Asset Purchase vs Share Purchase: A Comprehensive Analysis

When a company is looking to buy or sell a business, the owners or investors tend to have a choice; whether to purchase the assets of the business or to purchase the business via its stock or shares. The buyer of the assets or stock and the seller of the business can have various reasons for preferring one type of sale over the other. These are the two core methods for buying or selling a business. To understand the concept of asset and share purchase and the differences between the two, we must first look into the definitions of the two.

 

Definition of Asset Purchase:

An asset purchase involves the acquisition of some or all of the assets which are owned by a business and used to carry on the business of that business. Assets may include fixed assets (land, buildings, machinery, trading stock), and intangible assets such as goodwill or intellectual property. An asset acquisition strategy is one where a company purchases the assets of another company or competitor to boost its own growth as opposed to purchasing the stocks of this company. This form of acquisition varies from the traditional model of acquisition where an entire business is purchased by purchasing over 100% of the stock or shares of the business.

 

Definition of Share Purchase:

A share purchase is the traditional method of purchasing another business entity. It is typically completed by the purchase or sale of 100 percent of the company’s shares. This type of transaction is less complex than an asset deal, requiring fewer transfer documents. Documentation is only required for the transfer of the shares and occasionally for the assignment of shareholder loans.

 

Importance of Understanding the Distinction:

It is important for anyone looking to purchase a business to understand how these two options of purchasing a business. Each option comes with its own set of advantages and disadvantages which are essential to be understand for the business buyer. Given the position of the business buyer either of the two options can have a better outcome based on the buyer’s business goals. It is therefore, important for any prospective buyer to know the advantage and disadvantages of both the options so that they can make a better and a more informed decision for their investment.

 

Pros of Asset Purchase Acquisition:

1. Fewer Responsibilities: Purchasing business through purchase of assets puts the buyer under a lesser responsibility than purchase of the business through shares.
2. No Associated Liability: Through this acquisition process, the buyer elects not to continue with the legal structure of the existing business and therefore be unencumbered with the liabilities if the company that is being bought. The buyer who purchases assets is not subject to claims made by the seller’s creditors, because they bear no responsibility for the contracts signed by the seller before the transaction.
3. Tax Benefits: Another advantage of asset purchase is in the depreciation that can be availed on the assets which is also benefits in reduction of taxes. This strategy enables the buyer to reduce their taxable income and tax bill every year by depreciating the purchased assets.
4. Selective Acquisition: Any buyer does not have to purchase all of a company’s assets and can pick and choose what asset would be beneficial for their existing business.

Cons of Asset Purchase Acquisition:

1. Limited Access to Contracts: Before making such an acquisition, the buyer must make sure that the assets really belong to the seller and are not mortgaged to a third party. A buyer must conduct their own due diligence as to the conditions of the assets to be purchased by them. 
2. Potential Liabilities: The buyer must also ensure that the seller has paid all requisite taxes on the assets before their acquisition. 
3. Time- consuming Transactions: The transaction for the purchase of assets can be complex and time-consuming. Reassigning of assets can be a cumbersome and lengthy process to follow which may at times add to cost.

Pros of Share Purchase Acquisition:

1. Full Company Control:  Through the purchase of the shares of a company, a buyer acquires all 100% of the shares in this acquisition method. Purchase of 100% shares of a company gives the buyer the complete control over the working of the business as well as of all of its assets and liabilities.
2. No Need to Transfer Assets: In a share purchase acquisition, the buyer purchases the company or business in its entirety which includes the transfer of its assets. Therefore, in this method of business acquisition one does not require the transfer of assets as they are acquired with the business itself.
3. Lower Costs:  Acquiring a company through purchase of its shares offers the buyer the advantage of a typically lower price compared to acquiring the company through asset purchase.  The process of preparing for purchase of shares is also less exhaustive and therefore, considerably less costly.
4. No Payment of Additional Taxes:  The buyer is not required to reimburse the seller for the outstanding taxes that are yet to be paid when acquiring shares.

