There are a number of issues to consider with the sale or purchase of a business, one of them being whether the business should be sold via an asset sale or share sale.
One of the key issues to consider at the start of a business sale is whether the assets of the business, or all the shares in the company that owns the assets, will be sold. These two methods may have significant implications for each of the vendor and the purchaser and should be considered by both parties when structuring the transaction. In determining which structure is more appropriate, consideration should be given to the legal, commercial and tax implications as the financial consequences and risk exposures could differ significantly. It is therefore important to obtain independent legal, tax and accounting advice prior to committing to a particular structure.
Asset sale or share sale?
Broadly speaking, a purchaser may be more likely to prefer an asset sale to limit the extent of liabilities it takes on and to refresh the cost-base of the assets for CGT purposes in any subsequent re-sale. However, a vendor may prefer a share sale for tax reasons and to significantly reduce the extent of any potential liabilities that may remain with it. In most circumstances, the tax implications drive the structure of the transaction. The implications and key considerations under both structures are outlined in more detail below.
Under an asset sale, the purchaser acquires some or all of the assets owned by the vendor that is used in its business and the vendor retains the ownership of the corporate entity.
The vendor’s business name may or may not be included in the sale and the licences, contracts and employees may or may not be transferred to the purchaser depending on the terms agreed.
If the purchaser wishes to take on the employees, the relevant employees’ employment with the vendor will need to be terminated and those employees would need to accept new employment with the purchaser. Depending on the circumstances and the nature of the transfer, the employees may be entitled to redundancy pay from the vendor if new employment with the purchaser is rejected, or may be entitled to a payout of any accrued entitlements by the vendor if the purchaser is a non-associated entity of the vendor (because in those circumstances, the purchaser would not need to recognise the employees’ service with the vendor in respect of various accrued entitlements). If the purchaser wishes to have the benefit of any contracts or licences, such agreements will need to be assigned (if possible) or novated to the purchaser. Where there is a clause which prevents an assignment or novation of the agreement without the consent of the other party, the purchaser should cause, and the sale agreement should require, the vendor to obtain such consent from the third party before completion.
A purchaser is likely to prefer an asset sale because the purchaser can ‘cherry pick’ which assets to acquire and exclude any unwanted assets. Even when the purchaser is buying all of the assets, the purchaser still may prefer an asset sale as the company’s liabilities and encumbrances are usually not transferred to the purchaser unless the parties agree otherwise. Further, the cost base of assets for CGT purposes are refreshed to their market value which could reduce capital gains tax that might arise on a future disposal of those assets. Where the sale is classified as a “going concern”, no GST will be payable. However, where the sale cannot be classified as such, and GST is payable, input tax credits may be claimable. Depending on the State or Territory in which the assets are located, stamp duty or land tax may also be payable. In those circumstances, it should be noted that the stamp duty may be higher than if the shares in the vendor company were acquired.
Under a share sale, the purchaser acquires all the shares in the company that owns the assets and runs the business. By acquiring shares, the purchaser indirectly obtains ownership of all assets and assumes all liabilities of the company.
The parties will need to ascertain all the shareholders of the company and the number and type of shares comprising all the issued capital. Additionally, the parties will need to identify and comply with any restrictions on transfers, including any pre-emptive rights provisions in the company’s constitution or shareholders agreement. All contracts and licences of the company remain with the company, subject to their terms and conditions. Some contracts may contain change of control provisions requiring third party consent, without which, the third party may have the ability to terminate. The purchaser should cause, and ensure that the sale agreement requires, the vendor to obtain such consent prior to completion. Similarly, all employees remain with the company under their employment agreements, subject to any change of control provisions under which, consent from the relevant employee may be required.
A vendor is likely to prefer a share sale as the tax implications may be more favourable than an asset sale. Where an individual sells his/her shares, he/she is entitled to a 50% CGT discount on that sale. However, a company would not be entitled to such discount unless the small business CGT relief applies.
As the purchaser indirectly assumes all of the liabilities and encumbrances of the company (whether recorded or unrecorded and whether known or unknown), it is important to ensure that due diligence of the company is undertaken to identify these liabilities and encumbrances.
Whether the transaction is structured as an asset sale or a share sale, it is essential to obtain independent legal, tax and accounting advice so that the parties understand the implications of the transaction and undertake sufficient due diligence to manage any risk exposures. Further, to manage its risk exposure to breaches by the vendor in respect of undisclosed liabilities or encumbrances, the purchaser should obtain appropriate warranties and indemnities. On the other hand, the vendor should conduct its own due diligence to identify any ongoing risk exposure for it, such as any guarantees or securities provided and ensure that they are released on completion.