When purchasing a business, there are generally two methods available;
- an asset purchase; or
- a share purchase.
What is an asset purchase?
An asset purchase involves the purchase of some or all of the assets owned by an entity and used to carry on the business of that entity. Assets may include fixed assets (land, buildings, machinery, trading stock), and intangible assets such as goodwill or intellectual property. Usually, the assets are specifically identified in the sale and purchase agreement, allowing the buyer more control over which particular assets and liabilities (if any) it wishes to purchase. Sometimes employee liabilities such as accrued annual and long service leave are deducted from the asset price or paid out for tax reasons.
What to consider with an asset purchase
There are a number of issues at stake during an asset purchase, here are the main considerations:
- Employees – an employee’s current employment contract will usually be with the seller or entities controlled by the seller. When buying the assets, the employment relationship cannot be ‘transferred’ from the seller to the purchaser as employment contracts are personal in nature. In this circumstance, it will be necessary for the seller to terminate the employment contract with the employee and for the purchaser to enter into a new employment contract with each employee. The seller will need to consider the treatment of the accrued entitlements, which can vary depending on the terms and conditions of employment of each employee. Similarly, any employee benefit plans may also have to be acquired or assumed and that can be particularly costly in some situations.
- No Assignment – key contracts may need third party consent to be assigned, or may not be assignable at all, thereby reducing the value of the business to the purchaser. Specific arrangements may be required to vest title in the purchaser. For example, the consent of landlords or finance companies may be required for transfer of any property or plant & equipment leases where these are subject to mortgages or live purchase agreements.
- Ability to cherry pick – an asset sale provides the purchaser with the ability to choose which assets to acquire and to leave any unwanted assets with the seller.
- Apportionment – the purchase price must be apportioned between various classes of assets, including plant and equipment, land and buildings, stock, and goodwill if applicable. This can cause a conflict between a seller’s preference to adopt their book value and a purchaser’s preference to adopt a higher value to maximise tax benefits. The purchase price can, within relevant parameters, be apportioned between assets sold which may result in tax advantages for the seller.
- Tax consequences – for a purchaser, the cost of assets can be reset to their market value at the time of purchase which in most instances will reduce the capital gains tax that might otherwise arise at a future date and result in a benefit to the purchaser. A seller might gain a benefit by utilising tax losses to offset other tax liabilities arising from the sale.
- Capital Gains Tax (CGT) – where all of the assets of a business are transferred the sale may be classified as the sale of a ‘going concern’. This may result in no CGT being payable on the transaction. Alternatively, where the sale cannot be categorised as a going concern, a CGT liability may arise.
- Duties – Stamp Duty Land Tax (SDLT) is charged on the part of the consideration allocated to land and any inherent goodwill in the land. It is no longer paid on other assets acquired. Stamp Duty is paid at 0%, 1%, 3% or 4% depending on the consideration allocated to the non-residential land. For example, if the sale of the business included a freehold property valued at say £1,000,000, Stamp Duty is paid at 4% i.e. £40,000.
Advantages of selling assets
Here are the main advantages of selling assets:
- Increased negotiating power
- Ability to retain assets
- Personal guarantees
- Allowable losses
- Balancing allowance
Below, we’ve provided additional detail for each of these benefits.
- Negotiating power – In a share purchase the buyer is purchasing the entire entity which will include all assets, contracts and liabilities, whether they are aware of them or not. Once the transaction is complete the buyer assumes responsibility for the whole company. For this reason there would usually be greater due diligence and additional professional fee for a share purchase than an asset purchase. The seller may be able to negotiate a better price for relieving the buyer of these matters.
What is a share purchase?
A share purchase involves the purchase of a selling entities shares in order for a buyer to obtain ownership. A share purchase is slightly more complex than a purchase of a businesses assets, because with the shares come a range of potential liabilities, many of which may not be identified on the balance sheet of the entity. Share sales may involve the sale of the shares in a trading entity, related entities and occasionally units of a unit trust. In some instances the share value may be determined on the basis of the expected future earnings of the business and may not take into account the underlying market value of the assets or liabilities being acquired. Where a purchaser acquires 100% of the shares in an entity, the purchaser takes control of the entity and all of the assets and liabilities.
