Small Business Purchase – buying shares or assets…what’s best?

Many buyers and sellers ask me this question:  Is it better to buy the shares or assets of this business

Well as a “rule of thumb”….

If the business is not incorporated, you are buying the assets. (In Quebec you can check le registraire des enterprises www.registreentreprises.gouv.qc.ca/ to validate the status of the business).

Now, if the business is incorporated, you will often have a choice between buying shares and buying assets.  Make sure this is asked upfront since many people have no idea what they are getting into.

Whether buying shares or assets, it is important to determine whether you will be acquiring any liabilities or contractual obligations that are associated with the business.  For instance, in some provinces, if the employees of a business are part of a union, any purchaser of the assets is responsible for carrying on the union contract.  Some assets could be pledged as collateral for loans, so it would be important to ensure the assets are free of liens or encumbrances.

In most cases, if the business is a qualifying small business corporation, the seller will probably want to sell the shares, in order to take advantage of the $750,000 capital gains deduction (consult a tax lawyer or expert prior to embarking into this process).  This may make the seller motivated to accept a lower price than if the assets were sold.

Some advantages of buying shares:

• You may keep the company name which makes the change of ownership less evident to your customers

• In most cases the seller is motivated to accept a lower price offer.

• In certain situations where “non-capital losses” of the purchased corporation can be used by the new owner under certain situations

• Also, if the current corporation is in a loss position with losses expiring in that fiscal year or soon, you may be able to amend prior tax returns to reduce the losses.

Some disadvantages of buying shares:

• You are assuming all liabilities of the corporation

• There’s a possibility that there are liabilities that you are not aware of and are detected during due diligence and/or audits; such as income taxes, provincial sales tax, payroll taxes and even workers’ compensation premiums.
• Your capital cost allowance is based on the tax values of the assets in the corporation prior to the purchase, which could be significantly lower than their fair market value.

If buying the assets of a corporation, it is important to determine the allocation of total purchase price to each asset of the business; this is completed for capital cost allowance purposes.  If land is part of the purchase, the seller will want to allocate a higher value to land than to depreciable assets, in order to avoid recapture of capital cost allowance.  The buyer of the assets will want to allocate a higher value to depreciable assets in order to maximize future capital cost allowance.  If the buyer and seller do not agree on an allocation, it is possible that Canada Revenue Agency could reallocate the purchase price among the assets based on fair market value.

Some advantages of buying the assets:

• Buyer will never assume the liabilities of the corporation, so there are fewer chances of “hidden” liabilities.
• Buyer will be able to claim capital cost allowance based on the price paid for each depreciable asset.

Some disadvantages of buying the assets:

• The local provincial taxes may be payable on the price of the total assets
• All non-capital losses of the current corporation selling the assets cannot be used by the new buyer.

When you are considering of buying a business, it is strongly recommended that you perform a thorough analysis of after-tax cash flows from the purchased business, comparing the options of buying assets vs. shares.  Professional financial and legal help in this area is strongly advised.

The information provided to you in this article is not a complete list of everything that is entailed in buying a business.   A professional business broker and legal business lawyer can help with your due diligence in making the right choices!

One last “rule of thumb”:  if you are buying something bigger than you can fit on your driveway you should always get professional advice!  It’s your investment! Protect it!