The buyer is structured as a private equity roll up and is demanding we convert our operating company from an S Corporation to a Limited Liability Company before the transaction close to facilitate their tax structure. How does this structural change impact our net proceeds, and what protective provisions must we write into the purchase agreement?

Question

Tyler Smith · Accepted Answer

Converting from an S Corporation to a Limited Liability Company before a transaction is a major structural move. Buyers do this to achieve a step up in the tax basis of your assets, allowing them to write off the purchase price over time. While this benefits the buyer, it can trigger significant tax liabilities for you.

First, evaluate the conversion cost. An S Corporation conversion can trigger built in gains taxes or depreciation recapture depending on how your assets are valued. You must have your CPA run a detailed tax simulation before agreeing to this structure.

Second, if the conversion increases your tax bill, negotiate a tax gross up provision. This clause requires the buyer to increase the purchase price by the exact amount of the additional tax burden, ensuring your net after tax proceeds remain identical to what you would have received in a stock sale.

Third, write strict protective provisions into the purchase agreement. Ensure that the buyer is solely responsible for all legal and administrative costs of the reorganization. Most importantly, require that the closing of the reorganization and the closing of the sale occur simultaneously, so you do not find yourself with a restructured entity if the deal falls through at the last minute.