Acquiring a Business through Asset Purchase vs Share Purchase

When considering acquiring a business, there are two common choices: the purchase of assets or the purchase of shares. Shares represent ownership of equity in a business. The buyer of the assets or shares (the “Buyer”) and the seller (the “Seller”) of the business will tend to favour one type of sale over the other for various reasons. This guide is an in-depth look at what each type of sale is, how it works, and key considerations. Regardless of which sales method you use, you should consult with key business advisors – a lawyer, accountant, business valuator and/or any financial partners.  

Asset Purchase

When considering whether to acquire a business, you can elect to purchase certain assets used by the operator of that business which are integral to its operation. What this means is, you may not want or need to acquire the company as a whole, but rather certain aspects. To explain this concept, consider this example:

You are thinking about purchasing a well-established construction company (Construct Co). Construct Co’s assets are its trucks and equipment, its client list, and several ongoing contracts. Construct Co also employes 10 people. You are only interested in acquiring Construct Co’s trucks and ongoing contracts, and wish to employ only 5 of those employees. Therefore, because you only want certain assets and contracts of Construct Co, you can acquire the business through an asset purchase by purchasing only those assets and taking over employment of only 5 of the employees.

Key considerations for asset purchases:

1. Buyer’s liability is mitigated. The Buyer can control liabilities because they are only assuming the risk of the acquired assets and liabilities. Liability risk is not just applicable to known liabilities, but also unexpected unknown liabilities. If acquiring a company, the Buyer inherits all of the liabilities in the company.
2. Tax advantage for the Buyer – tax basis “bump”. When an asset is sold the Seller might realize a capital gain if the asset is sold for more than its original cost. Regardless of the original cost of the assets, the value of those assets in the accounting records for the purchaser, after purchase, can be increased to the price paid for those assets (which usually would usually exceed their original cost to the seller). As a result, if the buyer were to subsequently sell those assets, when calculating capital gains tax, the buyer could use the price paid for those assets as the cost base (subject to certain exceptions which are beyond the scope of this article).
3. Tax advantage for the Buyer – depreciating assets over time. Bumping up the tax value of assets to the price paid gives the Buyer more room to depreciate those assets for tax purposes. Depreciating assets allows the Buyer to reduce their taxable income and thus its tax bill each year.
4. Less due diligence. The due diligence search is less extensive than a share purchase because due diligence generally only needs to be conducted on the assets and liabilities being acquired, rather than all assets and liabilities.
5. Quicker transaction. Generally speaking, an asset purchase can be completed quicker than a share purchase as a result of less due diligence, potentially needing fewer shareholders to agree to the transaction, and the asset purchase agreement requiring less drafting time when compared to a share purchase agreement.
6. Higher purchase price. Mitigating liability risk may come with a higher purchase price. The higher purchase price is to accommodate the Seller because they may have less favourable tax treatment of the sale when compared to a share purchase, may need to liquidate the assets not purchased, may need to pay liabilities not assumed, and may need to terminate agreements not being taken over by the Buyer.

Asset transactions can be complicated, so it is important to keep in mind the business and transaction’s circumstances, the legal and tax implications, and the future of the business.

Share Purchase

Another common option to acquiring a business is to acquire the company’s shares from existing shareholders. In contrast to asset purchases, the Buyer will not own the assets of the business directly but rather through the company. To explain this concept, consider this variation of the Construct Co example:

You now decide you do not want to just acquire certain assets, but rather the company as a whole because you determine that transferring the ongoing contracts to you by asset purchase won’t be possible due to government regulations. Construct Co has 4 shareholders, each holding 25% of the shares. You therefore decide you will acquire Construct Co by offering to acquire 100% of Construct Co’s shares through a share purchase agreement, which after that transaction completes would result in you being the sole shareholder of Construct Co. This way, the ongoing contracts do not need to be transferred out of Construct Co and you can continue Construct Co’s operation in the ordinary course of business without interruption.

Key considerations for share purchases:

1. A simpler transaction. The Buyer is not selecting what asset, liabilities or obligations to acquire. The Buyer purchases all assets and liabilities, so the target is not left trying to liquidate the assets, liabilities and obligations not purchased.
2. More tax-advantageous for the Seller. Asset sales can result in double taxation for a corporate Seller – once in the company from the gain on the sale, and once when the proceeds are distributed to its shareholders. In a share sale, taxes payable are paid directly by the shareholders and only once.
3. Lifetime Capital Gains Exemption (“LCGE”) for the Seller. If the Seller is an individual, and certain other qualification criteria are met, the Seller might be spared from paying tax on capital gains income up to a certain amount when they sell shares in their company.
4. Extensive due diligence. It is essential to consult a lawyer and accountant during due diligence because, upon purchase of shares, the Buyer will assume all historical, present, and future liabilities. The due diligence process can be time consuming and costly, whereas in an asset purchase, due diligence is only required on the assets being acquired. Additionally, not all liabilities are known, and unexpected liability risk may arise.
5. Valuation of shares. The valuation of shares may be challenging, therefore careful consideration of the financial statements with an accountant is essential.
6. Shareholder approval. Often, the Buyer will need each shareholder of the company to agree to the terms offered. That said, there are circumstances where a particular majority of the shareholders can force all shareholders to sell their shares.
7. Company may have favourable relationships. Companies may have long-term contracts, developed advantageous relationships with suppliers, and developed rapport with customers. Leveraging those favourable relationships through transition in ownership may help ensure the company’s continued operations remain successful.
8. Patents, trademarks and copyrights. A share purchase allows the company to keep these rights without having to assign, transfer or purchase intellectual property, simplifying some aspects of the transaction.
9. Additional Tax advantages. Acquiring shares may allow for carry forward of tax losses, credits and tax incentives associated with the company that may be lost otherwise

Conclusion If you are considering buying or selling a business, you may want to find out more about your purchase options, and consult with one of the lawyers on our business team. We would be more than happy to help you navigate your business acquisition.