When purchasing a business, the transaction can be structured in one of two ways: an asset purchase or a share purchase. There are significant differences between the two that should be understood prior to the negotiation process.
In an asset purchase, the buyer is purchasing the assets of a business, i.e. everything the business owns, such as furniture and equipment, office supplies, phone numbers, trademarks and other intangibles such as goodwill (i.e., client/customer base).
In contrast, a share is a piece of paper or “share certificate” which represents ownership of a certain percentage of a company. To buy all shares of a company is to become the owner of that company. In this discussion, ‘Business’ refers to an incorporated company. Non-incorporated businesses such as sole-proprietorships do not have shares and can only be purchased through an asset deal.
Each of these methods has advantages and disadvantages and is beneficial in different ways to different parties involved. Generally speaking, those selling a business prefer a sale of shares and purchasers prefer an asset purchase. To understand this generally, it is important to first appreciate the legal consequences of each deal structure.
Asset Deals:
Asset deals are often analogized to cherry picking. As the name implies, the buyer of the business can pick and choose which assets to purchase and which to leave behind. This often includes the name of the business and phone numbers. With this type of purchase, buyers should be careful to list all the assets they wish to purchase. Unless the agreement is for the purchase of all assets of all types, the agreement would only include and be enforceable for what has been specifically included in the deal. Even if the purchase involves all assets of the business, to the extent practicable, the buyer should have a list of assets. One advantage of this type of purchase is that the buyer has a clean slate in terms of the company history and would not be liable for things such as unpaid taxes or rent of the corporation, unless specifically agreed upon in the agreement of purchase and sale.
One important aspect of an asset deal is the allocation of the purchase price. This is a clause that is often left to be dealt with at a future date. A vigilant lawyer would want to specify this allocation in the purchase and sale agreement and not leave it to be agreed upon after the closing date. The allocation of the purchase price, meaning the value of purchased assets broken down into categories (equipment, furniture etc.) is important and can have serious accounting consequences if it is not treated with care.
For example, if the value of a computer is set at $2,000, but it was purchased and recorded in the books of the company as $1200, there is an $800 tax triggering gain. As a seller, you should consult your accountant for an accurate accounting of these figures.
Share Deals:
A share deal involves buying the company, the good and the bad. It simply places one owner in the shoes of another. The buyers become the owner of the company, its reputation, its liabilities, its assets, its good or bad credit and everything else the history of the company entails–including liabilities that the buyer may currently be unaware of. Sellers prefer this type of transaction because, as per the Income Tax Act, the seller has a $750,000 capital gains tax exemption. This means up to $750,000 of the gain from the deal will be entirely tax free to the seller.
Choosing and negotiating the best type of deal is ultimately based on your needs, the leverage each party has, and the particulars of the business. Knowledge of the particulars of each sale or purchase method and how and to what extent they benefit the players involved will allow you to be in a better bargaining position. Most importantly, you should engage a lawyer who is well versed in corporate matters as early as possible in the process to ensure that your interests are protected. Once your lawyer has assisted in drafting the agreement, make sure you consult with them prior to making or agreeing to any changes.