Are you thinking about buying a business? As a buyer, it is important to understand the process, consider the potential liability and take steps to protect your investment. This Legal Insights article aims to answer some of the questions you might have when purchasing a business.
1. What is typically the first step?
The first step is often negotiating a letter of intent (LOI). This ensures that buyers and sellers are on the same page about the primary business terms of the transaction. The LOI will include details such as the price/consideration, adjustments to the purchase price, transaction structure, and expected timeline for due diligence and negotiating the deal. LOI’s are often non-binding unless the language in the document specifies that the companies are legally bound to some of the terms.
Even though a carefully drafted LOI may not legally bind the parties, it sets the stage for the deal and both the buyer and seller will refer to its terms when negotiating the definitive share or asset purchase agreement.
2. How does someone actually buy a business?
There are two core methods to buy or sell a business – an asset purchase or a share purchase.
3. What is the difference between an asset purchase and a share purchase?
This is one of the most frequently asked questions we receive at Emerge LLP. To put it simply, a share purchase requires the purchase of all the shares of the company whereas an asset purchase requires the sale of individual assets. With a share sale, (subject to any agreed price adjustments or indemnifications) the seller gets to walk away from any liabilities and the buyer takes them on. This is different from an asset sale which allows the buyer to cherry pick which assets it will purchase and which liabilities it will assume.
Buyers usually prefer asset transactions, whereas sellers usually prefer share transactions. This is not always the case, however, and the right option is highly dependent on the business being purchased, the reasons for purchasing, and the individual situation. For example, preference might change based on the differing tax implications for the buyer and seller in an asset or share transaction.
4. Why might buyers prefer an asset transaction?
Generally, buyers prefer buying assets directly, as it allows them to select which assets they want, and which liabilities are acceptable to assume. This minimizes risk and reduces the overall complexity of the transaction. Also, when assets are purchased directly, the tax cost of the asset will be the amount paid for the asset (assuming the buyer and seller are dealing at “arm’s length” with each other – i.e., buyers and sellers act independently without one party influencing the other).
5. Why might buyers prefer a share transaction?
Buyers sometimes prefer purchasing the entire business through a share transaction. This option is often considered if the company has a strong brand. Also, a share purchase is required if the buyer is looking to buy a company for its tax attributes, such as non-capital losses and investment tax credit carry forwards. In addition, share purchases are generally less complex than asset sales, as asset sales require transfer documentation for all the assets being transferred.
6. What is a purchase and sale agreement?
The Agreement of Purchase and Sale (APS) is a contract between a seller and a buyer for the purchase and sale of a business. The APS requires the buyer to buy and the seller to sell assets or shares of a corporation subject to the terms and conditions in the APS. Terms include: the purchase price, representations and warranties, conditions, and the closing date.
When a buyer is buying assets, the APS is called an Asset Purchase Agreement; when the buyer is buying shares, it is called a Share Purchase Agreement.
7. Why is due diligence important?
One way to mitigate the risk of unwelcomed surprises when purchasing a business is to have a lawyer conduct due diligence on the transaction. This means a lawyer will investigate and review the documents on your behalf for the purpose of providing information and evaluating the business you are looking to buy. The depth and extent of the due diligence required will be dependent on the business, and whether the buyer is choosing to purchase company assets, shares, or a combination of both.
In general, the due diligence process for an asset sale is relatively simple. This is because the buyer will not be automatically assigned potential liabilities of the purchased corporation.
On the other hand, the due diligence process required for a share purchase is more comprehensive. As stated, a share purchase means the buyer will be purchasing the entire business, including its liabilities. This means it is important to understand the company’s records, history, and if there are any issues that might change the buyer’s decision to purchase the business.
8. What are closing documents?
On the closing date of the sale of business, closing documents are prepared and negotiated to give effect to the transaction (these are in addition to the APS). Depending on whether its an Asset Sale or Share Transfer, there is a difference in what closing documents are required to be signed by both parties.
We hope this article will help you start thinking about the steps involved in buying a business and understand how you might structure a potential transaction. If you have any questions about buying a business, please contact one of our lawyers. We are happy to help guide you through the process!
The content of this article is written for general information purposes only and does not constitute specific legal advice. This article should not be used as a substitute for competent legal advice from a licensed lawyer. Please contact us at 416-238-5527 if you’d like to speak to an Emerge LLP lawyer.