Introduction
Whether you are buying out the competitor or buying your first business, you will want to ensure that the terms of the deal meet your needs and protect your interests. A fundamental concern is to first consider what it is you intend to purchase and how much you are willing to pay for it, and to then consider how the deal should be structured. This often leads a Purchaser to weigh up the pros and cons of purchasing a company’s shares or purchasing a company’s assets.
Purchasing Shares
By purchasing all of a company’s shares you become the new owner of the corporate entity, meaning you purchase the company in its entirety. This can be helpful if you wish to trade under the same name and wish to maintain the valuable agreements that are attached to the company.
However, purchasing all of a company’s shares means you also inherit any and all of the liabilities that are attached to the company. By way of example, this would include all outstanding debts, taxes and existing or potential lawsuits. A Purchaser purchasing shares also takes over the existing workforce and therefore a Purchaser who wishes to downsize a company should keep this in mind, as this means they may have to make costly redundancy payments to achieve their goal.
Purchasing Assets
Purchasing a company’s assets means that you purchase things such as its equipment, inventory, rights to use a certain names and even its goodwill. Many Purchasers prefer purchasing assets as they attract less liability, as the purchaser only inherits the liabilities connected to the specific assets they purchase.
A Purchaser also has flexibility as to what they can purchase, as they can pick the specific assets they want to purchase. Generally, they can also use discretion as to which of the Vendor’s employees they will take with them.
Purchasing assets also comes with certain tax benefits for a Purchaser. A Purchaser of assets can depreciate them over time (whereas a Purchaser of shares cannot depreciate the shares) and a Purchaser of assets can write-off amounts they pay for good will.
However, a purchase of assets invariably requires more legal work than purchasing shares, so the legal costs associated with completing the deal will often be higher.
Despite whether a Purchaser decides to purchase assets or shares, a Purchaser and their purchasing team (i.e. accountant and lawyer) must be thorough in their approach to due diligence, to ensure that the Purchaser can clearly evaluate the risks of what they are purchasing and to ensure that clear title to the assets or shares can be transferred to the Purchaser.
A Purchaser also needs to consider all the tax consequences of the purchase, including the implications of proceeding with an asset or share purchase.
Tax considerations
As a general proposition, Vendors prefer share sales and Purchasers prefer asset sales.
Share transactions – Vendor’s Issues
Canadian Vendors generally prefer share transactions, for a number of reasons:
- Share transactions will generally give rise to capital gains (which are taxed at half the rate of ordinary income);
- An exemption of up to $750,000 of capital gains may be available to Canadian resident individual Vendors, if the company that is disposed of is a small business corporation and certain other conditions are met;
- In a share transaction, a Vendor that is a company may be able to reduce its taxable gain by having the target company declare “safe income” dividends prior to the transaction (as such inter-corporate dividends are generally non-taxable);
- In a share transaction, the overall tax payable may be reduced if the Vendor’s tax cost of the shares (“outside basis”) is higher than the company’s tax cost of the assets (“inside basis”); and
- In a share transaction, the Vendor may have the opportunity to claim a reserve for any portion of the sale price that is not payable until a later year.
If the purchase price includes the shares of a Purchaser that is a Canadian company, the Vendor may be able to take advantage of available tax deferrals or “rollovers”.
Share Transactions – Purchaser’s Issues
A Purchaser might prefer a share transaction if the target company has significant business losses, as the only way for the Purchaser to acquire the tax losses of the target company is to acquire the shares of the target company.
However, a share sale may also have certain tax-related drawbacks:
- A share sale will generally result in a “change of control” that triggers a year-end for tax purposes, requiring the company to file a tax return; and
- Provisions of the Income Tax Act (Canada) will impose restrictions on the use, after a change of control, of capital and non-capital losses. Non-capital losses are generally “streamed” on a change of control as they may only be used to offset future income from the same or a similar business that generated the losses. Capital losses generally expire on an acquisition of control.
Sales Tax and other elections and filings are generally also required, and will need to be considered and completed, where necessary.
If you require assistance in purchasing a business, please contact Paul S.O. Barbeau.