Valuation and Deal Structuring

Top 3 Takeaways for Business Owners & Executives

1. Deal Structure Drives Tax and Legal Outcomes
   The way you structure your deal — asset sale vs. stock sale — can dramatically affect taxes, liability, and deal execution. The right structure balances both buyer and seller interests.
2. Negotiation Strategy Can Add or Erase Millions in Value
   Purchase agreements should balance protections, warranties, and concessions. Knowing when to push and when to compromise is key to maximizing your final sale price.
3. Avoid Costly Legal Mistakes Before Closing
   Many M&A deals fall apart over preventable issues — from poor documentation to hidden liabilities. Early legal guidance helps ensure your deal closes cleanly and profitably.

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In mergers and acquisitions, putting together a successful deal is never a simple proposition. Competing buyer and seller priorities, risk mitigation, potential tax liabilities, and even the process of negotiation can all ultimately affect the structure of the deal or whether a deal comes together at all. In our next several blogs on M&A transactions, we will discuss topics that can be key points of friction in negotiating to sell or buy a company. Awareness of these issues can help position potential buyers or sellers to not only understand strategies that are in their best interests, but also to understand the other side’s perspective to facilitate more fruitful negotiations. 

Part 1: Asset Sales vs. Stock Sales

A business sale can be structured as an asset sale, in which the buyer acquires only specific business assets along with their corresponding liabilities, or a stock sale, in which they purchase complete ownership of the business entity via shares of corporate stock or LLC membership interests. 

Buyers tend to prefer asset sales due to factors such as:

• Liability protection: The ability to pick and choose specific assets allows them to avoid taking on unknown liabilities belonging to the seller’s business that could create financial or legal problems post-sale.
• Step-up in tax basis: The tax basis of acquired assets rises to their purchase price in asset sales, which enables buyers to claim increased depreciation and amortization deductions and thus decrease their taxable income.  

Sellers, by contrast, tend to prefer stock sales due to:

• Capital gains tax treatment: The proceeds from a stock sale tend to provide a tax advantage to sellers, as they are taxed at a lower rate than regular income. 
• More convenient deal execution: Most contracts, licenses, and permits stay with the legal entity in a stock sale, meaning existing agreements do not have to be reassigned or renegotiated. This tends to streamline the deal process. 

On its face, it may seem like these perspectives are impossible to reconcile. Not so, but it is often far from easy and requires careful use of tax elections such as §338(h)(10) or §336(e) elections to achieve hybrid workarounds. Reaching an agreement on a deal structure that optimizes outcomes for both sides requires balancing these competing priorities and is ideally done with the advice of qualified legal and tax experts. Otherwise, parties risk unanticipated tax and liability consequences.

Part 2: Negotiating the Best Purchase Price

When a seller negotiates a purchase agreement for their business, they are naturally striving for the best possible price for the transaction. However, price is not a term that is negotiated in isolation, and the totality of the deal terms will have a significant impact on what a buyer is willing and able to pay and potential liabilities that may come back to haunt the seller later. The last opportunity a seller has to cement favorable sales provisions is in working out the details of the purchase agreement. Important considerations for negotiation include:

• Scope of protections: Sellers should try to minimize the scope of protections provided to the buyer to what is reasonable and fair. These can vary depending on the industry, market conditions, and any issues uncovered during due diligence.
• Representations and warranties: These should be reviewed carefully, as inaccurate representations or warranties could have serious financial and legal consequences for the seller. 
• Willingness to make concessions: Crafting a deal that leaves both buyer and seller satisfied invariably involves concessions on both sides. Understanding the difference between material points that are worth standing firm on versus those that can be conceded to secure larger benefits is critical.  

Part 3: Earnout Agreements

Earnout provisions have become increasingly popular as a tool for buyers and sellers to meet in the middle on deals, balancing a buyer’s caution about overpaying with a seller’s expectations of their business’s worth. These agreements allow buyers to pay less for a business up front, promising the seller additional future compensation tied to specific financial goals, lowering the buyer’s upfront risk and incentivizing the seller’s performance post-deal. 

While these sound like a win-win solution, when they are not carefully crafted they can lead to expensive post-deal disputes over whether goals were met and if the buyer intentionally sabotaged performance to avoid making agreed-upon earnout payments. Understanding potential pitfalls and effective strategies for mitigating risk are essential for utilizing earnouts in M&A transactions to satisfy both buyer and seller, or to determine when an earnout is not appropriate. 

Part 4: Top Legal Mistakes

For a business owner selling their business, legal issues are inextricably tied to the potential success or failure of the transaction. Legal oversights before and during the deal process can delay closing, lead to expensive disputes, or doom the transaction completely. Common issues range from the seemingly obvious to those that may be less so, including:

• Not putting agreements in writing
• Misrepresenting the business to the buyer
• Not correcting pre-existing legal problems before starting the sale process
• Not keeping sale details confidential
• Not securing intellectual property rights 
• Overlooking tax implications of the sale and deal structure
• Not working with expert legal counsel

Most common legal problems that could interfere with an M&A transaction are correctable with adequate foresight and knowledgeable legal guidance. Consulting the right professionals prior to initiating a sale and throughout the negotiation and conclusion of a deal can help maximize the value of the transaction and smooth the path to a successful sale.

Expert M&A Law Firm for Domestic and International Transactions

At Bridge Law LLP, our experience is your edge in achieving a merger or acquisition on the most favorable terms possible. To learn more about how we can assist in securing your deal with the highest quality legal services in the M&A market, schedule your consultation by contacting us here.