All posts by Ben Oppy

Asset or Share Sale? Which is Best for You?

When a business is sold, it is usually one of two types of transaction: an asset sale or a share sale. This article looks at the pros and cons of each.

What is an asset sale?shutterstock_165807425 (1)
An asset sale is where the assets of the business are sold, while the seller retains ownership of the business entity and company structure. Assets can include plant, equipment, inventory, property, company name, intellectual property and goodwill.

What is a share sale?
A share sale is where the buyer purchases shares in a business’s legal entity, rather than just the assets. In a share sale the acquirer may purchase anywhere from a minority shareholding to a majority or controlling interest to 100% of an entity. Generally speaking, acquisitions through share sales are more complex and involve greater risk than asset sales and therefore require greater due diligence (DD) by the purchaser to make sure the business is ‘clean’.

Which is right for you?
Ultimately, commercial, legal and tax considerations will determine whether a transaction is structured as an asset sale or share sale. Each type of sale has advantages and disadvantages, and the type of sale you opt for will be influenced by whether you are buying or selling.

Asset sale pros and cons for buyers
Asset sales generally pose a lower risk to buyers, as they are only purchasing the company’s assets and not the business legal entity, which may have unknown encumbrances associated with it. These could include contingent liabilities such as product liability, contract disputes, employee lawsuits or issues with product warranties.

On the downside, employee contracts are not transferable in an asset sale and must be re-negotiated with the new owner and entitlements factored in, all of which can affect the selling price.

Contracts with suppliers and customers as well as special licenses and permits may also not be transferable, and the consent of third parties may be required, which can also affect the sale price.

Certain assets can also be harder to transfer due to issues of assignability, legal ownership, and third party consents. Such assets could include certain kinds of intellectual property, leases, permits and contracts; all of which can slow down the sale and increase costs for the buyer.

Asset sale pros and cons for sellers
Asset sales can be advantageous for sellers in that they can stipulate the assets they wish to sell and retain ownership of those they do not  (i.e. they may wish to retain certain assets such as their cars or items of equipment).

However from a taxation point of view, they may wish to sell all of their assets as if this qualifies them for the sale of what is known as a ‘going concern’, then they may not be liable to pay GST on the sale.

One possible disadvantage of asset sales for sellers is that they may be subject to Stamp Duty, which is generally higher on the sale of assets than on shares.

Share sale pros and cons for buyers
One of the main advantages for buyers in share sales is the fact that they assume full control of the business and the transaction is usually smoother than an asset sale. This is because all contracts with suppliers and customers remain intact and as far as the outside world is concerned, the only thing that has changed is ownership of the business.

Continuity is also maintained with the company’s employees, as terms and conditions of employment remain unchanged with the new ownership.

The main downside of share sales for buyers is the increased risk they are exposed to, because they stand to inherit every element of the business, including any unknown legal, tax or other liabilities the seller may have.

The increased due diligence required to identify these possible encumbrances can also increase the cost of the transaction for the buyer.

Share sale pros and cons for sellers
The main advantage of share sales for sellers is that all of their potential liabilities are re-assigned to the buyer and they can make a clean break from the business

On the downside, because of the potential encumbrances the buyer is taking on, they may require more stringent warranties and indemnities from the seller.

Whichever type of sale structure you opt for as a buyer or seller, it is vital to get the right accounting, taxation and legal advice before committing yourself to a sale. If the size of a transaction exceeds $1 million, then hiring an independent business broker would be a wise decision.

What is Due Diligence?

Due diligence (DD) is the process of appraising a business prior to its acquisition. Usually initiated by a potential buyer, DD looks in detail at a company’s operations, finances, contracts, assets and liabilities in order to determine whether it is a commercially viable business and a worthwhile acquisition. The process is used to identify any risk associated with the purchase whether legal, regulatory, financial or commercial. Its findings typically influence deal structure and terms and may affect the final sale price.shutterstock_175108397

Who conducts due diligence?

Due diligence is usually conducted by either the purchaser or an independent DD provider. usually be called in after the buyer and seller have agreed in principle to the sale.Independent audits are performed by firms who are highly experienced in DD matters, and who will

In case any risks associated with the business or its acquisition cannot be adequately addressed, the DD provider is required to conduct an audit within a set time period (specified in a letter of intent) to ensure that the process does not go on indefinitely and that there is as minimal disruption to the business as possible.

What does due diligence involve?

Depending on whether the purchase is one of assets or sales, DD can involve looking at every aspect of a business, including its legal and tax compliance, financial and sales records, business operations, assets, expenses and debts.

Legal

  • The terms and conditions of any applicable lease agreements and what the buyer’s obligations and rights are in regard to such agreements.
  • Any outstanding notices or government requirements for work to be carried out on the premises, such as water or sewerage work.
  • Any current or pending legal proceedings that may have been instituted against the business or the person selling it.

Tax

  • Whether there are any capital gains tax implications, such as those that apply if the business is sold again within one year of purchase.
  • If there may be stamp duty implications, such as those that would apply if the buyer plans to restructure the business.
  • What the GST implications are for the buyer.
  • Whether the assets of the business have been valued for the best tax advantage.

Finances

  • Analysing its financial records over the short to medium term (past 3-5 years) to confirm historical performance and determine future cash flow and profitability projections.
  • Examining the accounts receivable with regard to any doubtful debts or payments made to the seller such as deposits that may be owed to you.

Sales

  • Whether they are accurate, or whether bad debts are still recorded as receivables.
  • Whether sales patterns are consistent or fluctuate according to seasonal factors or business cycles.
  • Whether sales levels can be maintained and improved with current resources.
  • Whether a few particular clients or salespeople are responsible for a large percentage of sales.
  • Whether the buyer has obligations with regard to existing warranties on goods sold.

Operations

  • Whether it is part of a group or franchise, which could restrict the buyer’s autonomy.
  • Whether it has all the necessary authorisations and licences to carry out its functions.
  • Why the owner is selling and whether they intend to operate in competition to you in the future.
  • Whether the seller is pivotal to the success of the business and whether the buyer has the necessary skills to fulfil the vacated role.
  • Whether the business is in a good location and if this is likely to continue.

Industry

  • The current state of the industry and whether it is likely to expand or contract in the future.
  • Where the business ranks in relation to its competitors.
  • Whether the same suppliers will be accessible on the same terms.

Assets

  • The book value, market value and replacement value of the fixed assets,which the buyer will pay for.
  • The intangibles and whether they are transferable to the buyer.
  • That the inventory has been accurately valued in cost of goods sold statements.
  • Whether plant and equipment is owned or leased, in good working order and if reasonable depreciation is being claimed.

Expenses

  • Whether any large expenses have been put off by the seller.
  • Whether any large expenses are likely in the near future.
  • Whether there are any ongoing expenses such as advertising costs that the buyer would be obliged to honour.

Debts

  • What the terms of repayment are and whether there are any risks for the buyer.
  • Whether the business generates sufficient cash flow to cover its debts.

When you’re looking at acquiring a business, due diligence is a way of ensuring you know exactly what you’re buying. It should be a part of every acquisition, because unless you know the true value of a business, you can never be sure whether you’re buying an asset or a potential liability.