Deal Structures Explained: Asset Sales, Stock Sales, F Reorganizations and More

Owners tend to judge offers by the headline number. Experienced sellers judge them by what they keep. Between the letter of intent and the wire transfer sit a set of structural choices: whether the buyer acquires assets or stock, which tax elections are made, how the price is allocated across the assets, and how much of the consideration is paid in cash at closing versus in equity, notes or contingent payments. Each choice shifts tax, risk and timing between buyer and seller.

This guide explains those choices the way they come up in a lower middle market sale: what each structure is, why buyers and sellers prefer different ones, how the answer changes for C corporations, S corporations and LLCs, and how to model the after-tax result before you sign a letter of intent. It focuses on US federal income tax, with notes on California, where the firm is based and where state tax materially changes the math.

Why structure matters as much as price

A sale has two sides of the ledger that structure affects. On the seller’s side, structure determines how many layers of tax apply, whether the gain is taxed at capital gains rates or ordinary income rates, and when the tax is due. On the buyer’s side, structure determines the tax basis the buyer gets in the acquired assets, which drives future depreciation and amortization deductions, and which historical liabilities come along with the business.

Because the buyer’s tax benefit from a stepped-up basis can be worth a meaningful share of the purchase price, structure is a negotiable item with real value on both sides. A buyer that receives a step-up can often afford to pay more, or to compensate the seller for the extra tax that asset treatment creates. A seller who understands that trade can capture part of the buyer’s benefit instead of giving it away.

Two offers with the same headline price can leave an owner with after-tax proceeds that differ by millions of dollars.

Asset sale vs. stock sale

In a stock sale (or a sale of LLC membership interests), the buyer purchases the owners’ equity. The legal entity does not change: it keeps its contracts, permits, employees, tax history and liabilities, known and unknown. In an asset sale, the entity itself sells selected assets, and usually some specified liabilities, to the buyer. The selling entity remains behind with whatever was excluded, including the cash proceeds, and is typically wound down after paying its remaining obligations.

Why buyers prefer asset deals

The main reason is the basis step-up. When a buyer acquires assets, its tax basis in those assets equals the price paid. The excess of the price over the seller’s old basis, which in an established business is often most of the price, becomes deductible over time: equipment through depreciation, and goodwill and most other intangibles through straight-line amortization over 15 years under Section 197. In a stock purchase of a C corporation, the buyer inherits the company’s existing, usually low, tax basis, and the purchase premium sits in stock basis that cannot be deducted until the buyer itself sells.

The second reason is liability. An asset buyer can define the liabilities it assumes and leave the rest with the seller. That protection is real but not absolute: successor liability can follow assets for certain environmental, employment, product and tax obligations, depending on the facts and the state.

Why sellers prefer stock deals

For a C corporation owner, a stock sale produces one layer of tax at long-term capital gains rates, while an asset sale produces two. For an owner of a pass-through entity, the difference is smaller but still real: an asset sale can convert part of the gain into ordinary income through depreciation recapture and the allocation to inventory, receivables or non-compete agreements. A stock sale is also cleaner: the seller walks away from the entity rather than retaining a shell with residual liabilities to manage.

Non-tax friction matters too. A business with hundreds of customer contracts that require consent to assignment, government contracts, or hard-to-transfer licenses may be impractical to sell as assets. That is precisely the problem that the elections and the F reorganization described below are designed to solve: tax treatment of an asset sale with the legal mechanics of an equity sale.

How entity type changes the math

The tax classification of the selling entity is the single most important input in choosing a structure. Legal form and tax classification are not always the same: an LLC may be taxed as a partnership, as a disregarded entity, as an S corporation or as a C corporation, and the tax answer follows the classification.

C corporations and double taxation

A C corporation pays federal income tax at a flat 21% on its own gains. When it sells its assets, the corporation pays tax on the gain; when it then distributes the after-tax proceeds to shareholders in liquidation, the shareholders pay tax again on the difference between what they receive and their stock basis, generally at 20% plus the 3.8% net investment income tax for high earners. This is double taxation, and it is why C corporation owners push hard for stock sales.

C corporation stock sales carry two potential advantages that are worth checking early. First, if the shares qualify as qualified small business stock under Section 1202, part or all of the gain may be excluded from federal tax, subject to holding period, gross asset, active business and per-issuer cap requirements, and with many service businesses excluded. Second, the buyer inherits the corporation’s tax attributes, including net operating losses, subject to limits under Section 382. Some C corporation owners also hold personal goodwill, such as relationships and reputation that belong to the individual rather than the company, which in appropriate cases can be sold directly by the owner at a single layer of tax. That position draws scrutiny and needs careful documentation.

