectly purchased assets, as well as the economic burden of acquiring unwanted assets (through the purchase of target stock) and of subsequently disposing of them. Ideally, these economic realities should be reflected in the purchase price.