KPA Lawyers – July 24, 2020

Buying or selling a business is a very serious financial and legal transaction in Ontario. There are two major ways that this is commonly done: asset purchases and share purchases.

Asset Purchase Agreements

In an asset purchase agreement, the purchaser is only buying specific assets and liabilities from the vendor. This is quite often the more preferential approach for Purchasers as it allows a purchaser to pick and choose what they want from the business which will reduce the risk of any unknown or undisclosed liabilities. In this type of purchase, the purchaser and seller maintain separate corporate identities and the seller will keep the assets and liabilities not purchased by the purchaser.

Some examples of assets that are purchased in an Asset Purchase Agreement include the following: inventory, accounts receivable, licenses, machinery, equipment and furniture, books and records, customer lists, distributor or supplier lists and goodwill.

This type of purchase is often seen as a way to apply a Purchaser’s money more effectively and reduce their risk. Purchasers also receive better tax treatment in an asset purchase as opposed to a share purchase.

Having said that; however, Purchasers need to be wary of neglecting to purchase an important asset. For instance, if a Purchaser acquires a specific business and leaves out a key supply contract, that purchaser may not be able to operate the business.

This is a risk specific to asset purchase agreements, so a Purchaser will want to ensure their lawyer includes a representation from the Seller stating that all the assets they are acquiring constitute ALL of the assets necessary to carry on business.

In contrast, Sellers do not typically favour asset purchases because they are left with both known and unknown liabilities and usually receive better tax treatment when selling shares rather than assets. Due to this, you will find that the Purchase Price in an asset purchase agreement tends to be higher than that in a share purchase and attributed less so towards the goodwill being acquired.

In breaking down the Purchase Price of assets, purchasers receive an adjusted cost base. This cost is used to calculate capital cost allowance, deductions, as well as income, capital gains, non-capital loss or capital loss on the sale of those assets. If the assets have depreciated in value, the

A purchaser can increase the adjusted cost base of those assets to current market value, which will minimize the buyer’s tax going forward because they have a higher depreciable asset base or a higher cost to reduce capital gains. This is favourable to a buyer.

The Seller on the other hand generally sees two levels of taxation in an asset sale. The first being at the entity or corporate level and the second being the shareholder level. If however, there is a capital gain on the sold assets, the Corporation may be able to pay capital dividends on the non-taxable portion of the capital gain which is then tax-free to the recipient shareholder.

Asset purchases are also more complicated and time-consuming than share purchases because the parties need to Identify and value specific assets, assign the assets to be purchased which will require transfers with different third parties, and consents to assign will also be required for third party contracts.

Share Purchase Agreements

In contrast to an Asset Purchase, we have the Share Purchase Agreement in which the purchaser is no longer picking and choosing the assets and liabilities they acquire. They are buying everything: assets, rights and liabilities, known and unknown from the seller. At the conclusion of this transaction, the Seller remains a corporate entity, but is now controlled by the Purchaser.

Ways that Purchasers can protect themselves from unknown liabilities include negotiating certain contractual provisions into the agreement such as indemnities, escrow provisions and representations and warranties of the seller that there are no undisclosed liabilities.

Another important consideration when purchasing shares in a corporation is whether there are other shareholders. If a Purchaser does not end up purchasing 100% of the corporation, they could end up with Minority Shareholders who may be difficult to deal with.

While the Purchaser takes on greater risk in this scenario, there is a significant need for thorough due diligence on the part of the Purchaser. Protective clauses and indemnities for tax and legal liabilities can also be incorporated into the Agreement. Notwithstanding the need for greater due diligence, share purchase transactions are simpler than asset purchases with fewer to no need for third-party consents depending on the nature of the business. Additionally, the purchase price in a sale share tends to be lower than that of an asset sale.

Sellers like shares sales because they will only need to contend with one level of taxation and, as individual Canadian resident shareholders, have the benefit of only 50% of the capital gain on the sale being taxed. Additionally, if the private business is a qualified small business corporation, the seller can generally claim a lifetime capital gains exemption to shelter all or part of the gain from tax. In 2020, the maximum amount applicable for a lifetime capital gains exemption for qualified small business shares is approximately $883,000.00.

The tax implication for Purchasers on a share purchase is that they will usually not receive any benefit until the subsequent sale of the newly acquired shares.

Having explained all this, it is important to note that while the rule seems to be that Purchasers prefer asset sales and Sellers prefer share sales, there are numerous situations as to why a Purchaser or Seller might prefer the exception to the rule.

Now you know a bit more about the options available to you when buying or selling a business. It is important to remember that this article is not intended as legal advice and you should always speak with a qualified lawyer to discuss the best structure for your purchase or sale.