Banks and thrifts structured as S corporations could suddenly start looking more attractive to potential buyers.
Though more than five dozen S-corp banks have been sold in the last two years, lawyers and banking consultants said they expect sales to accelerate as hundreds of banks near their 10-year anniversaries as S corporations.
The 10-year mark is significant because, under the Internal Revenue Code, S corporations that sell themselves before then must pay a substantial, built-in gains tax - a cost that the buyer typically absorbs. After the 10-year mark, the companies can structure deals for themselves as so-called asset sales, which would allow them to demand a premium - and let buyers deduct any premium they pay over the next 15 years.
"I'm sure there are quite a number [of S corporations] that have been waiting for that 10-year period to pass so they can take advantage of those provisions," said Ted Eissfelt, the head of the corporate group at Howard & Howard Attorneys PC in Peoria, Ill.
S corporations are small, closely held companies that pass their earnings on to their shareholders. Such companies must have 100 or fewer shareholders and, unlike more conventional C corporations, which are taxed at the corporate level, S corporations are allowed to pass income tax obligations on to their shareholders.
In exchange for the favorable tax treatment, the companies must pay a gains tax if they try to sell their assets before the 10-year period. Congress put this provision in place in 1986 to prevent companies from becoming S corporations to avoid taxes right before selling assets.
Banks were first allowed to become S corporations in 1997. That year 562 did - though some have since been sold - and hundreds more banks and thrifts have converted since then. Today more than 2,200 banks and thrifts, or roughly a fourth of the entire banking industry, are structured as S corporations.
With many S corporations set to turn 10 next year, observers say they expect a number to announce deals to sell themselves this year and close them next year.
Curtis D. Carpenter, a managing director at Alex Sheshunoff Investment Banking Inc. in Austin, said that 10-year-old S-corp banks that sell themselves can expect a premium of about 10% over those that have not reached the 10-year mark.
These banks can also command a higher premium than C corporations, because the buyer can deduct the premium it pays for an S corp. Buyers do not realize the same tax savings when they acquire C corporations.
Currently "there is practically zero difference in prices paid for C corps and S corps," Mr. Carpenter said.
In the last two years, he said, there were 411 deals for C-corp banks, in which buyers paid an average of 2.17 times the book value and 23 times earnings. The average numbers for the 69 S-corp deals were nearly identical - 2.16 times book and 23.1 times earnings.
"Beginning next year, we're going to start to see a separation," Mr. Carpenter said.
John Ziegelbauer, a managing partner with Grant Thornton LLP's national financial institutions practice, gave an example of a hypothetical bank that converted from a C corporation to an S corporation in 1997 and wants to sell itself for $70 million.
Assuming the bank has a $20 million book value, under a deemed asset sale, the buyer would have $50 million that it could record as tax-deductible goodwill. The buyer could take the tax deduction over the next 15 years and save $17.5 million in taxes, according to Mr. Ziegelbauer's calculations.
Without that deductible goodwill, the buyer may not be willing to pay the price the sellers are asking, he said.
Because deals take a long time to negotiate, Mr. Ziegelbauer said, he expects many S corporations to begin discussions with prospective buyers this year. Grant Thornton would advise its clients that will celebrate 10 years as S corporations next year to hold off on closing any deals until then, he said.
"There is going to be extra money on the table" for S corporations next year, Mr. Ziegelbauer said.
Mr. Carpenter also predicted that more C-corp banks might adopt S-corp status as they see the prices being paid for them.
"I think some of the C-corp banks who are pondering converting to S-corp status will do it because not only are there the short-term tax advantages, but there is a longer-term benefit: If you do ever sell the bank, you'll get a higher price for it," he said.
