A private equity buyer wants us to do an F-reorganization before closing so they can get an asset step-up while we rollover equity. How does this structural move affect our tax liability and what terms do we need to secure in the transaction documents?

Question

Tyler Smith · Accepted Answer

If a private equity buyer wants to buy your S Corporation while requiring you to roll over equity, they will likely insist on an F-reorganization. This three-step restructuring involves creating a new holding company, merging your existing operating company into it, and then converting the operating company into a single-member LLC. This structure is highly beneficial to the buyer because it allows them to treat the transaction as an asset sale for tax purposes, giving them a valuable step-up in tax basis, while allowing you to defer taxes on the portion of your equity that you roll over into the new entity. However, this structure introduces complexity and risk that you must manage carefully. First, ensure the transaction documents clearly state that the buyer is responsible for all legal and accounting costs associated with executing the F-reorganization. Second, you must secure representation and warranty insurance to cover any pre-closing tax liabilities of the old S Corporation, as the new entity will inherit these historical risks. Finally, negotiate a tax distribution clause in the new operating agreement to ensure you receive cash distributions to cover any pass-through tax liabilities on your rolled-over equity, protecting you from paying taxes out of pocket.