Babar Ali

When you hear about companies being sold for millions (sometimes billions) of dollars, an image of a suitcase bursting full of money may come to mind, or even a bank statement that has 7 figures on it. This is unfortunately not the case- the buyout is generally done as a stock deal, where the purchasing company gives its own stock to the owners of the company they are buying in exchange for the company. Why is this? Well, there are several reasons, the main two being:

1- Companies rarely have gobs of cash lying around at all time, and even when they do, it is often better for them to invest the money and see immediate returns, or at least hope to realize greater returns than the cost of financing an acquisition (in cases where they may have to borrow money to buy a company). It is easiest for companies to sell equity to the owners, namely stock, which is itself a form of financing.

2- Taxes! There is a loophole that allows tax benefits for stocks, whereas if you get cash money, you get a hefty tax hit. The deal is different for both parties though, with benefits and pitfalls in each case.

Allow me to explain…

To really understand a deal, you have to look at it from both angles. What is best for the seller and what is best for the buyer. It is generally better for the buyer to engage in an outright purchase of assets (cash method) since they would be able to amortize their purchase over a period of time. Note that any depreciation on the assets taken is recaptured as ordinary income.

The seller would want to sell off the company for stocks in the purchasing company. This way the
entire gain can treated as long term, and there would be no corporate level tax (tax treated in this case at individual level). Then there are the state-to-state differences…

You need to know if your current state recognizes “Sub S Corporations.” In a state where there is no Sub S Status, the sale of the company would not be taxed as a capital gain but taxed as a dividend distribution… which is good, and in a multi-million dollar deal, it literally translates to several million dollars.

Let me give you an example; everyone knows that the YouTube deal was sweet for the owners because of the dollar amount involved ($1.76 billion!!!), but what most don’t realize is that they deal was made even sweeter in that it was done as an all stock purchase. That’s right, other than a dinner or two, there was was really no cash being moved around. The YouTube owners got all that value in the form of Google stock. This doesn’t swell their bank accounts immediately (unless they sold some stock right away), but it does push their net worth through the roof! Not only that, but it saved them hundreds of millions in taxes alone. Google did that to give them more of an incentive to sell, and heck, they could afford to! Compare that to the more recent Google deal where they bought the uber-Advertising Firm, DoubleClick for $3.1 billion- a total cash deal. In that one, it just came down to a matter or negotiations and needs of the parties. DoubleClick was bought from private equity firms that would rather take the cash and reinvest it, because that’s what they do for a living, and it was also a company-to-company transfer which has different tax implications than that of a sole individual showing $3.1 billion as income for the year and getting almost 40% of it taxed right away- this was more sensible for the DoubleClick deal, whereas the YouTube founders are now set for life and count it as personal wealth.

So let me sum it up: If you are buying a company, do it outright with cash or debt financing (i.e. borrow money if you have to). If you are selling a company, get a stock deal from the buying company and save a ton on taxes. Make sure you look at your state-specific laws, and do I have to say it?… consult a tax professional before actually doing it! This piece is just educational.

Article of Interest: What is Facebook Worth?