Cons of Share Purchase Acquisition: 

1. Inherited Liabilities:  hen an individual acquires shares of a company; they assume the obligations and duties previously held by the seller. Since the company’s legal framework remains unchanged, and any agreements made by the seller continue to be valid, the liability of these previously made contracts is now inherited by the buyer. Consequently, creditors maintain their entitlement to seek repayment of outstanding debts from the buyer.
2. Minority Shareholder Challenges: In cases where the purchase of share capital is not a full 100% but only above 51%, the remaining minority shareholders of a business can present various challenges in the running of the business as the buyer may deem fit.
3. Legal Constraints:  Shares can solely be acquired from a corporation possessing an incorporated legal framework. Alternative business formations, like sole proprietorships, lack the presence of share capital and therefore cannot be acquired by this method.

Legal Implications:

Different legal implications are attached with the choice of method of acquisition. Any prospective buyer should be fully aware of these legal considerations before making  a decision to purchase a business.

 

Asset Purchase Legal Considerations:

• Due Diligence Requirements:

Asset purchase requires a buyer to conduct a proper due diligence of the asset that is required to be purchased. Due diligence needs to be done to access the proper title and ownership of the assets that are required to be purchased along with checking the conditions of the assets. A buyer is always advice to take the help of an experienced lawyer while conducting due diligence such that the asset being purchased is done with the proper paperwork and legal compliances. 

• Asset Valuation and Purchase Agreement:

A lawyer is required for advice on the proper valuation of the assets that are required for the purchase of business. Once the required assets have been decided, a sound valuation based on the condition of the assets that are being purchased. Based upon the valuation of these assets the lawyer will then draft a purchase agreement along with any other documents that are related to the transaction.

 

Share Purchase Legal Considerations:

• Shareholder Agreements:

A shareholders’ agreement serves as a contractual arrangement between the shareholders of a company, providing protection for both the business and its shareholders. This agreement outlines the various rights and responsibilities of shareholders, including the issuance of shares, the day-to-day operations of the business, and the decision-making procedures. The help of an experienced team of lawyers is required to assist with the changes in the shareholders agreements that will now be drafted with the purchase of the new business.

 

• Regulatory Approvals:

In accordance with the Competition Act (Canada), parties involved in a Share Purchase Agreement are required to notify the Competition Bureau and adhere to a 30-day waiting period before finalizing the transaction, provided that certain thresholds are met. However, this requirement can be bypassed if the parties obtain an advance ruling certificate or a non-action letter from the Competition Bureau, indicating that the Commissioner of Competition does not currently intend to challenge the transaction. The Commissioner evaluates whether the transaction, which meets the criteria for notification, will potentially hinder or significantly reduce competition in a specific market. It is worth noting that the filing fee for the Competition Bureau review is substantial, typically borne by the purchaser, although the parties involved may agree to share the cost. A seasoned legal practitioner is required for any buyer to help to comply with. 

 

Financial Considerations:

Apart from the legal considerations, certain financial considerations are also likely to arise with both the option to purchase the business.

 

Asset Purchase Financing:

Asset purchase financing refers to the considerations that will arise in whilst the buyer is in the process of purchasing the assets. The considerations that can normally arise are:

• Asset Valuation and Financing Options:

Asset valuation refers to the determination of value of the assets of a business. When a business is being purchased through the purchase of assets of a business, a sound valuation of the assets becomes a priority. Based on the valuation of the assets that have been selected by the buyer, they can look at a variety of financing options to facilitate with the actual purchase of the assets. These options can be either through the surplus cash influx with the buyer or even by taking up loans from banks among other non conventional financing options.

• Tax Implications:

When assets are purchased for the purchase of a business certain tax implications also arise with the purchase of these assets. These implications can range from depreciation and amortization that is available on the assets and the reduction of tax that can be availed for the same.  Purchase of any asset can also bring with it the implications with relation to capital gains and how they have to be financed to pay for the tax that is likely to be levied.

