Deal structure

Deal structure refers to how an acquisition is legally and economically assembled. The most consequential decision is whether the buyer purchases the target's equity (stock) or its assets, because the choice drives the allocation of liabilities, the tax outcome for both sides, and the consents required to close. Beyond the asset-versus-stock choice, "deal structure" also covers the form of consideration (cash, stock, earnout, seller note, rollover equity), the legal mechanics of any merger (forward, reverse triangular, statutory), and the indemnification architecture (escrow, holdback, R&W insurance, indemnification).

The two basic choices

Stock (equity) purchase

The buyer purchases the shares of the target entity directly from its shareholders and takes the company as a going concern — all of its assets and all of its liabilities, known, unknown and contingent. Contracts, licences and permits generally remain with the company and transfer automatically by virtue of the entity having a new owner rather than a new contract counterparty.

• Mechanics: stock-purchase agreement signed between buyer and selling shareholders. The target entity itself is not a party to the actual sale (though it makes representations to the buyer). At closing, share certificates (or book entries) transfer.
• Liabilities: all of them — known, unknown, contingent, undiscovered. The buyer is protected only by representations and warranties, indemnification and any R&W insurance policy.
• Tax basis: generally no step-up. The target's existing tax basis in its assets carries over.
• Consents: typically minimal. Contracts that don't have "change of control" assignment provisions transfer automatically.
• Seller tax outcome: capital-gains treatment for the selling shareholders. Single layer of tax.
• Buyer tax outcome: no incremental depreciation or amortisation from a basis step-up. Goodwill paid for in the deal is not deductible for tax purposes.

Asset purchase

The buyer acquires specific identified assets and assumes only specifically assumed liabilities, leaving unwanted obligations behind with the seller. The seller entity itself survives the transaction (often only briefly, before being wound up).

• Mechanics: asset-purchase agreement between buyer and the target entity (with the shareholders consenting). At closing, an exhibit lists the assets being acquired (real estate, equipment, inventory, contracts being assumed, customer lists, IP, goodwill) and the assumed liabilities.
• Liabilities: only those expressly assumed in writing. Successor-liability doctrine creates exceptions in some U.S. states (de facto merger, mere continuation, fraudulent conveyance), but the general rule is that the buyer takes only what it agreed to take.
• Tax basis: the buyer gets a step-up in the tax basis of the acquired assets to the price paid. The step-up generates future depreciation deductions on tangible assets and amortisation deductions on intangibles and goodwill (the latter over 15 years under U.S. IRC §197).
• Consents: many — most third-party contracts, leases, licences, permits and customer relationships require explicit consent to be assigned. Healthcare and government-contracts deals can require dozens to hundreds of consents.
• Seller tax outcome: generally taxable at the entity level (for C-corps, often a double layer of tax — first at the entity on asset gains, then at the shareholders on the distribution of proceeds). For S-corps, LLCs and partnerships, single layer at the owners' level, but with potentially different rates on different asset classes (ordinary income on depreciation recapture and inventory, capital gains on goodwill).
• Buyer tax outcome: future depreciation and amortisation on the stepped-up basis. Goodwill amortisable over 15 years.

Side-by-side comparison

Why buyers prefer asset deals (and sellers prefer stock deals)

The conflict between the two preferences is structural, not personal:

Buyers prefer asset deals because (1) they can cherry-pick assets and leave behind unwanted liabilities, dramatically reducing post-close exposure to undisclosed claims; (2) they get a basis step-up worth real money — a $30M deal with $20M of stepped-up basis amortisable over 15 years is roughly $7M of nominal future tax shield (≈ $2–3M present-value benefit at typical discount rates); (3) successor-employer issues are easier to manage; (4) anti-assignment provisions in unwanted contracts give the buyer leverage to drop them.

Sellers prefer stock deals because (1) they exit cleanly with a single layer of capital-gains tax rather than facing the C-corp double tax or the ordinary-income rates on depreciation recapture; (2) they don't get stuck with stub liabilities the buyer didn't want; (3) the consent process is simpler, which raises closing certainty; (4) they don't need to wind up the entity post-close.

In typical mid-market deals, the asset-vs-stock issue is one of the largest single negotiating points, and the answer is rarely "yes, asset deal" or "yes, stock deal" but rather a structure that captures asset-deal benefits while delivering stock-deal tax treatment to the seller.

Bridging the tax gap: §338(h)(10) and §336(e) elections

Because buyers want the step-up and sellers want capital-gains treatment, U.S. tax law offers elections that let a transaction be a stock sale legally but be treated as a deemed asset sale for tax purposes, getting both:

• Section 338(h)(10) election — available in the acquisition of an S-corporation or a corporate subsidiary in a consolidated group. Joint election by buyer and seller required. Treats the stock sale as a deemed asset sale at the target level for tax purposes; the seller pays tax as if it sold assets, and the buyer gets a basis step-up in the assets. The seller's tax cost is usually higher than a pure stock sale; the buyer's benefit is captured in a higher purchase price ("338 gross-up") that compensates the seller for the extra tax.
• Section 336(e) election — similar concept, available in some additional contexts (notably for certain partnership-like S-corp structures), unilateral by the seller.
• F-reorganization — pre-deal restructuring of an S-corp into a holdco / opco structure, which then enables a stock sale of the opco LLC that gets asset-sale tax treatment for the seller via the LLC's pass-through nature. Particularly common in lower-mid-market home-services M&A.