S corporations

An S corporation generally does not pay federal income tax at the entity level; gain flows through to shareholders and increases their stock basis, so the later liquidation does not trigger a second tax. The asset-versus-stock gap is therefore much smaller than for a C corporation. The remaining differences are character (ordinary recapture vs. capital gain) and state tax. Two exceptions deserve attention: a company that converted from C to S status within the past five years may owe corporate-level built-in gains tax under Section 1374 on appreciation that existed at conversion, and a company whose S election was never valid, because of an ineligible shareholder or a second class of stock, is actually a C corporation with all the consequences that brings.

LLCs and partnerships

An LLC taxed as a partnership is the most flexible seller. A purchase of all the membership interests is generally treated as an asset purchase for the buyer, so the buyer gets a step-up while the legal transaction is a simple interest transfer. The seller’s gain is mostly capital, except to the extent of so-called hot assets under Section 751, such as depreciation recapture, receivables of a cash-basis business and inventory, which produce ordinary income. A single-member LLC that is disregarded for tax is treated as an asset sale by its owner. Rollover equity into a buyer’s partnership can generally be done on a tax-deferred basis under Section 721.

Asset treatment in a stock deal: Sections 338(h)(10) and 336(e)

The tax code offers two elections that let a transaction be a stock sale for legal purposes while being treated as an asset sale for tax purposes. In both, the target is deemed to sell its assets at fair market value and then liquidate into its owners. The buyer gets a stepped-up basis; the legal entity, its contracts and its permits stay intact.

Section 338(h)(10)

A 338(h)(10) election is available when a corporate buyer makes a qualified stock purchase, meaning it buys at least 80% of the target’s stock by vote and value within a 12-month period, and the target is either an S corporation or a member of a selling consolidated or affiliated group. The election is made jointly by the buyer and the sellers on Form 8023; for an S corporation target, every S shareholder must consent, including any who do not sell. The deadline is generally the 15th day of the ninth month after the month that includes the acquisition date.

Two practical limits apply. The buyer must be a corporation, which excludes many private equity funds and individual buyers unless they acquire through a corporate vehicle. And the election depends on the target’s S election being valid; if it was not, the target was a C corporation all along, the election fails, and the buyer has acquired a C corporation with no step-up and potential corporate-level tax exposure.

Section 336(e)

A 336(e) election produces similar results but is made by the seller side and the target, through a binding written agreement and an election statement filed with the tax return, rather than jointly with the buyer. It applies to a qualified stock disposition, generally a sale or other disposition of at least 80% of the target’s stock within 12 months, and the buyer does not need to be a corporation. It can therefore work when the buyers are individuals, partnerships or several unrelated purchasers. Sales to related parties do not count, and a transaction that also qualifies for Section 338 falls under those rules instead. The same S election validity risk applies.

F reorganizations for S corporations

The F reorganization has become the default structure in many sponsor-backed acquisitions of S corporations because it delivers an asset-style step-up without depending on the validity of the target’s S election, works with any type of buyer, and makes tax-deferred rollover straightforward. The name comes from Section 368(a)(1)(F), which covers a “mere change in identity, form or place of organization” of a single corporation. The IRS described the typical steps in Revenue Ruling 2008-18.

1. The shareholders form a new corporation (NewCo) and contribute all of the target’s stock to it, so NewCo becomes the target’s sole shareholder.
2. NewCo elects to treat the target as a qualified subchapter S subsidiary on Form 8869. NewCo is treated as the continuation of the old S corporation and generally keeps its S election.
3. The target converts under state law into an LLC, which is disregarded for tax purposes. The operating business, its contracts and its permits stay in the same legal entity, now an LLC.
4. At closing, the buyer purchases some or all of the LLC membership interests from NewCo. For tax purposes, the buyer is treated as purchasing assets and receives a stepped-up basis.
5. If NewCo retains a percentage of the LLC as rollover equity, the LLC becomes a partnership for tax purposes, and NewCo generally recognizes gain only on the portion sold.

Because NewCo, not the converted LLC, is treated as the continuation of the old S corporation for federal income tax purposes, historical entity-level income tax exposure, such as tax owed if the S election turns out to have been invalid, generally stays with NewCo and its shareholders rather than passing to the buyer. That is a large part of the appeal for buyers. Other liabilities of the business remain in the LLC the buyer acquires, as in a stock sale, and are handled through the purchase agreement. Sellers should expect the purchase agreement to require the restructuring to be completed before closing, and should budget time for state filings, new tax registrations and bank account changes. Some contracts treat a conversion into an LLC as an assignment or change of control, so a contract review is still needed, although the consent burden is usually lighter than in a direct asset sale.

