In a previous article, my colleague Andrew Pitre discussed some of the important tax considerations when purchasing a business. More specifically, he addressed some of the considerations in choosing to buy the shares of an incorporated business versus simply buying the assets of that business. As Andrew explained, sellers typically want to sell their shares when they are exiting a business as they may receive preferential tax treatment if the proceeds of the sale are recognized as a capital gain. On the contrary, purchasers usually prefer to purchase the assets rather than shares of a business so that they may increase the cost base of the assets and thereby increase the amount of depreciation they may claim for tax purposes.

Tax issues aside, the decision to purchase shares or assets is largely driven by liabilities and risk factors. Generally, a purchaser should be reluctant to buy the shares of an incorporated business. A purchaser of shares not only buys the fixed assets and goodwill of the company, but also the entire legacy of the company, good and bad. On the contrary, a purchaser is generally interested in purchasing assets because typically the liabilities of the business do not attach to the assets. With limited exceptions, an unsuspecting purchaser of assets will not be subject to third party liabilities. This is not to say that a purchaser should dismiss the idea of a share purchase transaction, but it certainly means that the due diligence, negotiation and structure of the deal will be considerably different for each type of transaction.

A purchaser of shares in an incorporated business must employ a number of additional risk management strategies. For example, a purchaser of shares is well advised to carry out a much higher level of due diligence than a purchaser of assets, including searches of taxation authorities, court registries and civil enforcement agencies. In addition, a purchaser of shares will usually seek an indemnity from the seller that survives the completion of the transaction. Although technically this strategy reduces risk, a purchaser is still left with risk in collecting from the seller. Another risk mitigating strategy arises when the seller is financing some or all of the purchase price. Under these circumstances the purchaser may be able to negotiate a right to set-off contingent or unknown liabilities from the amount they owe to the seller. Similarly, a purchaser may be able to negotiate a holdback of a portion of the purchase price to cover unknown liabilities. Both of these can be very effective risk mitigation strategies and may come at little expense to either party.

While a purchaser of assets generally faces fewer risks than a purchaser of shares, a purchaser must still employ risk mitigation strategies in the transaction. A purchaser of assets is still advised to carry out a basic level of due diligence. Perhaps the most important is a search of the personal property security registry to confirm that there are no third party financial interests registered against the assets. Similar to a mortgage on real estate, these charges can affect an unsuspecting purchaser’s interest in the assets. I usually also recommend a search of court registries and civil enforcement agencies. While it is unlikely that these liabilities will attach to the assets, these types of searches can reveal a lot about a seller and may help to avoid unpleasant defenses of a purchaser’s good title to the assets. In the age of gift certificates, coupons and group buying vouchers, a purchaser must be careful to ensure that these liabilities are mitigated. While these types of liabilities may not technically be binding on a purchaser of assets, they can cause a considerable loss of goodwill for the purchaser, who appears to the public to be dishonoring its commitments.

In summary, a share purchase transaction can have considerable tax advantages to the seller, but at the same time expose the purchaser to unwanted risks. While these factors tend to favor a purchase of assets for the purchaser, the purchaser would be wise to keep an open mind in the negotiations. By employing certain risk mitigation strategies in the deal, the purchaser may be able to avoid many of the risks and obtain a significant reduction in the purchase price by agreeing to purchase shares. Purchasers are advised to seek the professional advice of their lawyer and accountant before making a final decision to purchase shares or assets of a business.