We recently finished an interesting project for a client who is a government contractor. For confidentiality purposes, we aren’t going to disclose any identifiable information about this client, so breathe easy. But this deal had twists and turns and was so rewarding to get across the finish line – and we did it on deadline!
Let’s dig into this juicy case study: Our client is a specialty service provider whose only client is the US Government. He receives 100% of his revenue from a specific agency of the government. This one contract was worth eight figures per year. A highly valuable asset!
Our client, wanting to expand his territory, learned that another contractor in his industry is retiring and wants to sell his business. So what do you get when you cross an existing government contractor with a retiring government contractor? A complicated stock sale!
From now on, we’ll call our client the “Buyer” and we’ll call the retiring contractor the “Seller”. Because the Seller also has a contract, under which he gets 100% of his revenues, with the same government agency, it would be difficult to impossible to do an asset sale.
With an asset sale, the Seller would sell the “insides” (assets) of his business but not the “container” (corporation) itself. In this case, one of the assets is a very lucrative contract that is the lifeblood of the business. And for anyone who has done government contracting before, you know how hard it is to transfer one of those contracts; it’s virtually impossible!
That left us with a stock sale, which means that the Buyer is buying the Seller’s “container” (corporation) and everything inside of it – including that lucrative contract. This way, the contract stayed in the name of the corporation and no changes were needed to keep the contract going.
Doing a stock sale means you buy the good, the bad and the ugly. You can’t pick and choose – you get what is known and what is unknown. (There are fancy mechanisms we use to moderate the risk but there’s still more risk in a stock sale than an asset sale – way more!)
We’re already dealing with a complicated situation (government contract + stock sale) so to take it up a notch, we’ll add a couple of layers to the Seller’s side. The Seller actually had a parent company with four subsidiary companies. One of the subsidiaries (we’ll call it Subsidiary A) had the government contract. The other three subsidiaries provided employees, equipment and leased property to Subsidiary A so it could fulfill the services in its government contract. To put it another way, think of one business broken up into four parts and each part was in a separate corporation – and all four of them were owned by another corporation!
As the attorney for the Buyer, we didn’t want our client to take on the liability for employees, so we thought it was a good thing the employees were separated out into a different corporation. (Warning: do not attempt to do this at home. This is a complex arrangement and takes sophisticated planning and administration.) We did not want the Buyer to buy the corporation that had the employees. We also didn’t want our client to purchase any real estate in a corporation, so we suggested that he buy the real estate with a separate LLC and structure that one as an asset sale.
That left two subsidiaries under a parent corporation that we needed to process for a stock sale. How should we do this? After researching and consulting with our client’s CPA, the whole team decided it would be best if our client bought the stock of the parent company instead of each of the subsidiaries. This made for a very complex (and long) Stock Purchase Agreement!
But how exactly should the Buyer structure three new corporations that he would be buying in this deal, not to mention a separate LLC to buy the associated real estate? The Buyer currently had one corporation and it contained his entire business. He could buy the parent company in his own name, but then he’d have two separate businesses. He wouldn’t be able to combine and economize to save money on common expenses.
After much discussion, the team decided that the Buyer should form another corporation as the “parent” company to his existing company. He’d have two layers – a parent company and a subsidiary for his existing business. Then he’d use HIS parent company to buy the Seller’s parent company. This resulted in THREE LAYERS of corporations! Quite a complicated transaction just to buy a business!
But at the end of the day, he was able to realize HUGE tax savings (thanks to his CPA’s) and he was able to keep the liabilities and risks in the Seller’s business separate from his existing business so it wouldn’t “taint” anything he currently had – just in case there was something he didn’t know about. When all was said and done, we were working out of eight corporate books and had transferred ownership of four separate corporations.
Moral #1: You better have the appetite for complexity if you go into business serving a government agency. Government contracting makes a business (and everything it does) complex.
Moral #2: Be prepared to do a lot of due diligence and to have a good team (CPA & Attorney) to help you manage and mitigate risks. Most of the time a business sale/purchase is structured as an asset sale. However, there are a few circumstances where it has to be structured as a stock sale. One of those circumstances is when there is a lucrative contract that cannot be transferred (such as a contract with the government).