Marketing & Promotions
There are many important economic, legal and tax consequences which flow from how a business acquisition is structured. When purchasing a small to medium sized business, there two general ways to structure the acquisition. The first is a share purchase and the other is an asset purchase. Here are some of the more important differences between them.
What are you Purchasing?
In an asset purchase, you are acquiring specific assets belonging to the corporation, therefore title to the assets changes from the corporation to the purchaser. The purchased assets could compromise all of the assets and undertaking of the business, or they may consist of select assets.
Here, there is flexibility as to which assets may be acquired and which liabilities of the business may be assumed. A purchaser could choose to purchase only assets and not assume any liabilities of the business.
However, in a share purchase, a purchaser cannot select which assets it wishes to purchase and which liabilities it wishes to assume. It must acquire the entire undertaking of the corporation, since ownership of the corporation’s shares ultimately result in indirect ownership all of the corporation’s assets and undertaking, including liabilities.
What are the Risks to the Parties?
In an assets purchase transaction, since the purchaser can select which, if any, liabilities it wishes to assume, there is no uncertainty to the purchaser as to the nature and extent of those liabilities. The purchaser assumes only those liabilities specifically agreed to in the purchase agreement and nothing more. The purchase’s liability is therefore fixed.
The legal “due diligence” required to be exercised by the purchaser is not as exhaustive as a share purchase. Such due diligence is generally confined to conducting various assets searches against the corporation to determine that there are no liens or encumbrances against the assets.
Also the numbers of representations and warranties (i.e. promises) given by the corporation in the purchase agreement is far less extensive than in share purchase, since the purchaser specially identifies which liabilities it is assuming and excludes all others by the terms of the purchase agreement.
However, a share purchase transaction is far riskier to a purchaser. The purchaser is acquiring the share of the corporation. Since corporations are considered by law to be legal entities themselves, a purchaser of shares is also indirectly acquiring all liabilities of the corporation, actual or contingent, known or unknown. This means that a purchaser must exercise a much higher degree of due diligence when buying shares of a corporation, and must obtain far more extensive representations and warranties from the owners of the corporation’s shares to safeguard against possible claims which may be made against the corporation in the future.
How are Employees Affected?
As employment laws evolve, the distinction between an assets purchase transaction becomes less significant insofar as it affects the employees.
In share purchase transaction, the status of the employees does not change, since they remain employed by the corporation before and after the sale of the shares. They preserve their seniority, salary, benefits and other advantages which they enjoyed prior to the sale.
In an assets purchase transaction, although employees are technically “terminated” by the corporation and, to the extent agreed to between the corporation and the seller, “hired” by the purchaser, many jurisdictions now have laws in place that preserve the seniority, salary, benefits and other advantages of employment, such the purchaser is deemed to be a “successor” to the corporation and essentially takes over the position of the corporation vis-à-vis the employees.
How are the Third Parties Affected?
All important contracts and agreements between the corporation and its suppliers, customers and other parties, including banks and land lords, must be legally transferred to the purchaser, failing which they are not effective against the purchaser, nor can they be enforced by the purchaser.
In a share transaction, since ownership of the corporate assets is not changing, legal title to these contracts and agreements does not have to change. However, most important contracts and agreements contain restrictions against transferability without the third party’s consent, including “change of control” provisions, which provide that a change of control in the ownership of the corporation is treated the same as a transfer of the rights in the contract. Failure to obtain consent of the third party to the transfer of the contract could lead to a breach under the term of the agreement.
Purchasers should also be mindful of “bulk sales” legislation in certain jurisdictions (In Ontario it is the Bulk Sales Act) which limit or restrict the right of a corporation to sell a significant portion of its assets without adequately providing for payment of all creditors of the corporation.
Are there any Tax Issues which must be Consider?
The simple answer to this question is yes. The tax consequences of the structure you choose can be very important to the decision as to whether to proceed by way of the asset purchase or share purchase. The nature of these differences is outside the scope of this Article, therefore it will not be discussed here. Again, one should consult with a professional adviser regarding the tax issues.
As you can see, the question as to how to structure a purchase can be a complicated one in a medium size business, with many issues to be considered, weighed and balanced against one another. The ultimate decision as to which structure to select will ultimately be based upon which of the considerations weigh most heavily on the parties to the transaction.
by Ben Hanuka, LL.B.