Corporate Finance/M&A

Whether you are acquiring a new business or selling a key division, one of the most important aspects of the transaction is its structure. Here are some of pros and cons of each.

The nuances of buying or selling a business or its assets are complex. This is particularly true in the Real Estate and Construction sectors where legal and income tax liability, as well as many other factors need to be considered. Whether you are the buyer or the seller, one of the first questions to ask is how to structure your acquisition or divestiture. The two most common options are through a share purchase or an asset purchase.

A Share Purchase

In a share purchase, all of the shares of a corporation or units in a partnership are transferred from the seller to the buyer. The buyer then steps into the shoes of the seller, and the operation of the business continues without interruption. In a typical share purchase, the seller rarely has any continuing interest in the assets, liabilities or operations of the business.

A share purchase has a number of benefits and drawbacks depending on whether you are the buyer or seller.

For the seller, first and foremost, selling shares means that all ties with the business are severed and the seller walks away from potential future liabilities of the business that are not specifically dealt with in a purchase and sale agreement. There can also be significant tax advantages as the seller may be able to shelter up to $750,000 of capital gains associated with the transaction. There may not, in all circumstances, be the potential to use the $750,000 capital gains exemption.

For the buyer, a share purchase means inheriting all the risks and prior and future liabilities of the corporation. Potential issues could include unforeseen environmental cleanup costs, tax liabilities, or pending lawsuits if material, could severely hamper the value proposition of the transaction. For this reason, it is imperative that buyers conduct an in-depth due diligence to fully understand the business, its risks and potential unrecorded liabilities. Furthermore, buyers need to ensure the costs related to the due diligence are included in the overall transaction budget.

Another potential drawback to the buyer in a share purchase transaction is that the buyer will not get a step-up in cost base for tax purposes of the assets acquired. The buyer simply inherits the existing tax cost base attributable to the depreciable assets which depending on the types of assets acquired and their age could mean significant lost tax deductions.

An Asset Purchase

In an asset purchase, the vendor sells the target assets in a corporation or partnership but retains ownership of the shares or units of the entity. The purchase and sale agreement covers only assets and liabilities which have been specifically identified as those being acquired by the buyer. An asset purchase provides flexibility to both buyer and seller as it can involve only certain assets or all of the assets of a business. In the context of real estate and construction, an asset purchase might involve a single property, a portfolio of properties, certain equipment or a division of a business.

Asset purchases are usually believed to favor the buyer because the buyer knows exactly which assets are being acquired and which liabilities are being assumed. Because of this, an asset purchase tends to be less complicated and usually involves less intensive due diligence as compared to a share purchase. Another advantage for the buyer is that an asset purchase allows the buyer to use the purchase price as their cost base for tax purposes which allows the buyer to shelter tax on the future cash flows by claiming amortization against the assets.

However, buyers do face one major drawback for asset purchases. In the GTA, real estate purchases have significant land transfer tax implications in real estate deals and can have implications of up to 4% of the fair market value of the property being acquired.

For the seller, an asset purchase is not particularly advantageous from a tax perspective as the gain is taxable and cannot be sheltered through the use of the $750,000 lifetime capital gains exemption, which may otherwise be available. However, there may be potential tax deferral and planning opportunities when the proceeds are maintained in a corporation.

For the factors mentioned above, in general, sellers prefer share purchases and buyers prefer to acquire assets. The above are some key issues to consider when you are buying or selling real-estate. How you structure your transaction will have a tremendous impact on your legal liabilities and taxes payable. However, equally important is to remember that every transaction represents an overall compromise between the buyer and seller. Advantages and disadvantages of one option over another should be considered in the context of the broader deal.