So You're Considering Selling Your Business? A Primer On Share Purchase Transactions For Sellers

Part Two of Our M&A Series

Are you a business owner looking to sell your business, but are not sure where to begin? Did you have a chance to read our article titled "So You're Considering Buying a Business? A Primer on Asset Purchase Transactions for Purchasers", and are wondering what the best structure is for you as a seller? Well you are in the right place, as this article will review the pros and cons of a share sale transaction.

Share Sale Transaction

A share sale transaction is often favoured by the seller because of personal income tax benefits that can be achieved, as the proceeds of share sales are taxed as a capital gain with only 50% of the proceeds included as personal income. Further, if your business is considered a qualified small business corporation (QSBC), there is a lifetime capital gains exemption (indexed to inflation) (LCGE) that would be available to you as an individual selling your shares. In order to determine whether your business is a QSBC, the Canada Revenue Agency considers the following:

1. Was the business a small business corporation when the sale of the shares took place? This looks into whether your business was a Canadian-controlled private corporation and that at least 90% of the fair market value of the business assets were actively used by the business in Canada at the time of the sale;
2. In the 24 months preceding the sale of your business, more than 50% of the fair market value of its assets were used in an active business carried on primarily in Canada; and
3. At the time of the sale, and throughout the 24 months immediately before the sale, no one owned the shares other than you, your spouse or common-law partner, or a partnership of which you were a member.

Note that LCGE is only available to you as an individual selling your shares. If you have a holding company that owns the shares in the business, LCGE will not be available on the sale of those shares unless you arrange for the shares of your holding company to also be sold to the purchaser. If this applies to you, professional legal and tax advice should be sought before you proceed with the sale.

Other Considerations

Some other aspects of a share sale transaction that are favourable to a seller are as follows:

• all of the liabilities and debts are included as part of the sale of shares to the purchaser, which may be part of what is negotiated between the parties prior to the sale; and
• contracts with clients, suppliers and employees remain with your business, requiring less effort and risk associated with ensuring clients, suppliers and employees stay with your business, unlike in an asset sale.

While there are substantive advantages to a share sale for a seller, there are also some disadvantages:

• the business retains all historical, actual and contingent liabilities, and therefore, to protect against these liabilities, you may be required to provide extensive warranties and indemnities to the purchaser. These warranties (unless limited) could be required for a significant period of time and the purchaser may also require the directors of your business to provide personal guarantees which may expose them to personal liability;
• part of the purchase price may need to be held in trust for a certain period of time or you may need to provide a bank guarantee as security if there happens to be a breach of a warranty in the future; and
• Sellers will need to comply with any restrictions on share transfers to third party, such as pre-emptive rights provisions in your business's articles or if there is a Unanimous Shareholder's Agreement.

Selling your business is one of the biggest decisions you will ever make and there is a lot to consider when choosing between an asset or share transaction. It is better to consider your options early, before you have found a buyer, to allow you to get into the best position before the sale to ensure you maximise the after-tax value of the sale of your business.

Once you are ready to sell, it is important to understand the commercial, taxation, and legal risks associated with both types of transactions and to obtain appropriate advice from qualified advisors, such as the lawyers at McDougall Gauley LLP before committing to any letter of intent.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.