An asset deal gives the buyer a stepped-up tax basis. What it is worth depends on how fast the deductions arrive and what the structure costs the seller.
A step-up is worth the present value of the extra tax deductions it creates, not the step-up times the tax rate. On a 90.0 million step-up at a 25 per cent tax rate, with 15.0 written off over five years and 75.0 of goodwill over fifteen, the deductions save 22.50 million in total but are worth 12.35 million today at 10 per cent, 10.3 per cent of a 120.0 million price. Grossed up, because extra price is itself amortised, the buyer can pay up to 14.14 million more for an asset deal than for a share deal.
Worked in full in Mergers and Acquisitions by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A fictional buyer can acquire a US target either by buying its shares or by buying its assets. In a share deal the target keeps its historical tax basis. In an asset deal the buyer takes the assets at the price paid, and the excess over the old basis becomes deductible. All figures are illustrative, in millions.
| Input | Value |
|---|---|
| Price, either structure | 120.0 |
| Tax basis of the net assets | 30.0 |
| Step-up allocated to equipment | 15.0 |
| Equipment recovery period (illustrative, straight line) | 5 years |
| Step-up allocated to goodwill and intangibles | 75.0 |
| Tax amortisation of goodwill (US section 197) | 15 years |
| Buyer's tax rate | 25% |
| Discount rate for the tax savings | 10% |
Step-up = price − tax basis = 120.0 − 30.0 = 90.0
Equipment: 15.0 / 5 = 3.0 a year, saving 3.0 × 25% = 0.75 a year for five years
Goodwill: 75.0 / 15 = 5.0 a year, saving 5.0 × 25% = 1.25 a year for fifteen years
Tax saved in each of years 1 to 5 = 2.00; in years 6 to 15 = 1.25
Each stream is a level annuity, so its present value is the annual saving times the annuity factor at 10 per cent.
Annuity factor = (1 − (1 + r)−n) / r: 3.7908 for five years, 7.6061 for fifteen
Equipment: 0.75 × 3.7908 = 2.84
Goodwill: 1.25 × 7.6061 = 9.51
Value of the step-up = 2.84 + 9.51 = 12.35
Excel: =PV(10%,5,-0.75)+PV(10%,15,-1.25)
The undiscounted saving is 90.0 × 25% = 22.50. Discounting keeps 54.9 per cent of it, because more than four fifths of the step-up, 75.0 of 90.0, is goodwill recovered over fifteen years. The longer the recovery period, the wider the gap between the two numbers, which is why the allocation of the price between asset classes matters as much as the step-up itself.
If the buyer pays more for the asset deal, that extra price is also stepped-up basis, almost all of it goodwill, and it too is amortised. Each extra unit of price returns 25% × 7.6061 / 15 = 0.1268 in present value. The maximum premium P therefore solves P = 12.35 + 0.1268 × P.
Maximum extra price = 12.35 / (1 − 0.1268) = 14.14
The buyer is indifferent between 120.0 for the shares and 134.14 for the assets.
For the buyer, the asset structure is worth 12.35 at an unchanged price and justifies paying up to 14.14 more. Whether the deal can be done that way depends on what it costs the seller. If the target is a C corporation selling its assets, it pays corporate tax on the 90.0 gain straight away: 22.50 at the same 25 per cent, before its shareholders are taxed again on the distribution. The buyer's benefit, 12.35, is only 0.55 times that corporate tax, a shortfall of 10.15. The shareholder-level tax falls somewhat because less is left to distribute, but in a case like this one not by enough to close the gap, so no price adjustment can make both sides better off.
The step-up earns its place where the seller's extra cost is small: a seller with tax losses to absorb the gain, or a pass-through owner for whom an asset sale (or a section 338(h)(10) or 336(e) election on a share sale) changes the character of part of the gain rather than adding a second layer. These elections have eligibility conditions and their effect depends on the seller's facts, so treat this paragraph as an illustration of the trade-off, not as tax advice. If the asset structure costs such a seller an illustrative 5 extra points on the 90.0 gain, 4.50, the buyer's 12.35 leaves 7.85 of value to share across the price.
| Discount rate | Tax 21% | Tax 25% | Tax 30% | Max extra price at 25% |
|---|---|---|---|---|
| 8% | 11.50 | 13.69 | 16.43 | 15.97 |
| 10% | 10.37 | 12.35 | 14.82 | 14.14 |
| 12% | 9.42 | 11.22 | 13.46 | 12.65 |
The tax rate moves the value proportionally; across this range the discount rate moves it less, though it still matters because most of the value sits in goodwill recovered over fifteen years. Which rate to use is a judgement: the deductions are only worth anything if the combined business has taxable profit to use them, so a rate near the cost of equity is more defensible than the cost of debt for a target whose profits are uncertain.
Valuing the step-up at 90.0 × 25% = 22.50 and adding that to the bid. That overstates the benefit by 10.15, 82 per cent more than it is worth, and wins the auction by paying the seller with money the tax authority will hand back only over fifteen years. The second mistake is the reverse: forgetting the gross-up and capping the premium at 12.35 when 14.14 is the true break-even. The third is assuming a share deal behaves the same way: there the fair value step-ups exist only in the accounts, they create a deferred tax liability rather than a deduction, as shown in how to calculate goodwill in an acquisition.
The tax rules used here (section 197 amortisation over fifteen years, straight-line equipment recovery, the section 338(h)(10) and 336(e) elections) are US rules simplified for illustration. Bonus depreciation, state taxes and the timing of the purchase within the tax year change the figures; check them with a tax adviser for a real transaction.
The book prices one deal seven ways and allocates its price, deferred tax included, in the free workbook for this case. The small business version of the allocation, where buyer and seller pull in opposite directions, is in how to allocate the price in a small business asset sale.
For tax, usually yes, because the buyer depreciates and amortises the assets at the price paid. In the illustrative case the step-up is worth 12.35 million in present value on a 120.0 million price. Whether the structure is better overall depends on the seller: a C corporation selling assets pays 22.50 of corporate tax on the gain at once, more than the buyer gains.
In the United States, section 197 intangibles acquired in an asset deal, goodwill included, are amortised straight line over 15 years for tax, whatever their accounting treatment. That slow recovery is why 75.0 of goodwill step-up, saving 1.25 a year at 25 per cent, is worth only 9.51 today at a 10 per cent discount rate.
Extra price paid for an asset deal is itself added to the stepped-up basis and amortised. Each unit of extra goodwill returns 0.1268 in present value at 10 per cent and 25 per cent tax over fifteen years, so the break-even premium is 12.35 / (1 - 0.1268) = 14.14, not 12.35.
This article is one calculation from Mergers and Acquisitions. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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