The purchase and sale of a business is a process that involves many considerations. A fundamental decision is whether to structure the transaction as a share purchase or an asset purchase. While each transaction will have its own unique intricacies, this article will discuss ten key considerations that should be taken into account when acquiring the assets of a Canadian business.‎1‎ For further information on the specifics of a share purchase and sale, please refer to our corresponding article on share transactions.

For the purposes of this article, we have assumed the target business is a privately held company.

#1 letter of intent

As an initial step, the parties will typically enter into a letter of intent (an “LOI”) which sets out the key ‎terms and parameters of the transaction. An LOI will typically address specifics such as: the type of transaction, the purchase price, the assets to be purchased and the timeline for closing. It ‎is essential that an LOI accurately capture the intentions of the parties, as it acts as a framework for drafting the definitive asset purchase agreement. Although, in most cases, while not legally binding, an LOI can specify that certain provisions therein are binding — such as, provisions relating to confidentiality, exclusivity and expenses. It is often in the best interests of the purchaser to include a binding exclusivity provision as it provides the purchaser with comfort that, before the purchaser expends significant time or resources pursuing the transaction, the seller will not enter into an alternative transaction with another prospective purchaser. For further information on LOIs, please refer to our article entitled Letters of intent for buying/selling a business.

#2 due diligence

The purchaser’s due diligence can involve business, IT, human resource, real estate, financial, tax and legal specialists to investigate the target business. The scope of legal due diligence involves reviewing the target company’s corporate documents, contracts, licenses and permits, and any intellectual property owned or used in connection with the target business. If the seller is a corporate entity, corporate legislation may require certain approvals for the completion of ‎a transaction. For instance, if the assets being purchased comprise all or substantially all of the assets of ‎the seller, the seller will also need to obtain shareholder approval. The purchaser should complete a review of the seller’s minute book to, among other things, ensure the correct shareholders’ consent to the sale of assets.

As part of the purchase, the purchaser will often want to assume certain contracts that are essential for operating the target business. Any contracts to be assumed by the purchaser should be reviewed in full as third-party consent may be required for the assignment of such an agreement. This time-consuming process ‎can be exacerbated when a third-party is difficult to reach or uses the opportunity to renegotiate better terms of the contract to be assigned.‎ Careful review of the contracts should be conducted as such agreements often set out ‎a specific process to be followed when consent is required (i.e. how consent is to be obtained and who ‎shall bear the costs incurred in connection with obtaining such consent).

Certain searches should also be conducted to obtain further information on the seller and the purchased assets. Public record searches will, among other things, reveal security registrations affecting the assets to be purchased and pending or past litigation involving the seller. Any such registrations or litigation will need to be dealt with prior to closing.

For further information on the due diligence process, please refer to our article: Due diligence: the buyer’s perspective.

#3 tax planning

If the assets being acquired comprise “all or substantially all of the property used in a business”, GST/HST is payable on closing, in which case, the purchaser and seller often agree to make a joint election under section 167 of the Excise Tax Act to have no GST/HST payable on the sale. Purchasers typically benefit under an asset purchase transaction due to their ability to use the purchase price as their cost base for tax purposes. However, it should be noted that sales tax and land transfer tax (to the extent that real property is involved) may be applicable on the purchase of assets. There are other tax elections that may be appropriate. For instance, the parties may elect to file an election under section 22 of the Income Tax Act. Such election allows the parties to deduct accounts receivable that are unlikely to be collected, if certain requirements are established. Overall, there are a variety of tax implications that should be considered when purchasing the assets of a business.

#4 parties, property and purchase price in the asset purchase agreement (an “APA”)‎2

Parties: Although the parties to an APA may seem obvious, some businesses have complex corporate structures in which different assets and liabilities are held by different entities throughout the corporate structure. In these scenarios, care must be taken to ensure the correct parties are entering into the APA. If the selling party is a corporation with no remaining active business, the principal of such corporation will often also be party to the APA. There are a variety of reasons why a principal may be added as a party. Such reasons include: to have the principal personally provide representations and warranties with respect to the purchased assets, because of restrictive covenants provided by the principal (such as a non-compete covenant) and so the principal is directly obligated under the indemnification provisions of the APA.

