Thinking about selling or purchasing a business? Your need to know about the differences between a sale of shares versus a sale of assets.
Small businesses often fast-track their growth through the strategic acquisition of an aligned business or by divesting an unwanted division. When considering a transaction for the sale and purchase of a business (whether you are the seller or the buyer), it is essential to think about how to structure the sale to meet your needs.
Here we discuss the differences between a sale of shares versus a sale of assets, and highlight the importance of the pre-sale due diligence process.
Share sale agreement
A share sale involves the sale and purchase of the shares in the company that owns the target business. The seller is the owner(s) of the shares in the company. The buyer acquires the target business through ownership and control of the company.
For sellers wishing to fully and cleanly exit their business, a share sale is typically preferable. As a buyer, a share sale will often be appealing as the totality of the target’s operations are acquired with limited disruption to the target business. Legal, financial and tax due diligence is critical in such arrangements to ensure the buyer understands the risks and liabilities, often hidden, that are being acquired and, as discussed below, to otherwise manage the impact of the sale on key contracts.
Asset sale agreement
A sale of business assets involves the sale and purchase of some or all of the assets of a business (such as goodwill, intellectual property, plant and equipment and contracts). The owner (seller) of the business will retain any assets and/or liabilities that are not sold as part of the sale.
“When considering the sale and purchase of a business, it is essential to think about how to structure the sale to meet your needs.”
For buyers, the ability to “cherry pick” the desired assets can be advantageous. Unwanted assets and liabilities can be left behind. For example, potential liabilities associated with legal claims and disputes are typically retained by the seller in an asset sale. As a seller, an asset sale may be preferable where a quick exit is required, where particular assets are considered surplus to needs or where the seller wishes to otherwise retain particular assets required for the continued operation of another business. The due diligence process associated with a sale of assets agreement can often be more straightforward as advisors can focus their attention on actual known assets being acquired.
For a seller, whether selling shares or assets, it is essential to ensure your intellectual property assets (e.g. trademarks, copyrights, designs and patents) are properly catalogued and owned by the correct entity. As experienced legal advisors in the areas of IP and business sale transactions, we know that IP assets often represent the real value of what is being bought and sold and thus warrant special attention. For example, in a share sale transaction this means ensuring the target company owns, or holds valid and subsisting licences to, all relevant and key IP assets.
Because different rules apply to the creation and transfer of ownership of IP assets, depending upon the type of IP involved, we always advise parties to a sale to conduct a careful due diligence of IP assets to ensure the effective transfer of these assets. A buyer might otherwise not attain ownership of the desired IP assets and the seller could be exposed to a breach of warranty claim under the sale agreement (e.g. a vendor warranty that the company owns certain IP).
As part of its sale preparations, a prospective seller should audit its IP rights to ensure all material IP assets are properly protected. The IP audit will often reveal instances where IP, thought to be owned, actually needs to be transferred from a company’s employees or contractors or, in the case of registrable IP (such as trademarks), need to be registered. If these issues are left to chance and uncovered by a buyer’s advisors a deal can be easily compromised. Worse still, a prospective buyer could disingenuously use a due diligence exercise to uncover a competitor’s IP weaknesses for their own competitive advantage.
In a share sale, the company’s employees are typically retained on their existing employment contracts. Pre-acquisition due diligence of these contracts is appropriate to ensure the buyer understands the nature of any unusual terms that they will inherit and to ensure new terms can be negotiated if required, e.g. with any key employees considered essential to the new owner.
An asset sale allows a buyer to choose which employees it wishes to retain and to negotiate new terms of employment with those employees.
Employees transferring to a new entity as part of an asset sale will often have the benefit of specific state and territory laws regarding continuous employment and long service leave (LSL). Provisions for an adjustment to the purchase price for an employee’s annual leave or LSL entitlements are usually included in the sale agreement.
Continuity of key contracts
Share sales are often desirable where continuity of the company’s key contracts (e.g. contracts with customers, suppliers, landlords, employees etc.) is important. The key risk to be managed here is ensuring that the proposed change in control of ownership (i.e. the sale of shares) doesn’t inadvertently trigger the termination of any of these contracts. A careful review of key contracts as part of the due diligence process will help manage this risk. Contracts requiring the counterparty’s consent can be identified and addressed in the sale agreement.
As part of an asset sale, the seller may wish to sell existing contracts. This typically requires an assignment or novation of the contracts to the buyer and involves obtaining each relevant counterparty’s consent.
We typically recommend sale agreements (whether of shares or assets) specify that completion of the deal is subject to the counterparty to each material contract agreeing to the change of ownership (in the case of a share sale) or transfer of the contract to the buyer (in the case of an asset sale).
Many businesses require a licence or permit from a government agency for their continued operation (e.g. a liquor licence). A change of ownership typically requires approval from relevant regulatory bodies. Buyers must ensure they understand the regulatory landscape impacting upon the continued operation of the target business and manage this as part of the acquisition process.
Every business sale, regardless of the size of the business and how it is structured, gives rise to tax consequences. These consequences need to be understood and managed as part of the sale process. For example, capital gains tax concessions are often available, particularly for small business owners. Quality taxation advice is an essential part of the sale process and to ensure parties can structure a transaction to maximum effect.
In some states and territories, the sale of a small business may require the seller and its advisors to prepare a disclosure statement. These statements are often required to be in prescribed form and to be provided to the buyer before a sale agreement can be executed. In some circumstances a failure to provide a disclosure statement can void the sale agreement – so proceed with caution.
Regardless of how a sale is structured, this article highlights the importance, for both sellers and buyers, of conducting an appropriately framed due diligence process. A seller can pre-empt many of the problems associated with a buyer’s pre-acquisition due diligence by planning for the proposed sale well in advance. The risks identified from a pre-purchase due diligence will guide the buyer’s negotiation of the transaction documents to mitigate against those risks, e.g. protections in the form of specific seller warranties, bank guarantees, performance guarantees or insurance.
Scott Buchanan, principal lawyer and Aimee Pomogacs, senior lawyer, Buchanan Law Firm Pty Ltd
This story first appeared in issue 25 of the Inside Small Business quarterly magazine.