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If a business is owned by a corporation, it may be bought or sold in two ways. One is the sale of the shares by the shareholders, and the other is the sale of the corporation's assets by the corporation.
Businesses owned by a sole proprietor or a partnership may only be transferred by means of a sale of the assets.
Business assets usually consist of tangible assets such as land, building, equipment and inventory and intangible assets such as goodwill, intellectual property, leasehold interest, licenses and other contractual rights.
Because the Income Tax Act contains different rules relating to each type of asset, it is extremely important to value each type of asset separately. For example, any increase in the value of land will be a capital gain, whereas buildings normally will be sold for a value greater than the undepreciated value shown on the business' books. All amounts greater than the book value, up to original value, will be taxed as ordinary income, while proceeds in excess of original value may be treated as a capital gain. The seller would therefore prefer that the division of purchase price between land and building be assigned mostly to the land. The purchaser desiring to be able to reduce its taxes by way of depreciation of the building, wants the allocation of the purchase price mostly on the building. Another example is the allocation of purchase price between goodwill and tangible assets. Goodwill is given a special type of capital gains treatment. The purchaser has a limited right of depreciation and the seller has a restricted amount it must include in income. Because of these and other income tax implications, sellers and purchasers should seek out both legal and accounting advice prior to entering into negotiations and should employ both professional services throughout the transaction.
The purchase and sale of shares has many pitfalls both for the purchaser and the seller. As the purchaser is buying the company itself, there may be a number of undiscoverable liabilities such as: potential lawsuits by customers, reassessment by the Provincial and Federal Taxing authorities, and unknown potential negligence actions. Although the agreement will provide for indemnity by the seller, this is of little use if the seller has left the jurisdiction. For the seller, who is also an officer and director of the corporation, there is a potential action by the purchaser against the seller for failure of the seller to properly carry out his or her director's duties. There have been cases where a purchaser of shares has caused the company to sue the selling shareholder / director for breach of duty while a director resulting in the purchaser, in effect, getting the company for nothing. Because of the dangers involved in a share sale / purchase transaction, it is strongly recommended that legal and accounting advice be sought at the earliest stage possible.
A purchaser may commence the proposed acquisition in one of two ways. One method is to provide a letter of intent to the seller. This letter should be carefully prepared to make sure that it is not a legal offer and is morally binding only. These letters contain a non-disclosure provision whereby the purchaser agrees not to disclose any confidential information provided by the seller. The letter of intent should set forth all of the essential elements of the proposed transaction. Such elements include, allocation of price, determination of inventory, the property to be included, terms of payment, the type of security to be provided if the seller is to carry part of the purchase price, the collection of accounts receivable if they are not being acquired by the purchaser, whether the seller is required to assist the purchasers following closing and if so on what terms, matters relating to the retention or termination of the seller's employees (this is very important), and the ongoing contracts and other agreements to be acquired. The letter should also provide for a due diligence period which would allow the buyer time to investigate the titles to the business and to evaluate the books of the business.
The second and the most usual way to commence the business transaction is by way of an offer to purchase submitted by the purchaser to the seller. Unlike the letter of intent, once accepted by the seller, the offer is transformed into a legally enforceable contract. It is very important that the offer be properly prepared by a lawyer. Again, an accountant should be a part of the process. The offer should provide for a due diligence period and specific conditions, set by the purchaser, that if not met will void the offer and require the return of any deposits. If the offer has been properly prepared, the acceptance by the seller should be the binding agreement. However, often the offer is deficient in a number of important areas. This results in the lawyers being required to settle the details of the transaction and prepare what is known as a Master Sales Agreement so that all of the terms of the sale / purchaser are properly recorded.
Once the sales agreement has been concluded, it will be the responsibility of the lawyers to conduct the necessary searches of title and to draw up the other documents such as bills of sales, leases etc., to complete the transactions set forth in the agreement.