Company acquisitions can be in the form of a share purchase or an asset purchase. Both can accommodate the full transfer of a going concern business. The fundamental difference is that in a share sale, the shareholders sell their shares and receive the proceeds personally (i.e. the legal entity that owns the assets changes hands) and, in an asset sale, the legal entity sells all of its assets including its name, IP, brand, customer contracts etc., and remains as a legal entity owned by the shareholders but now just has the sale proceeds as its main asset. A second taxable step of distributing the cash to the shareholders will have to take place for the shareholders to make use of the proceeds. Sellers that pursue this option may have plans for the company to re-invest the proceeds thereby deferring the tax impact.
So how are they different and which is better for a seller or a buyer? Ultimately, it is after-tax free cashflow or net cash in hand that drives the value, purchase price and optimal structure. The tax impact, whether it is reduced capital gains tax for the seller or lower go-forward income tax for the buyer, is usually the biggest driver in the decision between a share or asset sale.
Buyers will prefer an asset purchase when the purchase price is largely allocated to depreciable assets because they will benefit from higher CCA going forward. Sellers will prefer share sales when the $750,000 lifetime capital gains tax exemption has a material impact on the proceeds. In some cases additional family members can benefit from the lifetime capital gains tax exemption by enacting an estate freeze and creating trusts for the children. However, it must be noted that any shareholder will have to have owned their shares for at least two years for the lifetime capital gains tax exemption to apply so this can’t be done at the last minute. For a family with three children this can increase the exemption from $750,000 to $3,000,000; a big impact for transactions up to $5 million. For larger transactions it becomes more complex for sellers as depreciable tangible property may incur taxable recaptured depreciation or, where a significant amount of the sale price is allocated to goodwill, 50% of the profit on the sale of Goodwill is exempt from tax.
Beyond tax there are other factors to consider such as:
- Buyers prefer asset purchases because they avoid the issue of possible skeletons in the closet (undisclosed liabilities)
- Buyers will seek more reps and warranties in a share purchase agreement as they look to protect themselves from potentially undisclosed liabilities
- Sellers should consider the risks of possibly having to renegotiate key contracts with customers and employees in the case of an asset sale (where contracts include a change of control provision)
When selling your business, weigh the answers to the following questions to choose your path:
- Will you benefit substantially from the lifetime capital gains exemption?
- Will the lion share of the purchase price be allocated to depreciable assets or goodwill?
- Will transferring contracts (customers/employees) be difficult?
- Do you have a compelling opportunity to use the funds in the company?
The tax issue can be a complicated one, however, non-tax items such as obtaining customer consents, can sometimes trump it entirely and, if you are indifferent from a tax perspective, the flexibility to pursue either option may provide some helpful negotiating leverage. For a more detailed analysis of both the seller and buyer impacts see the Veracap M&A Value Strategies newsletter here.
Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap M&A International in Toronto.
