Selling Assets or Shares – Which is right for you?
September 17, 2019
A common question we are asked when planning the sale of a business is do you sell assets or shares? In our experience, the following scenarios would not be considered uncommon:
your accountant tells you to sell shares for tax purposes, or;
your friend tells you to sell assets, because that is what his lawyer advised him to do when he was selling his business, or;
you are looking to buy a business and your lawyer and accountant tell you not to buy shares, but instead buy the company’s assets.
But who is right and who is wrong? Who do you listen to? And what factors do you need to consider?
Unfortunately, there is no simple answer. A better question might be what is best for both parties to consider when thinking about selling shares or assets:
What are the potential liabilities and processes to quantify?
What is the percentage liability?
Is there a mechanism to manage it?
What is the seller’s tax implication on a share sale vs. an asset sale (based on the seller’s legal structure) and how does that impact the purchase/sale price?
What is the buyer’s tax implication on a share sale vs. an asset sale and how does that impact the purchase/sale price?
What are the mechanical implications to each party on a share vs. asset transaction?
What are the legal implications as they relate to a broker handling the transaction?
These are fundamental questions that require an objective and realistic assessment by a knowledgeable and unbiased professional, such as an M&A advisor, accountant or lawyer.
Depending on where you are located, there are governing, licensing and legal issues to consider in terms of who is facilitating the business sale:
Professional licensing requirements in Canada:
Provincial real estate laws and licensing in place require that if the transaction involves a real estate component as a material asset of the transaction, then a licensed real estate broker (or lawyer) is required for representation of sale.
And, if less than 100% of the shares are sold, then such a sale is governed under the Securities Act and will require a Securities license.
Asset sale in Canada:
The seller may take a big tax hit if the sale of the business qualifies under the Lifetime Capital Gains Exemption. If it does, then the seller will (likely) need a higher price to close the deal in order to make up for the tax bite. In this case, a share purchase may be advantageous if the right mechanisms are put into place to manage the potential liabilities.
A buyer could still be liable for GST or source deductions to the CRA even when purchasing assets. Severance pay can also become a buyer’s liability, as the firing and rehiring of staff by a different entity running the same business could be deemed continuous employment.
A buyer would need to re-establish credit and relationships with vendors and clients, re- execute and/or possibly re-negotiate material contracts and licenses, etc. This process can be arduous on a business and its buyer. As well, it may result in different terms and conditions to the buyer than what is already in place.
Buyers will be able to benefit from specific advantages, such as depreciation and amortization of assets and consolidated financials. However, subject to the purchase price allocation, the seller may be hit with a re-capture tax in which case the deal would likely fall apart.
Other complicated issues can also come into play such as material contracts, change of control of the corporation clauses, etc. Clearly, unless one is very familiar with all such potential issues, one really should be seeking professional advice from a knowledgeable and professional M&A advisor, transaction lawyer, tax accountant or other appropriate advisor.
Share sale in Canada:
If eligible, the seller can take advantage of the Lifetime Capital Gains Exemption ($848K, 2019 threshold), which may allow the seller to accept less for the purchase price of the business making the deal more attractive to both parties. Again, this assumes that all potential liabilities can be managed through legal instruments.
Except for material contracts, in which a change of control clause of the entity applies, the purchaser can assume such contracts without the need to re-negotiate, re-qualify or re-apply for credit.
In most scenarios, a share sale is a smoother transition for the buyer, as well as the seller.
But what about the receivables and payables you ask? Well often, they can be better handled through a share sale than an asset sale.
Managing through an asset vs. share sale or purchase is a complex issue, and one that needs to be assessed on an individual basis as each situation and scenario will differ. While in some cases it may not make much difference under specific scenarios and structures, in others could be substantial for the seller or the buyer and even a deal breaker! This is why it is important to retain an effective transaction lawyer to ensure there are the necessary legal mechanisms in place to support an equitable transaction.
One key investment that you should make is to arrange for a professional, fair market valuation of a business – as the disclosures and analysis performed here would consider such implications.
The above factors should encourage you to speak to a qualified, knowledgeable and professional M&A advisor, lawyer and accountant – and that you have qualified all the facts before you act. Ideally, at the end of the day, both the seller and the buyer should benefit from the transaction.