The economics of the 338(h)(10) gross-up depend on the seller's tax basis and the spread between capital-gains and ordinary-income rates. A competent transaction advisor models the alternatives at LOI stage and prices the trade-off into the negotiation.

Tax-free reorganizations under Section 368

A transaction can be tax-deferred to selling shareholders if it qualifies as a reorganization under Section 368 of the U.S. Internal Revenue Code. The most common categories in M&A:

• Type A — statutory merger, stock-for-stock or stock-and-cash within continuity-of-interest limits.
• Type B — solely-stock-for-stock acquisition; the acquirer must end up with control (≥80%).
• Type C — solely-stock-for-substantially-all-assets, with limits on assumed liabilities.
• Type F — mere change in form (the F-reorg structure noted above).

Tax-free treatment requires meeting specific continuity-of-interest, continuity-of-business-enterprise and business-purpose tests. Failure of any one re-characterises the deal as fully taxable. In private-company M&A the tax-free path is uncommon because most deals involve cash; it is more relevant for stock-for-stock acquisitions of public companies.

Other structural elements

Form of consideration

• All cash — certainty for the seller; buyer uses cash and/or financing.
• All stock — share-for-share exchange; can be tax-deferred under Section 368; exposes seller to buyer's stock-price risk.
• Mixed — most common in private deals: cash at close, earnout, seller note, rollover equity, escrow or holdback.

Merger mechanics

If the deal is structured as a merger (rather than a pure stock or asset purchase), the choice among:

• Statutory merger — target merges into buyer; target ceases to exist.
• Forward triangular merger — target merges into a buyer subsidiary; target ceases to exist.
• Reverse triangular merger — buyer subsidiary merges into target; target survives. The most common public-company acquisition structure because target contracts and licences are preserved.

Indemnification architecture

• Escrow — typically 5–10% of price held by a third party for 12–24 months.
• Holdback — buyer retains a portion of price for offset; functionally similar to escrow with the buyer in control.
• Indemnification caps and baskets — limits and thresholds on indemnification claims.
• R&W insurance — replaces or supplements the escrow with insurance coverage. Standard at $20M+ private deals; increasingly common at $10M+.
• Survival periods — how long the seller's reps survive closing. Fundamental reps survive longer (often indefinitely); general business reps typically 12–24 months; tax reps until the relevant statute of limitations.

Working-capital adjustment

A negotiated target level of net working capital, with a true-up at closing and again 60–120 days post-closing as final balance-sheet figures are finalised. Variances above or below the target move price dollar-for-dollar — a poorly-negotiated peg can quietly cost a seller six figures.

How structure interacts with deal size

Deal-structure preferences differ across the deal-size spectrum:

Frequently asked questions

What is the difference between an asset purchase and a stock purchase?

In a stock purchase the buyer acquires the target's equity and inherits the entire entity, including all liabilities. In an asset purchase the buyer acquires specific identified assets and assumes only specified liabilities, with the seller entity surviving the transaction. The two structures have meaningfully different tax, liability and consent consequences.

Why do buyers prefer asset deals?

Buyers get a step-up in the tax basis of the assets (worth significant future tax deductions), can leave behind unwanted liabilities, and can pick which contracts to assume. Sellers usually prefer stock deals because they exit cleanly with capital-gains tax treatment.

What is a 338(h)(10) election?

A joint U.S. tax election by buyer and seller that treats the legal stock sale of an S-corporation or corporate subsidiary as a deemed asset sale for tax purposes. The buyer gets the asset-deal basis step-up; the seller pays tax as if it sold assets (typically a higher cost than a pure stock sale, compensated by a "338 gross-up" in price).

What is an F-reorganization?

A pre-deal restructuring of an S-corporation into a holdco / opco structure under Section 368(a)(1)(F) of the U.S. Internal Revenue Code. The opco is dropped into a new LLC. The buyer then purchases the LLC interests in what is legally a stock sale but tax-treated as an asset sale due to the LLC's pass-through nature. Common in lower-mid-market home-services M&A.

What is a reverse triangular merger?

A merger structure in which the buyer creates a wholly-owned subsidiary, then merges that subsidiary into the target. The target survives, having absorbed the subsidiary, and becomes a wholly-owned subsidiary of the buyer. Used widely in public-company M&A because target contracts, licences and permits stay with the surviving entity automatically.

What is the difference between an escrow and a holdback?

Both are mechanisms to hold back a portion of the purchase price post-closing for indemnification. Escrow is held by an independent third-party escrow agent under a separate escrow agreement; holdback is retained by the buyer. Escrows are more standard in mid-market and larger deals; holdbacks are more common in smaller deals where escrow agent fees are disproportionate to the amounts involved.

What is R&W insurance and when is it used?

Representations and warranties insurance (R&W or RWI) is an insurance policy that pays out for breaches of the seller's reps and warranties, replacing or supplementing the indemnification escrow. Standard at $20M+ private deals; increasingly common at $10M+. Premium typically 2.5–3.5% of policy limits; retention ("deductible") typically 0.75–1.0% of enterprise value.