C-Corp-Complex Purchase Ideas

[John L]

I have a client that is looking to purchase a company primarily for its intellectual property. Upon commencing due diligence, we discovered that the target (Co A) was a C-Corp. About 52% of the shares are held by individuals (including the founder) and the remainder is held by another C-Corp (Co . Co B sole function is to hold shares of Co A. All of shareholders of Co B are also shareholders of Co A. Both Co A and Co B have NOL’s and related party debt. The founder has a controlling interest in Co B and combined with his ownership in Co A is the majority shareholder.

The “stain” of the C-Corp is making the transaction uneconomical for both parties. As a workaround, we were trying to figure out a way to enter into a licensing agreement that would effectively shut down Co A, give the acquirer/licensor full access to the intellectual property and push the licensing payments to the owners without incurring a double taxation. I have an idea that might work but I wanted to run it past some of our experts.

I propose the following:

Set up a new LLC (LLC A) and have all the shareholders of Co A and Co B transfer their shares into the LLC in exchange for LLC membership interests (preferably a non-taxable transaction). The LLC will assume the debts of the C-Corps (and probably wipe out the NOL’s of the C-Corps). In exchange for assuming the debt, Co A will allow the LLC to enter into a licensing agreement whereby the intellectual property of Co A can be used by the acquirer. The LLC receives all payments from the licensing agreement. Any remaining funds are distributed to the LLC members.

With that in mind, does anyone have any comments about the above structure or suggestions on a different approach?

[Nashville]

Comments

John, I'll offer a few comments, and add that we are a very incisive group for tax effects, but I would suspect very few of us are adept at subjects such as business combinations. Some of us may be, and I hope they will post.

First thing, what kind of entity is the new LLC? If a C corp, it becomes part of a "controlled group." If an S corp, it may be subject to the excess net passive income tax if indeed this is (in substance) a tax-free reorganization outgrowth of a C corp. If a partnership, have fun with the inside/outside basis.

Secondly, the licensing agreement avoids transfer of title. I'm not sure this is what the buyer wants, but if so, then so be it.

In general, I am not a big fan of littering the roadside with "empty shells" of entities. But owners are big supporters of inert corporations which allow them to escape capital gains. They're just kicking the can down the street though.