The sale or purchase of a business can be a complicated endeavour. When making such an important commercial decision, parties should consider the structure of their transaction. This article highlights the difference between a sale of shares and a sale of assets, two popular but distinct options that come with their own advantages and disadvantages.
In the asset sale model, ownership of the entity which owns and operates ‘the business’ does not change. Control remains with the shareholders and the entity itself sells the physical assets, transfers contracts and employment agreements and receives the price. As consequence, all historical risks and exposure liabilities which relate to the business remain with that entity. So too do the benefits, and the seller can expect to seamlessly retain the profits (and bear the losses) earned up until settlement. Parties should strive to agree on the value of work yet to be invoiced to avoid conflict prior to settlement. Insulation from existing liability can be attractive to a buyer for obvious reasons. Although an asset sale will carry more risk for the seller, it typically means that they have to provide fewer warranties.
One of the major advantages of an asset sale, is that it needn’t be a full measure. The parties can agree which assets will form part of the agreement, meaning that the buyer does not have to take on unwanted assets and the seller does not have to part with assets they would like to retain. Flexibility and precision are some of the key reasons that many parties may prefer an asset sale agreement.
As the entity does not ‘change hands’ in this transaction, buyer and seller may require the consent of third parties when assigning contracts or certain kinds of assets. Take, for instance, the sale of property managements by a real estate firm – each management agreement will be subject to a novation. The same goes for supply contracts, employment contracts and any lease agreement that is being transferred if the buyer wishes to set up shop where the seller has been doing business. In addition, if the assets being sold are subject to any encumbrance or security interest, the seller will have to procure a release before settlement. This is perhaps one of the biggest obstacles to the successful completion of an asset sale and parties should plan carefully to avoid last minute hiccups. If the sale can be classified as a sale of a ‘going concern’, which is to say all that is required to continue doing business is transferred in the agreement, the buyer might not have to pay GST on the purchase. That being said, a conveyancing duty may be payable on the transfer of real property and if the transaction cannot be classified as a ‘sale of a going concern’ the buyer will likely have to pay GST on the transaction
In a share sale agreement, the buyer will acquire shares in a company (or units in a unit trust, for example) which controls a business. The buyer then becomes the person who (as owner) will take-on the historical risk. The business, assets, liabilities and contractual benefits will remain within the company as a separate legal entity. For this reason and others, the share sale document is a larger, more complicated document and can be more difficult to negotiate than a sale of assets.
Parties may prefer a sale of shares where ‘the company’ has brand recognition and goodwill. These might have substantial (if difficult to quantify) value to a buyer. Unlike an asset sale agreement, the sale of shares merely transfers ownership of the company and thus does not require the assignment of contracts. This is a headache saver for both buyer and seller, as names, leases, intellectual property, supply contracts and employment agreements can all continue as they had before the transaction.
It is often beneficial for parties to settle ‘as at the expiry of the tax year’, meaning 30 June. This is because the process of determining tax liabilities is dependent on the preparation of assessment documentation that cannot formally occur until the new financial year. It is typical of both asset and share sale agreements that the seller keeps the profits of the business up until settlement. It is also often the case that new management decisions might cause a variance in profit (say expenditure is incurred for new investments) that will then influence whether dividends can be issued to the (new) shareholders. Having the transaction settle at the end of the tax year thus has significant benefits for the splitting of profits between the outgoing seller and the buyer, especially where the overzealous declaration of dividends may not reflect the actual performance of a company over a given period.
Given the extensive liabilities being transferred in the sale of shares, it is often the case that the seller must provide extensive warranties or even indemnities. Even if the seller does this, unless an indemnity is backed by money held on trust or some security such as a bank guarantee, the buyer will have to calculate the risk that the seller may not be capable of indemnifying the buyer if the occasion arises. The seller should also be cognisant of any financial transactions they have supported with personal guarantees or mortgages in relation to the company or the business. Conditions in such finance documents often include a condition that the seller must not allow the ownership of the company to change without advanced permission; in other words, if “control” of the company changes, the loans can often become “due”. A buyer may want to acquire an asset that is “unencumbered”, giving rise to an obligation that the seller pay out the company’s finance liabilities. This is a common demand, and parties should agree early as to the disposition of the company before entering into any agreement.
While both models of business sale have their own advantages, the first question to ask is ‘what do you want to get out of the transaction?’
Both buyers and sellers should plan extensively when making what is often a life-altering transaction. Mitigating the extensive tax, commercial and legal risks associated with the sale of a business requires parties stay informed.
If you have any queries or require further advice, please get in touch with the Business & Commercial team on 02 6274 0999 to discuss further.
Published 09 January 2024.