Studies have shown that a majority of Canada’s small business owners plan to retire within the next ten years. Many of these business owners plan to sell their business to either a family member or a third party. We believe that business owners hoping to sell should start the planning process as soon as possible.
Asset Sale v. Share Sale
One important consideration is how to structure the sale of the business. The sale of an incorporated business is usually completed by way of the sale of all of the shares of the operating company or all of the assets used to conduct the business. How to structure the transaction is a matter for negotiation between the parties. For various reasons, business owners typically want to sell shares because of potential tax benefits, while buyers usually prefer to buy assets. There are many considerations to take into account when deciding whether the subject matter of the sale should be shares or assets, including:
Tax Considerations
Business owners typically prefer share sales because of the potential availability of the capital gains tax exemption. If the shares sold are qualified small business shares, an exemption from capital gains tax is available with a lifetime limit of $750,000.
Where real property is involved, an asset sale can trigger property transfer tax liabilities for the buyer. If such taxes are significant enough, buyers are more likely to agree to a share sale in order to avoid property transfer tax.
Finally, a share sale is exempt from GST. An asset sale can be exempt from GST so long as all of the assets required to operate the business are sold to one individual or entity and the parties complete an election to exempt the transaction from GST.
Undisclosed Liabilities and Encumbrances
In a share transaction the buyer will be concerned about claims against the shares by any third parties and undisclosed claims against the company. Buyers reduce the risk of unknown liabilities of the company by purchasing assets rather than shares. In a share sale, the buyer will ask for representations and warranties with respect to these matters and will usually ask to be indemnified with respect to any undisclosed liabilities. However, buyers are not fully protected by indemnities from sellers because the indemnity is only of value if the seller has the ability to pay when required to do so.
Preparing for the Sale of the Business
Starting the planning process early may allow business owners to increase the value a third party places on the business. Working with an accountant or business valuator can provide business owners with the opportunity to make the necessary changes. It can also provide business owners with a realistic assessment of the sale price they can expect to receive.
Issues that business owners should consider prior to the sale of their business include:
- Does the business have any assets that are of little or no interest to a prospective buyer (e.g. excess cash or assets that are really the personal property of the business owners)? Also, are there any underutilized assets?
- Have the owners considered family dynamics to ensure that, to the extent possible, they have dealt with any issues that might arise on the sale of the business?
- Can the owners show a prospective buyer an up-to-date business plan?
- As the business’ leaders, are the owners critical to the day-to-day operations or have they made arrangement such that someone else can effectively manage the business?
Owners may also be able to increase the purchase price if they are willing to finance a portion of the purchase price by delaying payments from the buyer. This, of course, increases the risk faced by the seller, but may be quite attractive to the buyer. Sellers may also find the interest earned by financing a portion of the purchase price to be an attractive investment.
Further, owners may also want to consider restructuring their company by freezing existing shares at their current value and creating growth shares in a family trust. This may allow the beneficiaries of the trust to use the capital gains tax exemption when the shares are eventually sold, and thereby reduce overall taxes on the sale of the business.
How Pushor Mitchell Can Help
We recommend seeking advice from your lawyer early in the process of selling your incorporated business, ideally from the outset of negotiations or earlier. For over 35 years we have been assisting businesses of all sizes achieve their objectives. We do so by gaining a deep understanding of our client’s business and then working hard to help clients succeed. Our clients include emerging businesses and well established corporations across most sectors of the economy. For more information on our Business Law Team, please visit pushormitchell.com/service/business-law.
Stay tuned for related articles in upcoming editions of Legal Alert.