 

Share Purchase Financing:

Share purchase financing refers to the considerations that are likely to arise during the purchase of the business through the purchase of stock. These conditions usually are:

• Purchase Price Allocation:

A Purchase Price Allocation refers to the application of goodwill accounting wherein the buyer when purchasing another business through the purchase the shares, allocates the purchase price into various assets and liabilities acquired from the transaction.

• Funding Sources for Share Purchases:

Purchase of all the shares of a company or a business can be a very expensive ordeal and any prospective buyer for the business needs to have a setup funding or source of financing options to make the sale a possibility. Any buyer needs to make sure that they have a strategy for the funding of the share purchase and must have the required funds available with them before the transaction takes place. 

 

Impact on Employees:

The purchase of any business is likely to impact the existing employees of the business. Whether the purchase of the business is through the purchase of assets or shares, the impact on the existing employees of the business being purchased as well as the employees of the buyers company. These implications can differ given the option the buyer decides to buy the business with: 

 

Asset Purchase Employee Considerations:

• Employee Transferability:

When a business is purchases through assets the aim of the acquisition is not to integrate the business that has been bought into an already existing one, rather it is to use the assets of the business to facilitate growth. In cases such as these the transferability of the employees comes into question. The buyer needs to decide whether or not they are willing to get some employees of the business that is being bought integrated into their own business for any reason that they might deem necessary.

• Employment Contracts:

Contracts of the employees that might be losing their jobs or the ones that will get integrated into the buyers company have to get looked at by legal professionals. The employees that lose their jobs due to the acquisition of the business are entitled to receive severance from their employers. The employees getting integrated will have to receive new contract upon their integration into the business.   

Share Purchase Employee Considerations:

• Employee Retention:

The aim of a buyer when purchasing an existing business through the shares of that business is to integrate the existing business with their own business for sustainable growth. When the very aim of the acquisition is to facilitate growth through the purchase, it is essential to retain the employees of the business that is being purchased. The buyer can choose which of the employees are essential for the growth of their new integrated company and can decide whom it is that they want to keep employed in their organization.

• Changes in Management Structure: 

Since the organization of the buyer has now grown with the integration of new employees, the management structure of the organization will have to change. The new management structure is essential for the future growth of the business as this is what will help with the better functioning of an organization that has recently acquired more assets and people.

 

Tax Implications:

Purchase of the business through either of the two options whether it is through assets or shares will entail with it certain tax implications that are required to be considered by the buyer before making an informed decision:

Asset Purchase Tax Considerations:

• Depreciation and Amortization: 

Depreciation and amortization are ways to calculate asset value over a period of time. Amortization is a method for decreasing an asset cost over a period of time. Depreciation is the amount of asset value lost over time. When an asset is acquired from another business, it is already is being subject to either of the two. The depreciation and amortization on an asset helps the buyer with their tax reductions as well after the acquisition.

• Capital Gains Tax:

If you have made a profit from selling an investment during this fiscal year, you may be required to pay capital gains tax. In Canada, when you sell an asset or property at a profit, you are obligated to pay capital gains tax. Conversely, if you have experienced a loss, you will not be subject to taxation. In Canada, capital gains are only taxable to the extent of 50%; the taxable amount is added to your annual income. At the current income tax rates in Canada, no one’s capital gains tax liability exceeds 27%.

 

Share Purchase Tax Considerations:

• Stepped-Up Basis:

An asset sale provides the buyer with the opportunity to raise the tax expense of depreciable assets to their present market value. This modification, referred to as a ‘step-up,’ lessens the buyer’s forthcoming tax liability by allowing for higher deductions of capital cost allowance.