Purchase price allocation

Whenever a sale is treated as an asset sale for tax purposes, including through a 338(h)(10) election, a 336(e) election, an F reorganization or a purchase of all of a partnership’s interests, the price must be allocated among the assets. Under Section 1060 and the related regulations, the residual method applies: the price is allocated through seven asset classes in order, each up to the fair market value of its assets, and whatever remains falls into goodwill and going concern value. Buyer and seller each report the allocation on Form 8594 with their returns (Form 8883 is used for the deemed sales under Sections 338 and 336(e)), and purchase agreements usually bind both parties to an agreed allocation so that they report consistently.

The parties’ interests diverge. The buyer prefers more value in Class IV and Class V, where costs are recovered quickly. The seller of a pass-through entity prefers more in Class VII, which is taxed as capital gain, and less in non-competes, inventory and recaptured equipment, which are taxed as ordinary income. Allocations must still be defensible at fair market value; an equipment appraisal and a reasoned approach to intangibles are the usual support. For a C corporation selling assets, character matters less because corporations do not have a preferential capital gains rate, but the shareholder-level tax still applies on liquidation.

Worked example: after-tax proceeds by structure

Consider a company sold for $20 million in cash, on a cash-free, debt-free basis, with no transaction costs, escrows or working capital adjustments, to keep the arithmetic visible. The company has a $4 million tax basis in its assets. If it is a C corporation, its founder’s stock basis is $1 million, because retained earnings raise the corporation’s asset basis but not the shareholder’s stock basis. If it is an S corporation, the founder’s stock basis is $4 million, because S corporation income that was taxed and retained increases stock basis. In an asset sale, we assume $3 million of the $16 million gain is ordinary income from depreciation recapture and the rest is capital gain on goodwill.

Illustrative federal rates: 21% corporate rate; 23.8% on long-term capital gains for individuals (20% plus the 3.8% net investment income tax); 37% on ordinary income. State taxes are excluded here and discussed in the next section. The S corporation is assumed not to be subject to built-in gains tax.

Three conclusions follow. First, for the C corporation owner, the asset sale costs about $2.56 million more than the stock sale on the same headline price: the corporate tax is paid first, and then the shareholder is taxed on what is left. To be indifferent, the owner would need a meaningfully higher price for an asset deal, which most buyers will not pay in full. Second, for the S corporation owner, the gap between asset and stock treatment is only about $0.40 million, driven entirely by the recapture being taxed at ordinary rates. Third, the buyer’s side of the same trade is large: asset treatment gives the buyer roughly $16 million of additional deductible basis, worth about $3.4 million in nominal tax savings at a 21% rate and more at individual rates, spread over up to 15 years. Its present value is lower, but it still dwarfs the S corporation seller’s incremental tax, which is why an S corporation seller can usually negotiate a gross-up.

The example also shows why entity type should be part of exit planning years before a sale. A C corporation that converts to S status starts a five-year built-in gains recognition period; a conversion done well ahead of a sale can reduce or eliminate the corporate layer on later appreciation, while one done on the eve of a sale generally does not.

Forms of consideration

The price is not only a number; it is a mix of payment forms with different risk and tax profiles. In the lower middle market, an all-cash-at-closing deal is common for smaller transactions, while larger sponsor-backed deals often combine cash with rollover equity and, where valuation gaps exist, an earn-out or seller note.

Cash at closing

Cash is the simplest and least risky form, though part of it is often held back in an escrow or holdback for indemnity claims or working capital adjustments. Gain on the cash portion is generally taxed in the year of closing. Amounts placed in escrow may, depending on how the escrow is structured, be taxed when released rather than at closing.

Rollover equity

In a rollover, the seller reinvests part of the proceeds in the buyer’s acquisition vehicle, often in the range of 10% to 40% of the seller’s equity in sponsor deals. Properly structured, the rolled portion is tax-deferred: through a contribution to a partnership under Section 721, a contribution to a corporation under Section 351 when the control requirements are met, or a tax-free reorganization. In an F reorganization, the seller’s retained LLC interest is naturally tax-deferred. Rollover offers a second, potentially larger payday at the buyer’s exit, but it is illiquid minority equity whose value depends on the buyer’s leverage and performance. Read the governance, transfer and drag-along terms with the same care as the purchase agreement.

Seller notes

A seller note is deferred purchase price owed by the buyer, typically subordinated to the senior lender. Gain on a note can generally be reported on the installment method under Section 453 as principal is received, which defers tax. The installment method does not apply to depreciation recapture, which is taxed in the year of sale even if the cash has not arrived, nor to inventory. Where outstanding installment obligations from sales during the year exceed $5 million, an interest charge on the deferred tax may apply under Section 453A. The note should carry adequate stated interest; otherwise part of the principal is recharacterized as interest, which is ordinary income.

