When considering a transaction for the sale and purchase of a business (whether you are the seller or the buyer), it is essential to think about how to structure the sale to meet your needs. In this article we briefly discuss the differences between a sale of shares vs a sale of assets, while outlining some of the advantages and limitations associated with these methods. This article also highlights the importance of the pre-sale due diligence process.
Share Sale Agreement
A share sale involves the sale and purchase of the shares in the company that owns the target business. The seller is the owner (or owners) of the shares in the company. The buyer acquires the target business through ownership and control of the company.
For sellers wishing to fully and cleanly exit their business a share sale is typically preferable. As a buyer, a share sale will often be appealing as the totality of the target’s operations are acquired with limited disruption to the company’s continued ownership and operation of the target business. Legal, financial and tax due diligence is critical in such arrangements to ensure the buyer understands the risks and liabilities, often hidden, that are being acquired and, as discussed below, to otherwise manage the impact of the sale on key contracts.
Asset Sale Agreement
A sale of business assets, as the name suggests, involves the sale and purchase of some or all of the assets of a business (such as goodwill, intellectual property, plant and equipment, contracts, freehold and stock). The owner (seller) of the business might be a company, partnership, trust or a sole trader. The owner and seller of the business will retain any assets and/or liabilities that are not sold as part of the sale.
For buyers, the ability to ‘cherry pick’ the desired assets can be advantageous. Unwanted assets and liabilities can be left behind. For example, potential liabilities associated with legal claims and disputes are typically retained by the seller in a sale of assets transaction. As a seller, an asset sale may be preferable where a quick exit is required, where particular assets are considered surplus to needs or where the seller wishes to otherwise retain particular assets required for the continued operation of another business. The due diligence process associated with a sale of business assets agreement can often be more straightforward as advisors can focus their attention on actual known assets being acquired.
Some relevant considerations
For a seller, whether selling shares or assets, it is essential to ensure your intellectual property assets (e.g. trade marks, copyrights, designs and patents) are properly catalogued and owned by the correct entity. IP assets often represent the real value of what is being bought and sold and thus warrant special attention. For example, in a share sale transaction this means ensuring the target company owns, or holds valid and subsisting licences to, all relevant and key intellectual property assets.
Because different rules apply to the creation and transfer of ownership of IP assets, depending upon the type of IP involved, the parties to a sale must conduct a careful due diligence of IP assets to ensure the effective transfer of these assets. A buyer might otherwise not attain ownership of the desired IP assets and the seller could be exposed to a breach of warranty claim under the sale agreement (e.g. a vendor warranty that the company owns certain IP).
As part of its preparations for a sale a prospective seller should audit its IP rights to ensure all material IP assets are properly protected. The IP audit will often reveal instances where IP, thought to be owned, actually needs to be transferred from a company’s employees or contractors or, in the case of registrable IP (such as trade marks), need to be registered. If these issues are left to chance and uncovered by a buyer’s advisors a deal can be easily compromised. Worse still, a prospective buyer could disingenuously use a due diligence exercise to uncover a competitor’s IP weaknesses for their own competitive advantage.
In a share sale, the company’s employees are typically retained on their existing employment contracts. Pre-acquisition due diligence of these contracts is appropriate to ensure the buyer understands the nature of any unusual terms that they will inherit and to ensure new terms can be negotiated if required – e.g. with any key employees considered essential to the new owner.
An asset sale allows a buyer to choose which employees it wishes to retain and to negotiate new terms of employment with those employees. Any employees not transferred as part of the sale will usually be retained or terminated by the seller.
Employees transferring to a new entity as part of an asset sale will often have the benefit of specific State laws regarding continuous employment and long service leave (LSL). Provisions for an adjustment to the purchase price for an employee’s annual leave or LSL entitlements are usually included in the sale agreement.
Continuity of key contracts
Share sale arrangements are often desirable where continuity of the company’s key contracts (e.g. contracts with customers, suppliers, landlords, employees etc) is important. The key risk to be managed here is ensuring that the proposed change in control of ownership (i.e. the sale of shares) doesn’t inadvertently trigger the termination of any of these contracts. A careful review of key contracts as part of the due diligence process is how the buyer manages this risk. Contracts requiring the counter-party’s consent can be identified and addressed in the terms of the sale agreement.
As part of an asset sale, the seller may wish to sell existing contracts to the buyer. This typically requires an assignment or novation of the contracts to the buyer and involves obtaining each relevant counterparty’s consent.
Sale agreements (whether of shares or assets) typically specify that completion of the deal is subject to the counterparty to each material contract agreeing to the change of ownership (in the case of a sale of shares) or transfer of the contract to the buyer (in the case of a sale of assets).
Many businesses require a licence or permit from a government agency for their continued operation. A change of ownership typically requires approval from relevant regulatory bodies. Buyers must ensure they understand the regulatory landscape impacting upon the continued operation of the target business and manage this as part of the acquisition process. For example, buyers will often need to satisfy a government department or agency that a proposed change of ownership will not result in the revocation of the target’s rights to a particular government approval or funding arrangement. Again, completion of a transaction can be made conditional upon any material regulatory approval.
Every business sale, regardless of how it is structured, gives rise to tax consequences. These consequences need to be understood and managed as part of the sale process. For example, different rules apply to the treatment of Goods and Services Tax (GST) depending on whether a sale of business assets involves the sale of a going concern (typically GST free) vs the sale of only some of a business’ assets.
A taxation due diligence will help inform a buyer how best to structure a sale agreement and may highlight future tax liabilities that can be managed as part of the sale process – e.g. negotiating an indemnity from the seller for future expected taxation liabilities. A target company’s historical losses may be identified as a taxation asset that can be leveraged by a purchaser under a share sale agreement but not under an assets sale agreement.
The sale of a business, whether shares or assets, may also give rise to Capital Gains Tax (CGT) liabilities. CGT concessions are often available, particularly for small business owners. Quality taxation advice is an essential part of the sale process and to ensure parties can structure a transaction to maximum effect.
The above is an introduction to some of the issues relevant to determining how to structure the sale and purchase of a business. Professional advice should always be obtained to ensure the sale is structured towards the achievement of your specific objectives. Regardless of how a sale is structured, this article highlights the importance, for both sellers and buyers, of conducting an appropriately framed due diligence process. A seller can pre-empt many of the problems associated with a buyer’s pre-acquisition due diligence by planning for the proposed sale well in advance. While the risks identified from a pre-purchase due diligence will guide the buyer’s negotiation of the transaction documents to mitigate against those risks (e.g. protections in the form of specific seller warranties, bank guarantees, performance guarantees or insurance).