• Tax Considerations for Sellers:

There can be a number of tax considerations for the seller when it comes to sale of shares:

• Capital Gains Tax:

When selling a business, it is crucial to take into account the main tax factor, which is the potential liability for capital gains tax. In Canada, if you sell shares of a small business corporation, the profit is usually treated as a capital gain and subjected to taxation. Half of the capital gain is added to your taxable income and taxed at your personal tax rate. The tax rate for capital gains differs based on the province where you reside.

• Lifetime Capital Gains Exemptions:

The LCGE is a valuable tax benefit available to Canadian residents who sell shares of a qualified small business corporation. If you satisfy the eligibility requirements, you have the opportunity to request a lifetime exemption on the capital gain obtained from selling your business, up to a certain threshold. Nevertheless, it is crucial to understand that not all sales will meet the criteria for the LCGE, and the eligibility requirements can be intricate.

• Eligible Small Business Corporations Status: 

In order to be eligible for the LCGE, your business needs to satisfy specific criteria, which includes being classified as an eligible small business corporation. This entails that a minimum of 90% of your business’s assets must have been predominantly utilized in an active business conducted within Canada. Furthermore, your business should not possess assets exceeding $50 million at any point within the 24 months preceding the sale.

 

Negotiation Strategies:

It is important for any buyer to have prepared a set of negotiation strategies which can help them facilitate the purchase of the business through either of the methods of acquisition. Certain negotiation tactics can be used by the buyer to put themselves in a better position to acquire the business.

Asset Purchase Negotiation Tactics:

• Valuation Adjustments:

Valuation adjustments play a crucial role in business transactions, such as mergers and acquisitions or asset purchases. These adjustments involve modifying the initially proposed or estimated value of the assets or the entire business. Their significance lies in ensuring that the final purchase price or asset value accurately reflects the true economic condition and worth of the assets or the business. Negotiating valuation adjustments in a business acquisition requires employing strategic tactics. These tactics include conducting thorough due diligence, establishing clear adjustment mechanisms, fostering mutual understanding, and utilizing objective data for justification, negotiating reasonable thresholds, and considering flexible solutions such as earn-outs.

• Allocation of Liabilities

Lawyers have a vital function in the allocation of liabilities in business transactions. They carry out comprehensive due diligence to detect liabilities, negotiate terms in purchase agreements, and prepare documents that outline how liabilities will be shared between parties. Lawyers provide guidance on risk evaluation, strategies to mitigate risks, and legal compliance, all while safeguarding their clients’ interests through the agreements. Their role encompasses the creation of meticulous legal documentation and supervision of the implementation of agreements during the closing of transactions. In summary, lawyers’ expertise is essential in navigating and concluding the allocation of liabilities in business deals.

 

Share Purchase Negotiation Tactics:

• Control Premium:

Control Premium is a negotiation strategy wherein a buyer is willing to pay a price that is higher than the current market price of the shares specifically for a public traded company so that they can gain a controlling ownership interest in said company. This negotiation tactic is used in cases where 100% of the shares of a company cannot be acquires by the buyer.

• Indemnification Agreements:

Indemnity refers to the commitment made by an individual to provide compensation for any loss, liability, or damage that may arise as a result of an action or failure to act, whether it is on their own part or that of a third party, or due to an unforeseen event. It is important for the buyer to put in place indemnification agreements with the seller of the business so that they can protect themselves from any unforeseen circumstances which could not have been stipulated by them.

 

Key Differences between Asset and Share Purchase:

• Comparison of asset purchase and share purchase:

In a share transaction, the purchaser acquires the shares of a corporation, effectively obtaining complete ownership of the entire business. This includes all assets and liabilities, which are retained by the company and transferred to the new owner. Essentially, the buyer assumes control over or sells every aspect of the business. In a transaction involving assets, the company transfers ownership of specific or all of its business assets (such as inventory, equipment, buildings, working capital, accounts receivable, intellectual property, contracts, etc.) to a buyer, while the company itself remains under the ownership of the seller as a legal entity.

