Asset Purchase vs Share Purchase – Which Way To Go?
If you are buying a business—whether an active business or a passive business like real estate—you might have two ways to proceed. You for sure can buy it as a purchase of assets. Or, if the business is contained within a company, you could buy the shares of that company.
What are you buying when you buy assets?
If you are buying assets, you are literally buying all the things that make up the business. For an active business, let’s say a restaurant, you would buy the equipment, the furnishings, the stock of supplies, the “knowhow” of recipes, and you might pay something in addition for the reputation of the business which we call goodwill. Generally, you don’t buy the liabilities. So, you have a bundle of assets, and the overall purchase price is a sum of all these assets. This method is straightforward provided the bundle of assets is not overwhelming to list and value, and is not rapidly changing.
Can you buy shares instead?
If the business is owned by a company (and most larger businesses are), then you have another option– buying the shares of that corporation. (You’ll know it’s a company because the legal name contains Ltd, Corp, Incorporated, etc.) The owners of the Company are your vendors, and they are selling shares. This method might look even simpler since all you are buying is the shares, but it has its own complexity. Therefore, you should carefully consider both methods before deciding how to proceed.
What are you buying when you buy shares?
When you buy the shares of the Company, you are buying everything inside the Company on the closing date. Taking this apart, we see you are buying all the assets and all the liabilities, which includes inventory, work in progress, accounts receivable, equipment, possibly cash on hand; and debt, accounts payable, pending lawsuits. You are also buying the history of the Company, which means any unknown liability that becomes known later, such as lawsuits not yet started, and CRA audits in the future covering the time before you became owner—these are ‘skeletons in the closet’ that you buy when you buy the shares of the Company. You also buy these on the date of closing, so you must be clear about what you expect to be in the Company at closing. Do you expect that major debt to be paid off on closing? How much in receivables and payables do you expect there to be on closing?
Another major issue is employees. When you buy the Company, the employees come right along with it. There is no stop or start with their employment, so all their seniority carries on, and this determines how much compensation the Company would owe if they were terminated after closing. When you buy shares, the vendor is probably getting a capital gain on the value of their shares, which may be a tax advantage. Your cost base on the shares is their value at closing date. All parties will need good accounting advice on how this affects each side.
Finally, when debating a share or asset purchase, you will want to consider that the Company might have unique or valuable contracts in place that cannot easily be assigned. For example, a lease of commercial space, or contracts for the use of intellectual property, or contracts with customers and suppliers. When you buy shares, the Company continues to own all these without any interruption.
Which method is better?
Each deal has its complexities, and must be considered on its own, but here are some very general observations:
- If you trust that the vendor ran the Company cleanly, filed taxes properly, and generally was honest and organized, then you can consider buying shares. If you don’t trust the vendor on this, then there are just too many unknowns that cannot be quantified, and it’s better to buy assets.
- If you only want some of the assets or some of the liabilities and want to leave the rest inside the Company, then you probably have to buy assets.
- Creating the documentation for a share purchase is more complicated, as there are more items that have to be negotiated between the vendor’s lawyer and your lawyer. If there is a lack of trust or cooperation between the parties, then a share purchase is harder to get done, and so an asset purchase may be preferred.
- If the Company has a lot of problematic employees, consider buying just the assets. This leaves the employees still with the Company, which is still owned by the vendor.
- If the business consists mainly of land, consider buying by way of shares as this avoids you having to pay the property transfer tax. (At least for now—we expect the provincial government may close this off in the near future.)
- There may be tax reasons, especially for the vendor, to want to sell shares. This can become an opportunity for you to bargain for a lower price so the tax benefits are effectively shared between the vendor and you as the purchaser.
- If the Company has unique or valuable contractual arrangements in place, you may need to buy shares in order to “buy” your way into these contracts.
This article is just an overview of assets vs share purchase. Each deal needs its own legal and accounting due diligence. Because of this, you should never expect that a deal written as an asset purchase can just be swapped out for a share purchase. While it’s a good idea to have these two options, deciding which way to go takes its own time and work. Therefore, a final takeaway: make sure to get accounting and legal advice as early as possible in the process. I would suggest a minimum of one month, or better yet two or three months, between striking the deal and closing, to allow sufficient time to document the transaction, work through due diligence, and prepare for closing.
© Linley Welwood LLP. The contents of this article do not constitute legal advice. Readers should seek legal advice in relation to their own specific circumstances.