25 June 2009

Legal and Tax Considerations of Stock Purchase Agreements

When purchasing the shares or units of an Argentine business, the single biggest risk to the buyer are hidden liabilities that do not show up on the company's balance sheet -- hidden tax liabilities being the principal risk. A comprehensive due diligence process is required before closing any transaction in order to determine what taxes and other liabilities are owed.

In many cases, sellers are exiting the business because they have faced losses, are not well capitalized and have been unable to turn a profit. I was involved in just such a transaction with a distressed seller and one of the first measures that businesses with cash flow issues can do to relieve some of that pressure is start to fall behind on social security tax payments (cargas sociales), which represent about 30% of a business' total labor expenses. This was the case in the operation I participated in.

Obviously all debt owed by the company must, at a minimum, be deducted from the agreed upon purchase price. This must be explicitly stated in the share purchase agreement because Argentine law does not hold the seller responsible for hidden debts if there is no clause obliging the seller to take responsibility for these debts in the share purchase agreement.

Moreover, I also recommend buyers to refrain from large upfront payments and structure the purchase agreement with multiple payments over a long period of time in order to give themselves time, even after the transaction has closed, to find hidden liabilities and deduct them from follow-up payments made to the seller.

It is much easier for the buyer to retain a payment to a seller after finding a hidden liability than asking for a seller for reimbursement for the hidden liability after it is uncovered. Remember that although you may request guarantees and the seller may sign a document certifying that they will pay for any hidden liabilities, it will be a long and drawn out process if you need to judicially force a seller to pay back any portion of the purchase price.

The principal advantage of the stock purchase agreement is that the operation is straightforward in an operational, legal, tax, labor, and paperwork sense. Since the company continues to operate normally during and after the sale, the only issues that arise involve actors external to the company -- the buyer and the seller. The employees, assets, liabilities, etc., of the company are not affected by the share purchase.

The sellers of a company, if they are individuals, will no doubt want to structure the operation as a stock purchase agreement due to the fact that gains from the operation are not taxable to them and due to the fact that they are no longer responsible for liabilities after the sale has been completed (unless the share purchase agreement has provisions to the contrary, as I recommended above). Corporate sellers will be required to pay income tax on capital gains from a share sale.

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