Property: In addition to correctly identifying the parties to the transaction, the APA must also clearly describe the assets to be purchased and the liabilities to be assumed. Typically, a schedule is attached to the APA which sets out a detailed list of the purchased assets and the assumed liabilities. There are certain assets and liabilities that may be excluded from the transaction. To help alleviate confusion as to what assets form part of the transaction, it is common practice for the APA to contain a list of assets that are explicitly excluded from the transaction. A purchaser should carefully review such a list to determine whether any of the excluded assets would impact the purchaser’s ability to operate the business post-closing.

Purchase Price: When determining the purchase price payable in a transaction, parties should turn their attention to both the amount and the manner of payment. The purchase price can be paid entirely in cash, in shares of the purchaser (or a subsidiary or affiliated entity), in other property, or in a combination of the above. ‎

The timing of payment may also be adjusted based on the parties’ circumstances. For example, it is common for a portion of the purchase price to be paid up front with the balance deferred and evidenced by a promissory note. If the purchaser delivers a promissory note, the purchaser will often need to grant the seller a security interest over the purchased assets to secure obligations under the promissory note. For the seller’s security interest to be perfected in Ontario, the requisite security documents and financing statements must be registered pursuant to ‎the Personal Property Security Act (Ontario).‎

#5 working capital

One of the most common types of purchase price adjustments is a working capital adjustment — which is an adjustment based on the working capital (current assets minus current liabilities) of the purchased assets and the assumed liabilities. A working capital adjustment can help ensure a purchaser has a sufficient amount of working capital to operate the business post-closing.

#6 earn-outs

An earn-out is a mechanism to bridge a valuation gap. When an earn-out is utilized, a portion of the purchase price is contingent upon the achievement of mutually agreed upon objectives in the future (financial or otherwise). An earn-out can be an effective way to motivate a seller to contribute to the overall wellbeing and success of the target business post-closing, as favourable outcomes will increase the earn-out portion of the purchase price. Caution should be taken as an earn-out may not only increase the complexity of a transaction, but also result in unintended tax consequences. Parties should consult their accounting/tax specialists in this regard.

#7 representations and warranties

Representations and warranties are the “guarantees” that the seller makes to the purchaser about itself, the target business and the condition and completeness of the assets to be acquired by the purchaser. A purchaser wants to obtain assurance from the seller that the seller has good and marketable title to the assets being acquired, that those assets are in good condition, and are not subject to litigation or any registered security interest. The number of representations and warranties included in an APA varies depending on the nature of the transaction.

An APA should include a survival provision which stipulates the length of time to which a party can claim a breach of the representations and warranties. It is typical for the survival period to range from 12 to 24 months for non-fundamental representations and warranties. Certain representations and warranties survive longer than others. For example, those pertaining to fundamental corporate matters, such as title to the assets, will often survive indefinitely or until the expiration of the applicable limitation period.

#8 indemnities

If a representation and warranty is found to be inaccurate or false within the applicable survival period, the aggrieved party could bring an indemnification claim. Standard indemnification provisions provide that one party is to be indemnified by the other in the event the other party breaches a representation, warranty or covenant of the APA. Other line-item indemnities could also be included. The indemnification provisions should be tailored to address the specific concerns of the purchaser. For instance, if certain assets or liabilities are explicitly excluded from the transaction, the purchaser may want to insist on indemnification for any claims relating to the excluded assets or liabilities.

A purchaser should also consider a seller’s financial ability to fulfill potential indemnity claims. The purchaser could consider whether a portion of the price should be held in escrow — only to be released upon the occurrence of certain conditions. As previously mentioned, it may be advantageous for the purchaser to request that the principal, or a parent company (if the seller is a subsidiary), of the seller be a party to the APA to further guarantee the indemnification obligations.

