Article Series: Guidance on Business Sales (Part 1)
INTRODUCTION
There are many factors to consider and ‘moving parts’ to manage when buying or selling a business. Depending on the business that is being bought and sold, a business sale can be a complex and overwhelming process for both the buyer and the seller.
In this 4-part series, we aim to provide potential buyers and sellers of a business with a better understanding of the transaction structures available and the main considerations associated with each structure, relevant documentation required and the processes involved in the sale of a business from negotiations to settlement.
This series will comprise of the following parts:
part 1 will explore the main acquisition structures to effect a business sale and summarise the advantages and disadvantages of each, both from a buyer’s and seller’s perspective;
part 2 will summarise the key legal documents that are commonly prepared to document the transaction terms and also step through the key stages of an acquisition process (from the commencement of negotiations through to settlement);
part 3 will highlight the importance of conducting thorough due diligence and the types of enquiries a prospective buyer may wish to consider; and
part 4 will be an extension of part 3 and focus on potential legal hurdles that may be identified during due diligence and how they are overcome (including competition concerns, foreign investment review board approval requirements, and other regulatory approval requirements).
PART 1 : Acquisition structures
In this first part of the series, we will provide:
an overview of the key methods used to buy and sell a business;
a summary of the key differences between those methods; and
the factors to be taken into consideration by a potential buyer or seller.
Acquisition structures
While variations do exist, there are two main methods used to buy and sell a business, namely:
Business sale – the buyer buys the individual assets constituting the ‘business’. Conceptually, a ‘business’ can be thought of as a collection of different asset classes (e.g. tangible assets such as equipment, machinery, real property, customer lists, records and stock and intangible assets such as goodwill, intellectual property, permits and approvals and rights under contracts). The types of assets will differ from business to business. The buyer will generally not assume any liabilities of the seller unless otherwise agreed. For this reason (and others set out below) business sale transactions are more common.
Share sale – the buyer buys all of the shares in the target company that operates the business, including all of its assets and liabilities. Following the sale, the directors and shareholders of the target company will be nominated by the buyer, which in turn, provides the buyer with control over the management and operations of the target company and the right to benefit from the profits and capital of the target company.
The appropriate structure to be used for a business sale will depend on the parties’ commercial objectives and specific circumstances of each of the parties as well as the negotiations that take place between them.
Key advantages and disadvantages
The following tables provide a high-level summary of the main advantages and disadvantages of each method from the perspectives of both the seller and the buyer. The matters described in the tables below are the relevant considerations to be taken into account when determining the preferred structure.
Business Sale
| Party | Advantages | Disadvantages |
|---|---|---|
| Seller | · The seller can exclude any assets that it does not wish to sell from the asset sale. · Any tax losses will remain with the seller. · The seller may be able to take advantage of certain small business capital gains tax (CGT) concessions. | · The seller will continue to be responsible for its liabilities, other than those the buyer specifically agrees to assume. · The seller will need to procure releases of all security interests affecting the assets being sold. This may require paying out the financier in relation to these assets to ensure that the assets being sold are free of encumbrances at settlement. · If a third party refuses to consent to the novation of a key contract or if the key contract is assigned (i.e. only the benefits / rights under the contract are transferred to the buyer),the seller will continue to be bound by its obligations under the contract. · If the buyer elects not to accept a transfer of certain employees or to recognise certain employee entitlements (mainly, redundancy pay and annual leave) of the transferring employees, the seller will be required to terminate and pay each terminating employee those accrued entitlements prior to settlement. |
| Buyer | · The buyer is able to choose the assets that it wishes to buy and any liabilities that it wishes to assume. However, care should be taken that the ‘choosing’ of assets does not prejudice any goods and services tax (GST) exemptions (see below). The buyer will not automatically assume the liabilities of the seller however, it should conduct due diligence to ensure it is aware of any liabilities in relation to the assets being purchased. · The buyer may be able to select which employees it wishes to transfer with the business and may be able to negotiate whether it will assume certain accrued employee entitlements such as redundancy pay and sick leave and if so, a potential reduction of or adjustment to the purchase price. However, note that certain entitlements such as sick leave must be recognised by a buyer on a continuing basis. · GST is not payable on the sale of the business if the business is being sold as a ‘going concern’ (i.e. the sale includes all