 

Factors to consider when choosing between the two:

The factors that need to be considered before either of the two options can be chosen differ depending on the situation of the buyer and their business. These factors can be the financing of their purchase strategies, tax considerations related to the purchase, legal considerations and even the impact that the purchase of an already running asset will have on the existing employees of the business.

• Implications for taxes, liabilities, and ownership:

Sellers typically favor a share sale due to the favorable capital gains treatment it usually entails. When an individual sells their shares in a company, any proceeds exceeding the adjusted cost base of the shares and certain selling expenses are considered a capital gain, which is subject to only 50% taxation. Moreover, if the shares are classified as Qualified Small Business Corporation (QSBC) shares, the seller may potentially protect all or a portion of the capital gain from taxation by utilizing their Lifetime Capital Gains Exemption (LCGE). In a transaction involving an asset sale, the buyer acquires ownership of a company’s assets, including inventory, equipment, and accounts receivable. The buyer is not held accountable for any liabilities associated with the existing business, except for the ones they intentionally choose to assume. Essentially, this method of purchase enables the buyer to selectively decide which assets to acquire and which liabilities, if any, to take on, thereby minimizing their level of risk.

 

Hiring a Pacific Legal Lawyer:

Hiring a Pacific Legal lawyer to assist you with your business purchase needs can help you streamline the process of business acquisition manifold. We at Pacific Legal have a team of experienced lawyers who pride ourselves in assisting our clients achieve all of their mergers and acquisition needs. We have a track record of original and ground-breaking solutions and innovations that have had a dramatic impact on business and law.

• Role of a Lawyer:

The advice of a lawyer is especially important for any buyer in their asset or share acquisition journey. Whether it is for the conduct of due diligence or even the drafting and review of all documents that are required to facilitate the entire acquisition transaction. At Pacific Legal, we understand the importance of helping our clients facilitate the acquisition transaction in a timely manner and with the utmost efficiency.

• When to Seek Legal Counsel:

It is advisable for anyone looking to purchase a business to seek legal counsel as soon as possible so that a legal professional can help you understand which of the two options to acquire the business is more suitable given your business goals and help facilitate the same.

• Factors to Consider:

The considerations that must be taken into account before selecting either of the two options vary depending on the buyer’s situation and their business. These considerations may include the financing of their purchasing strategies, tax implications associated with the purchase, legal factors, and even the potential impact on the current employees of the business if an already operational asset is acquired

Book an appointment to learn more with our lawyers in Ontario, Canada.

Frequently Asked Questions (FAQs):

 

1.What is an asset purchase?

An asset purchase involves the acquisition of some or all of the assets which are owned by a business and used to carry on the business of that business. Assets may include fixed assets (land, buildings, machinery, trading stock), and intangible assets such as goodwill or intellectual property.

2. What is a share purchase?

A share purchase is the traditional method of purchasing another business entity. It is typically completed by the purchase or sale of 100 percent of the company’s shares.

3. How do tax implications differ?

Tax implications can differ based upon the method of acquisition. Asset purchase usually helps the buyer save onto tax using depreciation and amortization. Tax implications via sale of shares can be taken up for the favorable capital gains treatment.

4. What role does due diligence play?

Due diligence is one of the most important aspects to find out what kind of method a buyer should be using to purchase the given business and then subsequently to access the situation of the business being acquired.

5. Is it better to buy shares or assets of a company?

No one method of acquisition is superior to the other, the decision to take up either should be done after seeking appropriate advice and conducting the required due diligence.

6. What are the advantages of an asset purchase over a share purchase?

Purchase of asset puts upon the buyer fewer responsibilities as the business liabilities are not acquired with the assets. It is also beneficial for the tax benefits that it can provide. Asset acquisition also helps the buyer pick and choose what asset they are willing to purchase.

7. What are the disadvantages of asset purchase?

Asset purchase can normally be a more complex task for the buyer. Their can also be an associated liability with the asset that has been purchased in cases where tax has not been paid on them by the seller.