This Practice Guide provides a general overview of share sales (i.e., share purchases or share transactions) versus asset sales (i.e., asset purchases or asset transactions) in private company acquisition transactions in Canada.
Often, the first decision to be made between parties to a proposed acquisition transaction is whether the Purchaser will acquire the target company through an acquisition of the shares of the target company which owns the business (i.e., "share purchase" or "share sale") or through the acquisition of the assets and related liabilities of the business (i.e., "asset purchase" or "asset sale"). In general, Purchasers prefer to acquire a business through an asset purchase, whereas Vendors prefer to sell their business through a share sale. This Practice Guide examines some key considerations when negotiating an acquisition agreement of a private company in Canada.
Generally, asset purchase agreements are more complicated than share purchase agreements.
Asset Sale. An asset sale will require transfer documentation for all of the assets and liabilities being transferred (e.g., real property, permits and licenses, leases, contracts, equipment and vehicles, intellectual property, accounts receivable and accounts payable, prepaid expenses, goodwill, debts, contractual obligations, purchase and supply orders and warranty claims). Each asset to be acquired from the target company and each liability assumed by the Purchaser, as well as any exceptions or exclusions, must be dealt with individually to ensure good and clear title is conveyed and to allocate the purchase price among all assets and liabilities. An asset purchase agreement may trigger the need to obtain third party consents to the assignment or transfer of the assets (which can be a time consuming and expensive process) often not required under a share sale. Under a share sale transaction, it is necessary identify and deal with any provisions in contracts, leases, licenses and permits which may require consent to a change of control of the target company, but that is typically less burdensome. In addition, it may be that certain assets, such as government licenses and permits, are not assignable at all and hence cannot be legally transferred in an asset sale.
Share Sale. By contrast, under a share sale, all of the assets of the target company remain with the company. Typically, the only required transfer is of the shares of the target company that owns and carries on the business (and possibly an assignment of shareholder loans owed by the company to shareholders). The acquisition agreement needs to describe the number and class of the shares to be purchased, as well as the identity of the owners of the shares. In general, third party consents are not required for transfer of shares, although in some cases, material contracts, including loans agreements and security for loans, and real property leases, might include restrictions against changes in control of the company without the consent of another party.
In an asset sale, the target company is the Vendor of the assets and, along with the Purchaser, will be party to the acquisition agreement. Following completion of the asset sale, in most cases, the target company continues to be owned by its existing shareholders. Often, the target company will distribute the consideration received for the assets to its shareholders, leaving the target company as a shell company with no material assets. As a result, Purchasers will typically insist that all of the shareholders of the target company (e.g. where it is closely held by a small number of shareholders), or at least the majority or principal shareholders (where the target company may have a larger number of shareholders, which may include employee or minority shareholders) also become party to the agreement and, along with the target company, make the representations and warranties that the target company is making, and provide the indemnification obligations that the target company is providing.
In a share purchase transaction, the Vendors that are party to the agreement are the shareholders of the target company. Such shareholders typically must provide representations and warranties not only regarding the shares that they are agreeing to sell (and that they have capacity to enter into the agreement, which is binding upon them), but also representations and warranties regarding the target company and its business, and indemnification obligations in relation to such representations and warranties. Where there are only a small number of target company shareholders, such obligations are typically “joint and several”, such that each shareholder can be liable for the entire obligation. Where the number of target company shareholders is larger, it can be an item that is subject to negotiation as to whether each shareholder must be jointly and severally liable, or whether some (e.g. minority employee shareholders) can potentially be liable only to the extent of their proportionate ownership interest. Typically a Purchaser will want to have at least majority shareholders agree to stand behind the representations and warranties relating to the target company and its business, and indemnification obligations relating thereto, on a joint and several basis, rather than only in proportion tot heir ownership.
In a share purchase transaction it can be a negotiated issue whether the principal of a corporate shareholder of the target company may also be required to become party to the agreement and effectively guarantee the target company’s obligations. Similarly, in an asset purchase transaction, where a shareholder of the target company that is required to become party to the asset purchase agreement is a corporation, a Purchaser may seek to require the principal or parent entity of that shareholder to also guarantee obligations.
Choice of Assets and Liabilities
When a Purchaser acquires a company through a share purchase, all of the assets and liabilities of the target company remain with the target company. This means that, subject to any agreed upon price adjustments or indemnification obligations in the acquisition agreement, shareholders of the target company will not retain or become liable in relation to the liabilities of the target company, and that such liabilities and obligations will remain with the target company, which becomes owned by the Purchaser. An asset sale allows the Purchaser to "cherry pick" which assets it will purchase and which liabilities it will assume. As a result, the Purchaser can agree only to expressly assume and become responsible for certain liabilities and obligations (e.g. obligations under leases and material contracts that are assigned to the Purchaser, but only in relation to the period after Closing). However, by law, an asset purchaser may become liable for environmental contamination and for obligations to employees (e.g. union employees) in an asset transaction.
Asset Sale. In an asset sale, there is no legal obligation for Purchasers to agree to employ non-union employees. However, the target company will generally seek to require the Purchaser to offer new employment contracts to all or most employees on terms that are substantially similar or identical to their existing contracts (including a recognition of prior service) to protect the target company against wrongful dismissal claims made by employees.
Share Sale. In a share sale, the target company’s employees remain employed by the company, unless a change of ownership triggers rights under the employment agreements of certain employees (such as senior executives). Therefore, unless the target company terminates certain employees and pays severance pay before closing, the target company retains all of its employees post closing, and the target company, and not its shareholders, will be responsible for any severance or employment termination obligations.
Share Sale. The proceeds of a share sale (above the seller’s adjusted cost base) are taxed as capital gains, meaning only 50% is included as income. If certain conditions are met, a $800,000 lifetime capital gains exemption (indexed to inflation) is available to Canadian residents who sell shares of a qualified small business corporation.
A corporate seller may be able to reduce its taxable gains by causing the target company to pay a non-taxable inter-company dividend from “safe income” (that portion of retained earnings attributable to earnings reported for income tax purposes) before the sale. The purchase price will be reduced accordingly.
A Purchaser may prefer a share transaction in order to take advantage of the target company’s non-capital tax-loss carry-forwards (i.e., business losses) that can be applied against future income. A share purchase also allows a Purchaser to avoid paying sales and property transfer taxes on purchased assets.
Asset Sale. A target company will usually want the purchase price allocated to minimize the recapture of capital cost allowance previously deducted on depreciable property. A Purchaser will usually want to allocate as much of the purchase price as possible to depreciable property so that it can ‘step up’ the value of assets to their fair value, resulting in higher tax deductions for depreciation expenses in the future.
A Purchaser will be required to pay property transfer tax on real property and buildings (including permanently affixed equipment) and, subject to GST and HST exemptions for the sale of substantially all of the assets of a business, sales tax on equipment and inventory (subject to any available exemptions).
For many people, selling or buying a business is one of the biggest decisions they will ever make. Determining the appropriate structure is critical to a successful transaction. It is critical to obtain appropriate advice from qualified advisers before committing to any structure, even on a generally non-binding basis pursuant to a letter of intent.