With respect to funding indemnity claims, another option that may comfort a purchaser would be the right of set-off, where payments are due from the purchaser to the seller. For example, a postponed portion of the purchase price to be paid on a later date can be offset against damages suffered by a breach of a representation and warranty or other indemnity.

#9 employment and labour considerations

Subject to jurisdictional differences or certain statutory requirements, a purchaser is normally not obligated to retain the non-unionized employees of the business when completing an asset purchase. This differs from that of a share purchase where, with the exception of certain employees, the share purchase does not usually alter the employment status of employees. A purchaser should complete a thorough investigation of the employment and labour relations of a target business to determine the personnel needs and obstacles that it will encounter in operating the target business post-closing. The APA should contain fulsome representations and warranties with respect to employment and labour related matters.

Since employment agreements between a seller and its non-unionized employees are not automatically assumed by the purchaser in an asset deal, the purchaser has the ability to choose which employees, if any, it wishes to retain post-closing and, subject to statutory minimum requirements, the terms and conditions of employment that the purchaser will offer to the seller’s employees. This may mean new employment agreements are entered into between the purchaser and some or all of the employees that the purchaser wishes to retain.

Subject to the provisions in the APA, the seller will remain liable for any employee who is not offered employment with the purchaser or who otherwise refuses an offer of employment from the purchaser. To limit the seller’s employment liabilities, sellers will often seek to have the purchaser hire all employees of the seller on the same, or substantially similar, terms and conditions of employment.

If the seller is bound by any collective agreements in respect of the target business being sold, the purchaser will be declared a “successor employer” under labour relations legislation and become bound to the seller’s collective agreements post-closing. As a successor employer, the purchaser will assume any unionized employee who works in the target business and must recognize the union as the bargaining agent for those unionized employees.

Legal advice should be obtained as employment and labour law considerations vary between jurisdictions and there are a variety of factors to consider.

#10 regulatory approvals

Under the Competition Act (Canada), where certain thresholds are met, parties to an APA must notify the Competition Bureau and observe the 30-day statutory waiting period prior to completion of the transaction, unless the parties obtain an advance ruling certificate or a non-action letter from the Competition Bureau indicating that the Commissioner of Competition (“Commissioner”) does not presently intend to challenge the transaction. The Commissioner considers whether the notifiable transaction will have or is likely to have the effect of preventing or lessening substantially competition in a definable market. The filing fee for Competition Bureau review is significant and while typically born by the purchaser, the parties may agree to share the cost.

The Investment Canada Act (“ICA”) applies if the purchaser is a non-Canadian entity, and purchases all or substantially all of the assets of a Canadian business. The transaction may require review and approval by the federal government under certain circumstances, such as where certain monetary thresholds are exceeded. Where the target of the acquisition is a Canadian “cultural business” (as defined under section 14.1 of the ICA), the monetary threshold is much lower, and even where such a transaction falls below the threshold, the government may still order a review on a discretionary basis.

Where such governmental approval is required, the government must be satisfied that the acquisition is likely to be of “net benefit” to Canada. An asset acquisition that is not reviewable is notifiable, and such notification must be filed with the Investment Review Division either any time prior to or within 30 days following the closing of the transaction.

In addition, if the government has reasonable grounds to believe an investment could be injurious to national security, the government may make an order for a review of the investment.

Post-closing considerations and conclusion

Some standard post-closing matters typically include items such as: completing income and taxation remittances or elections; filing or recording any documents of ownership; or any post-closing items identified in the APA. Thought should also be given to any working capital adjustments (or other purchase price adjustments) that may need to be dealt with post-closing. If the APA contains an earn-out, the determination of whether the specified objectives have been satisfied, and the payment of the corresponding earn-out amount will also need to be addressed post-closing.

An essential question in the purchase and sale of a business in how to structure the transaction. An advantage of an asset purchase is that the purchaser is able to cherry-pick the assets it wishes to purchase and is only responsible for the liabilities assumed, not the liabilities of the business as a whole.

That said, there are numerous legal issues to work out and this article has discussed a number of them.