There is a lot of confusion amongst business owners on the best sale option – assets or shares. Getting it wrong can incur unexpected liabilities and loss.
There are two types of business sales:
- An asset sale (plant, property, machinery, equipment, goodwill, etc)
- A share sale (being shares, either all or part).
However, understanding the risks and benefits will help business owners make an informed decision.
The sale/purchase decision should consider debt structures, securities held and required, the level of transparency sought, risk profile of the parties, the tax impacts, how the business operates, who is required, and whether the business will attract investors. It also depends on consents being achieved, transferability or gaining of regulatory licenses, warranties, contingent liabilities, and shareholder support in a share sale.
The choice is usually dependent upon the respective objectives and bargaining powers of the vendor and purchaser. The logical option is one that optimises the economic benefit of both buyer and seller.
OPTION 1 - ASSET SALE
The large majority of purchasers favour asset sales. This option leaves the vendor with a company that is either held for tax purposes, or for future use, or that can be liquidated. The liquidation of a solvent company enables capital profit to be distributed tax free. The liquidation of an insolvent entity tidies up loose ends and provides for an independent party to ensure creditors are paid in the right priority and order.
A business asset sale involves the sale of some or all of the company’s assets. The assets may include fixed assets such as machines, land and buildings, trading stock, and intangible assets such as, intellectual property, patents, trademarks, and goodwill.
When to make an asset sale
An asset sale will depend upon the objectives of the parties. A purchaser may only be interested in certain assets for a particular purpose. For example, specialised machinery, or maybe only the retail arm. In the sale of part of a business, GST will be charged on the part sale if the part sold cannot be operated independently as a separate business.
What happens after an asset sale
Under an asset sale, the sale proceeds are paid to the vendor company and are extracted from the company by the company’s shareholder(s) after payment of creditors. The shareholder(s) are usually left with a company that requires a liquidation process to settle disputes and liabilities (if funds are insufficient to clear all debts) or a solvent liquidation to extract the capital gain tax free.
For an asset sale, the apportionment of the sale value is important and can be a contentious area of negotiation with the purchaser. If individual assets have been depreciated or amortised below market value there may be tax claw-back. The purchaser will have a different view on the value attached to assets and goodwill.
An asset sale is usually preferred in the following cases:-
- Smaller and simpler businesses are more likely to be sold by way of an asset sale for various reasons (e.g. fewer assets to transfer, accounts are often unaudited and less reliable).
- An asset sale is preferred if the buyer does not want all the assets, only part, or does not want to take all of the employees, or wishes to merge the business it is acquiring with its own business under its own branding.
OPTION 2 - SHARE SALE
Vendors commonly prefer a share sale. Under a share sale, the proceeds are paid directly to the company shareholder(s). The buyer assumes full responsibility and risk for the company going forward.
When to make a share sale
Businesses where a substantial portion of the asset value is attributable to goodwill and Intellectual property are more likely to be transferred by way of a company share sale.
A share sale minimises tax issues for the vendor. The share sale proceeds are usually tax free (unless the company shares were acquired for the principal purpose of sale in the short term).
What happens after a share sale
With a sale and purchase of shares, the business does not change hands. Continuity of the business continues. The relationship with employees is not affected. Ownership of the business remains with the company. On settlement, the purchaser(s) becomes the shareholder(s) of the company.
The legal impact is that on settlement the full benefit of the business (and also the liabilities) lies with the company. In many cases, the contracts between the company and its customers and suppliers continues unaffected, subject to consent being gained or termination clauses being dealt with upfront.
A share sale requires due diligence as risks are high.
ADVANTAGES AND DISADVANTAGES OF SHARES SALE VERSUS BUSINESS ASSET SALES
The advantages for a share sale for a vendor are:-
- the vendor can exit the business cleanly;
- the purchaser acquires ownership of all of the company’s assets and liabilities (the complete package);
- the purchaser effectively assumes all of the liabilities of the on-going company (subject to any specifically excluded under the Sale and Purchase Agreement); and
- the transaction is between the shareholder(s) of the company and the purchaser so the purchase funds go directly to the shareholder(s).
The advantages of an asset purchase for a purchaser are:-
- it eliminates risks associated with unknown liabilities;
- flexibility - the purchaser specifies the assets to purchase and the liabilities (if any) it is prepared to take over;
- tailored due diligence investigation can focus on the assets being purchased;
- valuation - usually assets are relatively simple to value;
- tax advantages - for a purchaser, the cost of assets are valued at market value at the time of purchase (for a vendor, tax losses can be used to eliminate any tax liability on the sale); and
- the purchaser does not necessarily have to take on all employees. They are likely terminated following sale by the vendor.
The disadvantages for the purchaser of a share sale are:-
- unforeseen liabilities are often assumed, such as tax and contingent liabilities. The vendor may not even know about these liabilities. They can include leaky building issues, lease issues such as reinstatement of premises on exit, or even prior anti competitive behaviour claims;
- the risk of assuming all liabilities can be potentially significant. It is however possible to minimise the risks with carefully drafted Sale and Purchase terms, but contingent liabilities can be forgotten or missed;
- complicated valuation - more costly; and
- minority shareholder approval - complications arise if they refuse to sell.
The disadvantages to the vendor of an asset sale are:-
- the vendor will be left with the company liabilities to pay. Liquidation is an option for both the remaining solvent or insolvent company.
An asset sale can be used to sell any type of business; a share sale can only be used to sell an incorporated business.
- In an asset sale, you can choose what you’re selling to a degree. For instance, you may want to keep the name of the business, or a particular asset. In a share sale, the entire business passes to the new owner, including things such as the business name.
- In a share sale, the liabilities are sold along with the rest of the business; in an asset sale, only assets are sold, meaning that the original owner may still be responsible for the business’s liabilities.
- Tax wise, in a share sale there is a possibility that the entire price you pay for the business may be tax free.
Care should be taken by both parties in the decision to buy and sell. Proper due diligence should be undertaken.
An asset sale provides greater protection for a purchaser. An asset sale is also best for an insolvent vendor company. If the company business for sale is insolvent then a sale of assets option is the recommended course. This will likely lead to a liquidation of the vendor company. There are options for insolvent companies to hive down and for directors to start up again in the right circumstances. This is the topic for another article.