What to consider with a share sale
- Continuity of business name – the business is carried on by the same entity with the purchaser stepping into the shoes of the seller thereby reducing the need for costly and time consuming administration matters. In some instances, customers may not even realise there has been a change of ownership.
- Employees – usually remain with the entity and purchaser. Apart from possible provisions in the sale and purchase agreement that may provide for redundancy of specific staff or specific benefits to be paid upon change of control of the business, the legal identity of the employer remains the same.
- Assignment – prohibitions against assignment may not arise as the contracting party remains the same. This means that it may be easier to sell the shares than re-assign or novate a large numbers of contracts or licences. It is still important to review the terms of these agreements as often they have ‘Change of Control’ clauses which may have implications for the new purchaser.
- Tax consequences – there may be franking credits, tax losses or undisclosed tax liabilities. Potential tax benefits may arise for the seller including small business tax concessions. There may be more flexibility to structure the transaction to optimise the after-tax outcome for the seller. Remember that the purchaser of shares inherits all the “skeletons in the cupboard” of the entity acquired and warranties in the agreement may be of little future value if the seller has dissipated the funds received.
- Unrecorded liabilities – including tax liabilities or warranties the purchaser may not know of. It is important to ensure tax, legal and accounting due diligence is undertaken in an effort to identify these liabilities.
- Stamp Duty – When purchasing shares, Stamp Duty is paid at 0.5% on the value paid for the shares, e.g. a purchase price of £1,000,000 will incur a Stamp Duty of £5,000.
- Warranties – the purchaser will need to ensure they obtain relevant warranties from the purchaser to ensure they are not left with unresolved liabilities such as unpaid fringe benefit tax or payroll tax.
- Property leases – review property leases in the entity name including “make good provisions”.
Advantages of a Share Sale
Here are the main advantages of a share sale:
- Entrepreneur’s relief
- No double tax charge
- Roll-over relief
- No capital allowances balancing charges
Additional detail on each of these points is provided below.
- Entrepreneurs´ relief – If the shares are sold for more that the seller paid for them there is likely to be a chargeable gain. If the company is a trading company (or holding company of a trading group) the seller can benefit from a capital gains tax (CGT) rate of 10%. To qualify, throughout the period of one year before the disposal, the seller must have been a director or employee of the company (or a company in the same group) and must have held at least 5% of its ordinary share capital, allowing him to exercise at least 5% of the voting rights. The relief applies to the first £10 million of qualifying capital gains (after deduction of any related losses).
- No double tax charge – There is a potential double tax charge on an asset sale can result in the seller being taxed twice, once on the gain made from the sale of the assets and again when the sale proceeds are distributed. The selling company may suffer corporation tax on chargeable gains that arise on the sale of the assets. The shareholders in the selling company may then pay income tax on dividends paid out of any profit that is made from the sale of assets.
- Roll-over relief – A share sale should enable the seller to defer tax on chargeable gains to the extent that the consideration takes the form of shares or loan notes in the buyer. This is not possible on an asset sale, although similar relief is available on an asset sale if the proceeds are reinvested by the seller in certain qualifying replacement assets. In each case, the effect of the relief is to defer tax on any gain until the subsequent sale of the consideration shares, loan notes or replacement assets.
- No capital allowances balancing charges – A single chargeable gain will arise on a share sale. On an asset sale, the sale of each category of asset will have different tax consequences. For example, the disposal of certain assets in respect of which capital allowances have been claimed could trigger a balancing charge for the seller. This could be the case if the particular asset or, in the case of pooled assets, the asset pool, is sold for more than its tax written down value as the excess is treated as taxable trading income to the extent that it is less than original cost and as capital gain to the extent that it exceeds original cost. Similarly, the disposal of goodwill or intellectual property rights for a price in excess of the value at which those assets are recorded in the company´s balance sheet could trigger a charge to tax on income under the tax regime for intangible assets acquired on or after 1 April 2002.
- Continuity – A share sale does not affect the continuity of the business which carries on without interruption. With an asset sale it may not be possible to transfer some assets or agreements without the consent of a third party.
Please do not hesitate to contact our commercial law department if you have any further questions.