Accountants - M&A related question
 

Assume a small service company has divested itself of virtually all of its assets, but even after recovering the maximum past tax payments, still has a significant amount of operating loss on the books. Is the NOL of value to a potential purchaser?

entity type?

^^
It's a closely held C corp (2 stockholders). I think that's what you're asking.

Potentially. There will be limitations. There's can be 382 limitations possibility which limit how much you can use or you might have to apply only against future earnings of this company. Sorry, I vaguely remember the issues I've come across. If someone thinks they can turn the company around, definitely, future tax savings (deferred tax asset).

Yes, but only if the acquirer buys the stock of the company (Stock sale). Most small biz and "main street" acquisitions these days are Asset sales. Unless there are some heavy reps and warranties, full disclosures, and a hold-back placed in escrow as a "clawback", I doubt you'll see a stock sale in a service biz turn-around play.

A stock sale places ALL the past liabilities onto the purchaser/acquirer, and in a turn-around play a stock sale is not likely to happen when the company has no assets. Whether S-Corp or C-Corp doesn't make much difference.

In a small service company, unless equipment heavy, the only real asset is the customer list. In many service businesses 75-90% of the purchase price allocation is applied to the customer list as goodwill.

Finding a larger strategic buyer who values, and feels they can retain, the customer list is about the only way anyone will realize the benefits of all the accumulated deferred tax asset.

Depends on the (type of) purchaser and deal structure.

Individual or partnership buyer? No.
100% asset deal? No.
Anything that constitutes an “ownership change” in the eyes of the IRS? Yes, but probably not much (382 limitations apply).
Corporate M&A stock deal? Possibly.

However, even with the asset and/or ownership-change deals, the NOL can often be used by the target themselves (against the income from their asset sales). So, it can be factored when negotiating purchase price.

With ownership-change deals, the “surviving” (usable) NOL is severely cut by the 832 limitation(s), making it’s “value” negligible in many cases, even if it does carryover for 20 years. Some sellers may try to give their NOL’s a dollar-for-dollar valuation (hilarious), but buyers tend to give them a pennies-on-the-dollar valuation at best. On deals where the seller is firm on their NOL valuation, a good compromise may be to just add a "utilization" clause to the contract. That is, the buyer agrees to pay the seller a certain percentage of any future tax savings. If it’s a complex merger/stock deal where NOL might be a significant factor, a thorough tax eval. (to include NOL trace and prior ownership-changes) is key. This one sounds relatively simple, but larger “consolidated group” corps can have many layers and NOL “pools” to dissect. If you are at that level, you probably have a team of tax lawyers advising you anyway.

Bottom line: the mechanics of the 382 limitation applications can be quite complex so it’s worth talking to a pro if you are unsure.


ETA: While on the subject of tax implications, another matter to consider with M&A deals is tax liability indemnification. This is especially important if the company previously took rather aggressive tax positions.
Even if you have a tax liability indemnity clause in the contract, a (3rd party) tax liability insurance policy may still be a good idea IMO. If an issue ever arises, the IRS would be knocking on your door, not the seller’s.


Yours truly,
Patrick Bateman

It would be a large corp with a service business buying the stock of a small corp service business (with 6 months left on a client contract). I'm thinking the large corp can buy the stock in the small corp, switch some of its profitable contracts to the small corp, and use the NOL. Maybe not. Just noodling here until my accountant gets back from vacation.

This sounds like a possibility. The corp has dispersed its assets. All that is left is the name, the dregs of one contract, and the NOL on the books.