Hi Reader

If you've been around business acquisition circles for any period of time you've undoubtedly heard of the "F reorg."

It's one of the most powerful buyer tactics but also one of the most misunderstood.

After closing upward of 140 deals and helping folks plan many more, I've seen lots of angst about F reorgs:

• Misunderstanding what it is
• Bad advice about how to do it
• Worry about complication
• Concerns over deal delay
• Mistakes (including bad ones) when folks other than tax lawyers orchestrate the reorg

So, in today's issue of Buyers Black Book I'm breaking down this critical deal tactic to give you the real deal on the what, when, why, and how of F reorgs to help you be a smarter buyer.

Caution: don't ask ChatGPT or Grok to help you explain F reorgs. Out of all the M&A topics out there, I've found their explanations and answers on F reorgs to be the worst. The aspects of F reorgs where the information there is 100% wrong is scary-dangerous.

What is an F-Reorg?

Let's discuss exactly what an F reorg (in the context of M&A deals) is.

From a 50,000 ft view, an F reorg is a pre-closing, tax-free reorganization of the target company's structure to permit a stock (or membership interest) purchase while accomplishing certain important buyer (and seller) goals.

Though there may be minor variations, the steps in an F reorg typically involve the following:

1. Seller creates a Holding Company ("Holdco")
2. Seller contributes 100% of their ownership of Target to Holdco in exact proportion to current ownership
3. (Optional) If Target is a corporation, it must perform a state conversion to become an LLC
4. Holdco elects to treat Target as a Qsub
5. Target chooses to be a disregarded entity for federal tax purposes
6. Buyer buys Target from Holdco

Why F-Reorg?

An F-reorg is a powerful deal tactic that helps to accomplish certain buyer and seller goals while avoiding certain deal traps.

Before we dive into the goals met and traps avoided, there is one threshold consideration to keep in mind:

Here are the buyer goals that an F-reorg helps to meet:

1. Tax Step-up. An F-reorg results in a step-up for purposes of federal taxation for all of the assets purchased. This can be a very important consideration for you, especially for targets that own a good amount of physical/tangible assets. In a stock purchase structure, without a step-up, you would otherwise assume the seller's basis in the assets. Usually, they've long since fully depreciated their assets already so you would lose out on important depreciation expense that can negatively affect cashflow, While a "336(e) election" is another tool that can also help you get a step up on a stock purchase deal, it isn't as guaranteed as an F-reorg. If the seller had ever violated S-corp rules (like had a de-facto second class of stock/equity) or improperly filed for the S-corp election in the first place, both of which are not uncommon, then if you got audited, you could lose out on the asset step-up.
2. Purchase Through Entity. There are two ways you can purchase and own the stock of the target: either individually or through an entity. Anytime you have business partners or investors, you will need to purchase through an entity. When the target is taxed as an S-corp, purchasing through an entity creates an immediate violation of S-corp rules. As a result, at closing, the target gets converted from an S-corp into a C-corp resulting in a pretty different (and unfavorable) tax picture for you.
3. Keep EIN. Often, it can be important for you to keep the target's EIN for contracting, certification or other purposes. An F-reorg permits you to keep the same EIN while having the benefit of a tax step-up.

Here are hidden tax traps that F reorgs help you avoid:

1. Tax "Penalty". This one is for sellers who are keeping equity (rare now with new SBA rules). An F-reorg helps them avoid paying more taxes than needed. Specifically, without an F-reorg, a seller who retains equity is always treated as having sold 100% of their equity. So, even if they sell 90% and keep 10%, for federal tax purposes, they are treated as having sold 100% (and rolled 10%). Depending on deal size, this can be a pretty big hit for sellers and this unfair tax treatment is avoided with an F-reorg.
2. Historic Reclassification Risk. A significant tax risk when purchasing an S-corp target as a stock purchase is that of historic reclassification. Specifically, if the seller has ever violated S-corp rules or even improperly elected in the first place, an IRS audit could result in a retroactive reclassification of the Target into a C-corp resulting in significant retroactive taxes and penalties. As the new owner of the Target, you would be responsible for those taxes and penalties (though those are almost always losses for which the seller would have to indemnify you).

When To Broach the Issue?

I often have buyers ask me when they should discuss the need for an F-reorg on their deal with the seller team.

My answer is always "as early as possible."

The F-reorg topic always creates ltos of seller angst including cost, deal delay, fear about tax consequences, and just because it "sounds complicated."

So, giving the seller plenty of time to get comfortable with it (and making sure that bringing it up later in the deal isn't seen as "retrading") is key to successfully using this tool.

Important note: Given the complication of the F-reorg process (and if done wrong, it will result in negative tax consequences for both you and the seller) I always recommend that it be done by a tax lawyer. Of course tax lawyers don't come cheap so expect a price tag of $5-10K+ for adding an F-reorg to the deal.

To recap, I usually recommend that F-reorg discussions be held pre-LOI and for the LOI to clearly state:

• An F-reorg would be needed
• It needs to be done prior to closing by the seller
• Who will pay for the F-reorg costs

Pro-Tips for F-reorg Success

After working on over a dozen F-reorg deals, here are my best tips for F-reorg success:

1. Early discussion and inclusion in LOI (yes, I know I just mentioned it, but this is so important I have to reiterate)
2. Introduce trusted tax lawyers to seller team early so they can get correct info on what it is and what it entails. Seller advisors giving sellers wrong advice, or sellers doing internet research on F-reorgs can be very problematic. All of the F-reorg savvy tax lawyers I work with are available to consult with the seller team to explain the process including provding an easily understandable slide deck to show them the process.
3. Ensure a tax lawyer you trust is either directly handling the F-reorg or reviewing the process for you. I specifically keep a roster of trusted tax lawyers in my rolodex and offer to either introduce to seller counsel so seller can engaged directly, or offer to my buyer clients so they can review to make sure it's done right. Improperly filed F-reorgs can cause significant deal delays or even result in unintended tax consequences for both you and the seller.
4. Choose an experienced SBA lender who is not daunted bo the F-reorg process. While working with smaller lenders may seem like a good idea (low promotional rates might seem attractive for instance) it can be a nightmare when it comes to understanding the F-reorg process. I've had more than one deal get delayed unnecessarily because of lender inexperience. One even got so overwhelmed by a straight-forward F-reorg deal that they submitted the whole thing to the SBA for general processing (which adds weeks of time and lots of uncertainty) even though they were a PLP lender (so could internally approve the loan). Working with the right SBA lender is always important, but it is critically important when you have F-reorg in your deal structure.

At the end of the day, an F-reorg isn’t just a tax maneuver—it’s a credibility test. The 99% of buyers either miss it, mishandle it, or bring it up too late. The 1% recognize it early, frame it correctly, and bring the right professionals to the table. That’s how you turn a potential landmine into a competitive edge. If you’re serious about closing clean deals and protecting yourself from costly mistakes, treat the F-reorg as non-negotiable—and handle it like a pro.

Stay sharp,

Eric

Publisher, Buyers Black Book

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