4. Ambiguities: If you find the facts given to be insufficient to answer a question, state any additional factual assumptions you deem necessary and answer the question as though your assumptions were a part of it. However, do not make the mistake of changing the question by changing the given facts. Some of the necessary facts may be missing; part of your assignment is to identify what additional facts you need, ask for them, and discuss precisely how those additional facts would change your answers and recommendations.

5.

Seth Paisley is the chief executive officer, president, and a director of Red Rock Energy Publishing Company, Inc. (Red Rock Co.), a California Subchapter C corporation. Red Rock was formed as a Subchapter C corporation in the 1970’s by Seth’s parents, Breeze and Mitchell Paisley, when their tie-dyed T-shirt and hippie souvenir business "took off." Red Rock Co. today continues its T-shirt and souvenir business, but business in these divisions of its operations has recently fallen off considerably due to changes in popularity of the subjects portrayed by its products. However, about 5 years ago, Seth joined the business and, for "fun," started a website called redrock.com in which users can electronically send photos and music clips to people for free. Seth sells advertising on the website and funds operations that way, but for the most part the website generates no real revenue. However, it has become wildly popular and a number of other web-based companies are interested in acquiring it, according to Seth.

He seeks your advice as to the tax consequences and the preferred manner of structuring a transaction in which Red Rock Co. would sell its web-based business, redrock.com (the "Website"). Redrock.com was recently listed as one of the five most-visited sites on the Internet. Although it does not charge for its services to visitors to the site, it does sell advertising. As a result of this recent listing of redrock.com as an oft-visited site, Seth has been receiving several phone calls each week from other web-based businesses who wish to acquire redrock.com. The most favorable proposal has come from a web-based public company called ezZone that sells goods through the web as well as offers a search engine to users. ezZone wants to acquire only the Website; it is not interested in acquiring the other assets of Red Rock Co., whose sales and popularity are flagging. However, ezZone is willing to acquire all of the assets of Red Rock Co. if absolutely necessary in order to maximize favorable tax consequences of the acquisition, but would likely dispose of the unwanted assets shortly after the acquisition.

ezZone’s stock is publicly traded on the New York Stock Exchange. It has two classes of stock outstanding, $1 par value common stock and $10 par value voting preferred stock. It has many shares of both common and preferred stock which are authorized but unissued. It can issue new shares of either type of stock; however, assume that, due to federal securities laws, any such newly issued unregistered shares cannot be registered or sold by their holders on the stock market until two years after their issuance.

The stock of Red Rock Co. is privately owned by five individuals, three of whom are related to each other. The other two shareholders are employees of Red Rock Co. Only one class of stock is outstanding; common stock, held 40% by Breeze Paisley, 30% by her husband, Mitchell Paisley, and 20% by their son, Seth Paisley. The other 10% is held equally (i.e., 5% each) by two employees, Richard Settle and Anaya Moon. Breeze and Mitch are nearing retirement and would prefer to receive cash for their stock; Seth intends to continue working in the Website’s business and does not have an immediate need for cash. Richard and Anaya are long-term employees of Red Rock Co. Neither employee has immediate needs for cash. The shareholders’ bases in their Red Rock Co. stock are as follows:

ezZone’s net worth is about $20M and it has about $2M in cash and marketable securities. Red Rock Co.’s net worth is about $1M, including the Website assets. The Website portion of Red Rock Co.’s business is worth about $800K. Red Rock Co. has about $160K in marketable securities and cash (i.e., liquid assets). Richard Settle spends about 80% of his time managing and running the Website business and would like to continue working in that business. Anaya spends all of her time managing and running the T-shirt and souvenir business and would like to continue working in that business; if those divisions of Red Rock Co.’s business are acquired by ezZone, then she will probably dissent from any merger or share exchange proposed between ezZone and Red Rock Co. (e.g., exercise her state law shareholder dissenters' rights). She will then probably insist on receiving cash in exchange for her Red Rock stock. If those divisions are not acquired by ezZone, then she will want to continue working in that business.

The Website’s assets have a total fair market value of $800K, consisting of $50K of cash and marketable securities (with adjusted basis equal to or close to their fair market value), developed software and web pages with a minimal adjusted basis and fair market value of $500K, contract rights with a minimal adjusted basis and a fair market value of $150K, and goodwill worth $100K with a zero adjusted basis. Assume that the Website has no liabilities. All of the other assets of Red Rock Co. have a total fair market value of $300K, or $200K net of a $100K liability, with a total adjusted basis of $375K, which includes the debt of $100K.

Work with your teams to brainstorm all of the various options for ezZone to acquire the Website from Red Rock Co. using only the tools of corporate dividends, distributions, redemptions, and complete liquidations (e.g., Chapters 4-7 only). List the advantages and disadvantages of each option. Then, make your recommendation as to the best way to accomplish all of the objectives of Red Rock and its shareholders. It is possible that no single transaction or series of transactions will satisfy all of their objectives. Even if you ultimately conclude that one structure for the deal is best, please list the consequences of all other options available for this transaction. Finally, list any additional facts that you need in order to render more precise advice on this proposed acquisition. Address your recommendations in a memo to Seth Paisley of Red Rock Co.

Project #2 will ask you to write a two-page memo on the taxable and taxfree options for this acquisition using only the tools of taxable acquisitions and taxfree acquisitions/reorganizations (e.g,. Chapters 8-10 only). It will be due Friday, April 21, 2000.

Teams:

Feel free to work in smaller teams within your Team, if it is easier to do so. Each person on a Team must hand in a individual answer, even if everyone on a Team works together and collectively arrives at a "Team" answer. It is fine for more than one person to hand in the identical, same answer; but individual names must go on each of the papers. If work is handed in as the collective work of more than one person, each person handing it in must truly have substantially contributed to the collective work (i.e., you can’t hand in someone else’s answer as your own just because you’re on a Team together, and people on your Team are not required to allow you to hand in their work as yours just because you’re on their Team).

Team 1: Brooke Carson, Steve Hall, Jim Tackett, Chuck Dargo, Geoff Baker, Keith Michaelis, Chris Goodwin, Sarah Williams, Chris Krisiewicz, and Russ Dempsey.

Team 2: Sean Espy, Eric Cromwell, Cindy Steele, Mike Beldy, Matt Schaeffer, Dara Greene, Joe Sylvester, Barry McConnell, Kristin Denny-Rasmussen, Mei Zhang, and Kelly Yee.

Team 3: Jessica Holleran, Ted Chapman, Tonia Smith, Jay Chakravarti, Melissa Music, Robbin Russell, Raimee Gordon, Cathy Reece, Christy Zimmerman, Laura Allen, and Simon Reeve.

Team 4: Steve Barnhart, Shawn Hiller, Andy Balderson, Scott Griffith, Suzanne Kuhns, Jason Gunsorek, Kevin Burnett, Cathy Tyson, Steve Feldbauer, and Luis Alcalde.