This resource has been prepared by Nicholas dePencier Wright of Wright Business Law for educational purposes. This information is current as of the date of writing and does not constitute legal advice, which should be obtained prior to relying on anything herein.
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When entering into a business transaction, one of the critical decisions that both buyers and sellers must make is whether to structure the deal as an asset purchase or a share purchase. In Canada, these two types of transactions have distinct legal, financial, and tax implications, which can significantly impact both parties involved.
This blog post will break down the key differences between asset purchases and share purchases, outline their advantages and disadvantages, and explain the legal considerations that must be taken into account in the context of Canadian law.
- What is an Asset Purchase?
An asset purchase occurs when a buyer acquires specific assets of a business, such as equipment, inventory, intellectual property, or real property, while leaving the business’s legal structure, liabilities, and shares behind. In this type of transaction, the buyer typically selects which assets to acquire and which liabilities to assume, making it more flexible.
Key Features of an Asset Purchase:
Selective Asset Acquisition: The buyer can pick and choose which assets to acquire, such as physical assets, intellectual property, or customer lists.
Liabilities: Generally, the buyer does not assume the seller’s liabilities unless specifically agreed upon. This is a major advantage for the buyer, as they can avoid inheriting unforeseen liabilities.
Tax Considerations: In an asset purchase, the buyer can “step up” the value of the acquired assets for depreciation or amortization purposes, providing potential future tax benefits. However, the seller may face double taxation—first on the sale of the assets and then on the distribution of proceeds from the sale.
- What is a Share Purchase?
In a share purchase transaction, the buyer acquires the shares of the target company, thereby taking control of the entire business, including its assets and liabilities. Essentially, the buyer purchases the company itself and inherits all of its obligations, rights, and contracts.
Key Features of a Share Purchase:
Whole Business Acquisition: By purchasing the shares of a company, the buyer assumes control of all the assets and liabilities of the business, including any legal obligations and potential risks associated with the company.
Liabilities: Unlike an asset purchase, a share purchase means that the buyer also assumes the company’s existing liabilities, including contracts, debts, pending litigation, and other financial obligations.
Tax Considerations: The buyer cannot step up the value of the acquired assets in the same way as with an asset purchase. However, the tax consequences for the seller are generally more favorable, as the seller is typically only subject to capital gains tax on the sale of shares, rather than facing double taxation.
- Advantages of Asset Purchases
Protection from Liabilities: One of the biggest advantages of an asset purchase is that the buyer can generally avoid assuming the seller’s liabilities. This is especially beneficial if the target company has significant pending lawsuits, debt, or other liabilities that the buyer does not wish to inherit.
Flexibility in Asset Selection: In an asset purchase, the buyer has the ability to select the specific assets they wish to acquire. This allows them to avoid purchasing unwanted assets and focus on the most valuable parts of the business.
Depreciation and Tax Benefits: The buyer can often take advantage of tax benefits by stepping up the value of the assets purchased, which may result in higher depreciation or amortization deductions.
Simplicity in Structuring the Deal: Asset purchases can be more flexible and tailored to the needs of the parties involved. They allow for a more customized allocation of purchase price among the various assets.
- Disadvantages of Asset Purchases
Double Taxation for Seller: In an asset sale, the seller may face double taxation. First, they must pay corporate tax on the sale of assets (such as inventory, real property, or goodwill). Then, if the proceeds are distributed to shareholders, they will also be taxed on the dividend or capital gain.
Complex Transaction: Asset purchases can be more complex than share purchases because each asset must be identified and transferred individually, which can be time-consuming and costly, especially when dealing with contracts, real estate, or intellectual property.
Contract Assignments: Many business contracts, such as leases or supplier agreements, may not automatically transfer in an asset purchase. The buyer may need to obtain consent from third parties, which could delay the transaction or result in renegotiations.
- Advantages of Share Purchases
Simplicity and Continuity: A share purchase is often simpler to execute because the business entity itself is not changing. The buyer purchases the shares, and the business continues as usual. There is no need to transfer individual assets or renegotiate contracts.
Tax Benefits for Seller: The seller is generally only subject to capital gains tax on the sale of the shares, which is typically more favorable than the double taxation incurred in an asset sale. If the seller has held the shares for a significant period of time, they may also be eligible for the lifetime capital gains exemption (LCGE), which can reduce the tax burden.
No Need for Asset Transfer: In a share purchase, the buyer acquires the entire business, including all contracts, liabilities, and ongoing relationships. This makes the transition smoother, particularly for businesses with long-term customer relationships or proprietary contracts.
- Disadvantages of Share Purchases
Inheriting Liabilities: The biggest disadvantage of a share purchase is that the buyer assumes all of the target company’s liabilities, including any hidden or contingent liabilities, such as outstanding lawsuits or tax liabilities. This can be a significant risk, especially if the seller has not disclosed all liabilities.
No Step-Up in Asset Basis: Unlike asset purchases, share purchases do not allow the buyer to step up the value of the underlying assets. This means the buyer cannot depreciate or amortize the assets based on the new purchase price.
Potential Tax Liabilities for the Buyer: In some cases, the buyer may be subject to tax consequences if the target company has accumulated unused tax attributes, such as tax losses, which could be lost in the share purchase.
- Legal Considerations in Asset and Share Purchases
Regardless of whether a transaction is structured as an asset or share purchase, both parties must navigate important legal considerations:
Due Diligence: Whether buying assets or shares, thorough due diligence is essential. Buyers must assess the financial, legal, and operational health of the business, as well as identify any potential liabilities or risks.
Contracts and Agreements: In asset purchases, the buyer must ensure that key contracts (such as leases, employment agreements, and supplier contracts) are transferred. In share purchases, the buyer must ensure that the company’s organizational documents, shareholder agreements, and corporate records are reviewed.
Warranties and Representations: In both types of transactions, warranties and representations regarding the business’s assets, liabilities, and operations should be included in the agreement. These provide legal protections in case any issues arise post-transaction.
Financing and Payment Terms: Whether the deal is structured as an asset or share purchase, the buyer and seller should negotiate payment terms, including whether the transaction will be financed through debt, equity, or a combination of both.
- Conclusion
In Canada, the choice between an asset purchase and a share purchase depends on various factors, including the buyer’s desire to assume liabilities, the seller’s tax situation, and the overall structure of the deal. Each type of transaction has its advantages and drawbacks, and both parties should carefully consider the financial, tax, and legal implications of their decision.
Consulting with legal and financial professionals is crucial when structuring these types of transactions. With proper guidance, buyers and sellers can navigate the complexities of asset and share purchases to achieve their business objectives while managing risk.