assets necessary for the continued operation of the business by the buyer). | · As the title / ownership of the individual assets constituting the business such as intellectual property, business names, key contracts (e.g. supply agreements, client contracts, leases) will need to be individually transferred to the buyer, the administrative process involved is likely to be time-consuming and reliant on the consent / approvals of third parties. There may also be specific forms of transfers required in relation to different assets. · If any approvals / licences are required to operate the business, the buyer may need to apply for and obtain these approvals and licences if these cannot be transferred (e.g. food premises registrations). If they can be transferred / assigned, they are in any event, likely to be subject to consent from the relevant authority / party. · The key contracts required to continue operating the business will need to be assigned or novated to the buyer or alternatively, new contracts will need to be entered into. In the case of a novation (i.e. where both rights and obligations are transferred to the buyer) and also assignments in the majority of cases, consent of the third party is required. Some third parties may not be willing to provide this consent and may use this as an opportunity to negotiate new terms and conditions. Depending on the number of key contracts that need to be assigned or novated, this can be a lengthy process often involving separate negotiations with the third party. · While the majority of stamp duty payable on a sale of a business have long been abolished, some assets continue to attract an assessment of stamp duty upon transfer (for example, vehicles and real property). |
Share Sales
| Party | Advantages | Disadvantages |
|---|---|---|
| Seller | · All key contracts and assets will remain with the target company and as such, there is less administration involved as these do not need to be transferred individually (as is required with asset sales). · The entirety of the target company (including its assets and liabilities) are being sold to the buyer meaning that unless otherwise agreed and subject to any warranties the seller agrees to give, the seller is not responsible for the liabilities of the target company following the sale (whether accrued prior to or following settlement). | · The seller is likely to be required to gather and provide extensive due diligence materials at the buyer’s request for the buyer to consider. · The buyer will often require the seller to provide extensive warranties and indemnities in favour of the buyer due to the potential liabilities that it may be exposed to. Parties often spend considerable time negotiating the scope, extent and limitations around seller warranties. · CGT may be payable by the seller on the sale of shares. · The seller may be required to obtain third party consent if there are any restrictions that apply to share transfers made to third parties, for example leases often contain clauses that require that a landlord’s consent must be obtained prior to the change in control of a tenant. |
| Buyer | · All key contracts and assets will remain with the target company and as such, there is less administration involved as these do not need to be transferred individually (as is required with asset sales). However, note that many contracts (e.g. leases) contain ‘change in control’ provisions which may necessitate the requirement to obtain third party consent. · The buyer may be able to access the tax losses of the seller (provided the same business test or similar business test is satisfied). · GST is not payable on the sale of shares. · Stamp duty is generally not payable on a sale of shares (subject to certain exceptions, in particular where the target company holds real property). · As there will be no change to the target company, the continuity of the business is not disrupted particularly from the perspective of customers and suppliers. | · The buyer is buying the entire business including all of the target company’s historical transactions, rights and obligations of the target company and liabilities (which includes pre-existing liabilities which have not been discharged by the target company, liabilities owing to creditors and potential or active litigation claims and unknown future liabilities such as future tax liabilities). As such, it is recommended that extensive due diligence on the target company and the seller be conducted. · Certain contractual arrangements may require the consent of a third party where there is a ‘change in control’ (i.e. a change in the target company’s ownership and management resulting in a different group of shareholders or directors with decision-making powers in respect of the target company). |
The chosen method of sale will have an impact on the process involved in the sale of the business and will also inform the terms and conditions on which the transaction occurs.
In the next part of this series, we will be providing an overview of the required documentation and the key stages of the process involved in a sale of a business once an appropriate structure has been determined by the parties.
If you are looking to buy or sell a business, please feel free to contact us. We would be happy to guide you through this process.
Disclaimer: The content of this publication is provided for general information purposes only. It does not, nor is it intended to, constitute legal advice and must not be relied upon as such. Should you wish to obtain advice pertaining to a matter covered by this publication, we recommend you get in touch with us to discuss your specific circumstances.
This publication was written by Nicole Tram, Lawyer and Winston Lay, Director.