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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?

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.

> LEARN ABOUT JOHNSONS’ APPROACH TO MID-MARKET BUSINESS SALES

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.

Who conducts due diligence?

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

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.

> LEARN HOW JOHNSONS FACILITATES THE BUSINESS SALE PROCESS

This article looks at the main types of mergers and acquisitions and the motives of the participants in each case.

Mergers and acquisitions occur every day in the business world for a variety of different reasons. Corporate restructuring is going on all the time. If you look in a newspaper, chances are there will be at least one announcement of a merger or acquisition. In the world of small and medium sized business, acquisitions and divestments are also happening all the time, even if we rarely hear about them. It is simply the nature of business – and the ultimate aim is either to grow and/or divest at the expense of another or with their mutual support.

Mergers

A merger is where two or more companies join forces for mutual benefit. Control and operational management form part of negotiations and may be shared or end up in the hands of a single party There are five common types of mergers that occur:

• Conglomerate merger – A conglomerate merger is where two companies that have nothing in common with each other merge in order to share assets or to reduce their business risk.
• Horizontal merger – This is where two companies in the same industry merge. They are often competitors, and the aim of such a merger is to reduce costs and to gain a greater share of the market.
• Market extension merger – Market extension mergers are when two companies in the same industry but in separate markets merge, with the aim of creating a larger customer base.
• Product extension merger – This is where two companies in the same industry but producing different products merge in order to increase profits by grouping their products together to access a bigger market.
• Vertical merger – A vertical merger is where two companies producing different products in the same supply chain merge together to increase their efficiency.

Acquisitions

An acquisition is where one company takes control of another by purchasing its assets or the majority of its shares. There are five main types of acquisitions:

• Value creating – Value creating is where a company acquires another company, improves its performance and then sells it again for a profit.
• Consolidating – This is where a company acquires another company to remove competition from an over-supplied market.
• Accelerating – Accelerating is when a larger company acquires a smaller company and uses its greater resources to accelerate market access for the smaller company’s products.
• Resource acquiring – This is where a company acquires other companies to gain resources, skills, intellectual property, technologies or market positioning they need, because it is more cost effective than developing their own.
• Speculating – Speculating is when a larger company acquires a smaller company with a new product, with the aim of cashing in on its future growth potential.

Businesses Involved in M&A

Much discussion and most news coverage of M&A activity focuses on the actions of large and/or publicaly listed enterprises. In reality, M&A activity occurs as frequently if not more so in the SME market, which comprises small and medium sized businesses.

When acquisitions involve smaller companies transacting with each other, most of the purchases fall into either the “resource acquiring” or “accelerating” categories (see above). In this space there are two main types of buyers – trade and individual. The former refers to businesses buying businesses and the latter to individuals buying businesses. Buyer motivation and perception of value in this space depend on what problem they want to solve. Some typical reasons why smaller entities acquire other businesses include:

• Geographic scale – to enter a new geographic market
• Market extension – to acquire access to a customer base and/or demographic in order to grow market share.
• Channel extension – to gain new channels to market for an existing product / service offer.
• Product extension – to gain new products or services for offer to an existing market and/or channel, thereby extending market share.
• Revenue growth – acquire a similar business offering similar product / service to similar markets in order to grow revenue and customer base faster than through organic growth.
• Brand or positioning acquisition – to gain improved market position through a recognised brand or competitive position.
• Operational bolt-on – to increase capacity and/or resources through infrastructure, capabilities, intellectual property and/or human resources, when the acquisition is more cost and time effective than building them organically.
• “Buying a job” – where an individual buys a business to gain access to an income stream and potential long-term equity growth.

> LEARN ABOUT JOHNSONS’ APPROACH TO STRATEGIC ACQUISITIONS

Selling a business is much like selling anything else in that it must be presented as a solid investment with the potential to benefit the buyer. Following are five tips to help you present your business to buyers in the best possible light and to divest yourself of it in a timely manner and at the right price.

Create a good impression

First impressions are everything, so make sure your business is clean, tidy and running efficiently when buyers come to look at it. Show them examples of your past accomplishments and of your company’s potential for future growth.

Be ready with the right answers. For instance, they will want to know the reason you are selling your business. Have your answer prepared and ensure you tell them that it is for a valid reason, such as to pursue other interests or retire. Otherwise they may assume that the business is changing adversely or that the industry/market outlook may have diminished for reasons they are unaware of.

Have your books in order

No matter how good your first impression, a buyer will always want to see hard evidence of performance, profitability and future opportunities. Make sure your books are up-to-date and on hand, and that they clearly illustrate the viability of your business. Show them your solid sales figures and mid to long term margin performance. Put your vision of the company’s future down on paper in the form of projections, as demonstrating your company’s growth potential in the hands of an acquirer is key.

Use professionals

Selling a business has legal and tax implications, so make sure you use professionals such as an accountant, financial advisor and solicitor to draw up contracts and to advise you of your obligations.

If you want to increase the number of potential buyers, you should also invest in the services of a broker, who will assist you in finding prospective buyers, present your business in the best possible light, qualify interested parties and negotiate the sale on your behalf.

Reduce perceived buyer risk

When evaluating a business, buyers look at both the prospective upside and potential down-side. This means that as critical as it is to demonstrate current value and future performance and growth potential, it is equally important to reduce any perceived risks in the purchase of your business.

Some concrete “risk-reduction” steps you can take prior to marketing your business are:

• Have your books and financial statements in order, i.e. performance data is available, consistent and up to date.
• Eliminate any bottlenecks such as reliance on a single staff member, customer or supplier.
• Make a handover appear less risky by putting in place management structures and resource(s) as well as industry-standard or benchmark processes and information systems.
• Resolve any outstanding legal or regulatory risks and issues, e.g. those involving staff, clients, suppliers or industry bodies.
• Be prepared to offer to stay around during an agreed handover period to ensure a seamless transition between old and new ownership.
• Make sure current client contracts and purchase orders are documented and up-to-date.
• If and where issues or uncertainties do exist, it is better to raise them earlier in discussions rather than later. Do not wait for a prospective buyer to discover “hidden skeletons” during due diligence. This experience will create fear and mistrust for the buyer – in the best case prolonging due diligence and in the more common case devaluing the sale price if not derailing the transaction completely.
• Finally, if and where issues and uncertainties do exist, you may have to consider a staged buyout, in which some portion of the agreed sale price is paid on a deferred basis and dependent on actual performance milestones.

Be flexible and patient

It’s not over until the proverbial lady sings, and divesting a business can in some instances take time. After completing offer and acceptance with an interested party, many vendors find the due diligence and closing stages of a deal especially long and frustrating. It seems like the deal is done, but settling on the terms of sale, of payment, and of handover can involve lots of give and take on all sides. Add the involvement of third parties like solicitors and the mix of different agendas can easily knock a deal off the rails.

As a vendor it is therefore important to keep an open mind, as you might have to explore options that diverge from your original expectations or vision of getting out. It’s best to enter into a divestment process with as few fixed ideas as possible and focus on the long-term outcome for yourself and return on investment for your acquirer.

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