Assets vs Shares

 In Business Law

So you’ve decided to buy a business after months (or perhaps years) of deliberation and due diligence.  The investment looks sound to you, and now you need to make the next step and actually acquire your business target.  So how do you do this?

Concerning business acquisitions there are basically two methods:

  • Asset Transactions: a purchaser can directly acquire the underlying assets of the business from the business owner; or,
  • Share Transactions: a purchaser can buy the shares of a corporation that owns and operates the business.

Each method has different legal, business, and tax consequences, and so it is important to familiarize yourself with the pros and cons of both options before you make your ultimate decision.  Below are a few factors to consider.

Liabilities

In an asset transaction buyers can specifically choose which assets of the business they wish to purchase, and also which liabilities they wish to assume.  In this case the selected assets and liabilities are transferred directly from the seller to the buyer, and any excluded assets and liabilities remain the seller’s responsibility.  As an example, perhaps the business has a supplier contract that you do not wish to carry on post-closing.  This contract can be excluded from the transaction, and it will be up to the seller to ensure that he/she either: (i) continues to comply with the terms of such contract after closing; or (ii) bears the costs of terminating it.

Conversely, with a share transaction a buyer will acquire full control of the corporation that owns the business.  No assets or liabilities are being transferred from the seller to the buyer at all in this situation – they simply remain with the corporation.  By virtue of acquiring the corporation, the buyer in this situation also acquires all of the underlying assets and liabilities of the corporation (whether known or unknown).  Some refer to this acquisition method as buying the business with “warts and all.”

On this basis alone, a seller is more inclined to request a share transaction – so as to avoid being left with unwanted assets or liabilities after closing – whereas a buyer would find an asset transaction more appealing for the same reason.

Simplicity

In a share transaction the only assets actually being transferred are the shares in the corporation, whereas an asset acquisition requires that each asset must be conveyed from the seller to the buyer in the appropriate manner.  For example, if there are vehicles involved in an asset acquisition the ownerships and registrations will have to be transferred, whereas all of this would remain the same in a share transaction (the corporation would still own the vehicles). Furthermore, in an asset transfer it is more likely that third party consents will be required before any contracts or leased assets can be transferred from the seller to the buyer.  These parties contracted with the seller and will have a say as to whether they want to carry on the contract with the buyer after closing.  Some contracts will have provisions built in that will require the consent of a third party on the change of control of a corporation.  In most cases a share transaction will leave the contracts unaffected because the parties to the contract do not change (much like with the vehicles mentioned above, the contracts remain with the corporation).

On a simplicity basis, therefore, a share transaction can be appealing to both sides.

Taxation

With respect to taxation, a seller is typically more concerned with the immediate income tax consequences resulting from the transaction, and will usually prefer a share sale because the proceeds of the sale may receive capital gains tax treatment.  This means that the seller will be entitled to maximize their lifetime capital gains exemption, so that the first $866,912.00 of the purchase price (the lifetime capital gains exemption as of January 1, 2019) will be entirely sheltered from any capital gains taxes provided certain tests are met.  In the event that the purchase price exceeds this amount, only half of the excess will be taxable as a capital gain.  On the other hand, in an asset sale the seller will face some adverse tax consequences possibly as a result of: (i) a possible recapture of capital cost allowance on the sale of depreciable property; and, (ii) any profits realized on the sale of inventory (if sold for greater than cost), both of which would be taxed as ordinary income.

For a buyer the priority will be to maximize tax deductions from the transaction going forward, so as to use them to reduce the income of the business in future years.  As such a buyer will usually prefer an asset transaction.  For instance, if a buyer acquires depreciable assets, the cost base of such assets will increase (the new cost base will be the portion of the purchase price allocated to the asset), and the buyer will be able to claim capital cost allowance on these depreciable assets using the new cost base.  In a share transaction the buyer will simply inherit the original cost base of such assets (as set when the corporation originally acquired them), and will only be able to continue to claim capital cost allowance based on the original cost base.

Therefore with respect to income taxes a seller will typically prefer to sell shares and a buyer will prefer to buy assets.  That said, it is important to review the potential tax consequences of the transaction with an accountant before you decide which option is best for you based on these criteria.

Conclusion

As you can see, there are certainly a number of issues to consider when trying to decide how to structure your transaction.  A few have been discussed here, but rest assured there are indeed many more factors to consider. Ultimately it is important that you seek out appropriate legal and tax advice before you decide, in order to make sure you are making a decision best suited to your needs and priorities.  Our corporate and commercial law team at Mann Lawyers would be more than happy to assist you with this.

This blog post was written by Ian McLeod, a member of the Business Law team.  Ian can be reached at ian.mcleod@mannlawyers.com or at 613-369-0373.

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