Stock Sale and financial liability

by a searcher from University of South Carolina - Darla Moore School of Business

9 months ago

I am in LOI on a deal which needed to be done as a stock sale.  In due diligence, finding that the seller did massive amounts of personal expenses through the business.  It amounts to about $250K/year for 3 years in a row.

My CPA and attorney both say that it is possible to limit liability and potential penalty from IRS for such a situation, however I'm not convinced.  Again, it's a stock sale and it is a concern.

Obviously, there are potential  liabilities for other aspects of the company which the lawyer working on checking.

What are everyone's thoughts on this?

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7 comments

searcher from Fort Hays State University

There have been a lot of good insight in how to handle the risks/liability of a stock sale. The other factor that needs to be included in the equation is the lack of ability to gross up assets (and also depreciate these assets) with the stock sale. In my calculations an asset sale is worth quite a lot more than a stock sale.

4 weeks ago | like reply | 0 likes

professional from University of Minnesota - Twin Cities Campus

More detail here would be great. Any way you cut it, there is some increased risk of tax liability here, and I'd be sure to address this regardless of whether I'm buying stock or assets. If you're sure the business opportunity justifies this risk, I'd price it accordingly (properly kept books are worth more than crappy books) and I'd also hold plenty of cash as either a holdback or as an offset against a Seller Note so that if issues arise, you can spend the money to resolve it (and offset that amount against what you owe Seller) rather than relying on Seller to resolve it to your satisfaction. Regardless of liability, you will be involved in the headache and this will almost certainly be a distraction from operating your business.

Also, keep in mind that the statute of limitations for tax issues can be very long (3 years/6 years/never, a good summary here: http://www.woodllp.com/Publications/Articles/pdf/13_IRS_Statute_of_Limitation.pdf) so a holdback that adequately covers you is easier said than done. Seller will not likely be excited about your proposal to hold part of the purchase price for 6 years, of that I am fairly certain.

In the absence of this, a tax indemnity in a PA needs to be very carefully worded, and I would make darn sure the beneficial owner of the Company is liable under the PA. It will be a huge headache in the event of an audit/issue, but presumably you can likely avoid the liability - just be aware it's not likely as simple as forwarding the audit on to your Seller and letting them handle it.

I would love to hear a war story from someone who has dealt with a Seller tax liability/audit rearing it's head post-closing. It would be extremely valuable (albeit anecdotal) to the community.
The tough part Seller needs to understand is that when you get cute on taxes, you likely pay the piper eventually. Go into this situation with your eyes wide open.

9 months ago | like reply | 2 likes

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