Earn-outs and contingent consideration

An earn-out pays additional price if the business hits defined targets after closing, typically revenue or EBITDA over one to three years. Earn-outs bridge valuation gaps but carry the highest risk: the seller no longer controls the business, and disputes over accounting and operating decisions are common. For tax purposes, earn-out payments are generally treated as additional purchase price eligible for installment reporting under the contingent payment rules, with a portion treated as imputed interest. If payments depend on the seller’s continued employment, they risk being treated as compensation, taxed as ordinary income and subject to payroll tax.

Mergers and tax-free reorganizations

A merger is a legal mechanism, not a tax result. Under state law, one entity merges into another and the survivor takes all assets and liabilities by operation of law. The three common forms in acquisitions are the direct merger of the target into the buyer, the forward triangular merger of the target into a buyer subsidiary, and the reverse triangular merger, in which a buyer subsidiary merges into the target and the target survives as a wholly owned subsidiary.

The reverse triangular merger is the workhorse when a company has many shareholders. It lets a buyer acquire 100% of the company with the approval threshold set by state law and the charter, rather than needing every shareholder to sign a stock purchase agreement, while keeping the target entity, its contracts and its permits in place. For tax purposes, a cash reverse triangular merger is treated as a stock purchase, and a forward merger for cash is treated as an asset sale followed by a liquidation.

When a buyer pays mostly in its own stock, a merger may qualify as a tax-free reorganization under Section 368, letting sellers defer tax on the stock they receive while paying tax on any cash, or boot. Qualification depends on continuity of interest, meaning a sufficient share of the consideration is buyer stock (40% is a commonly cited benchmark for statutory mergers), continuity of the target’s business, and a business purpose. Reverse triangular mergers have a stricter rule: generally at least 80% of the target’s stock must be acquired for buyer voting stock. These structures are more common when a public company or a large private platform is the buyer.

State taxes and California

State tax can rival federal tax in a sale. California taxes capital gains as ordinary income, with no preferential rate, at marginal rates up to 13.3% for individuals with the highest incomes. California corporations pay 8.84% on corporate income, and S corporations pay a 1.5% entity-level tax in addition to the shareholders’ personal tax. California also does not follow the federal Section 1202 exclusion for qualified small business stock, so a federally tax-free QSBS gain can still be fully taxable in California, and it does not follow federal bonus depreciation, which affects buyers’ state-level benefit from a step-up.

Applied to the worked example, a California-resident C corporation owner in the top bracket selling stock would owe roughly another $2.5 million of state tax on a $19 million gain. In an asset sale, the corporation would also owe California corporate tax on its gain before the liquidating distribution. State residency at the time of sale, the sourcing of gain for nonresidents, and multi-state apportionment for companies operating across states all change the result; owners considering a move before a sale should take advice well in advance, as California reviews such moves closely.

Asset sales also raise non-income-tax state issues. In California, a buyer of a business that does not obtain a tax clearance certificate from the California Department of Tax and Fee Administration can become liable for the seller’s unpaid sales and use tax, and similar successor rules exist for payroll taxes. Transfers of fixtures and equipment can be subject to sales tax, and real property transfers can trigger documentary transfer taxes. These items are usually small relative to income tax but should be on the closing checklist.

Negotiating structure: a practical checklist

Most structural leverage exists before exclusivity. Once a letter of intent is signed, the buyer’s counsel drafts the purchase agreement, and every structural point not settled in the letter becomes harder to win. A disciplined sequence helps.

• Confirm the entity’s tax classification and history: C or S status, date of any S election or conversion, ownership changes, and whether all S corporation requirements have been met continuously.
• Model after-tax proceeds for each plausible structure, at both federal and state level, before going to market, so that offers can be compared on a net basis.
• Ask every bidder to state its intended structure, tax elections and treatment of rollover in the letter of intent.
• For S corporations, expect an F reorganization or election request; quantify the incremental tax and ask for a gross-up where it is material.
• Agree the purchase price allocation principles early, supported by an equipment appraisal where equipment values are significant.
• Review customer, supplier, lease and license agreements for assignment and change-of-control clauses that affect the choice between asset, equity and merger structures.
• For rollover equity, confirm the tax-deferral mechanism and review the operating agreement, including governance rights, transfer restrictions, drag-along and tag-along rights.
• For seller notes and earn-outs, test subordination terms, interest, acceleration triggers, accounting definitions and the buyer’s operating covenants.
• Engage tax counsel and the company’s CPA before the letter of intent, not after, and keep them involved through closing and the first post-closing tax filings.

How Laurent Capital helps

Laurent Capital advises owners of lower middle market companies on sell-side processes, recapitalizations and exit planning. We work alongside each client’s tax and legal advisors to model after-tax proceeds by structure, compare offers on a net basis, and negotiate structure, allocation, gross-ups and consideration terms while competitive tension is still present. If you are weighing a sale in the next few years, an early conversation about structure is often the most valuable one.