Many of our clients work very hard to establish and grow their business, and the sale of their business is often relied upon to fund their retirement or to fund other ventures. What business owners may not realize is that the way in which the sale transaction is structured can greatly impact their net return from the sale, as well as their ongoing liability and responsibilities to the purchaser.
The decision of whether to sell the shares of the business or the assets of the business should not be taken lightly. Both methods can have the same practical result, that is, transferring the core operating business to the buyer, however, the different structures can result in very different tax and liability outcomes. Generally speaking, it is often preferable for sellers to sell the shares of the business whereas it is often preferable for buyers to purchase the assets of the business. For this reason, the interests of the seller and purchaser may not be aligned and the determination of the appropriate structure forms the basis of much negotiation.
For sellers, it is often desirable to sell the shares of the business because the purchaser will acquire all of the assets, liabilities and obligations of the business. The sale of shares triggers capital gains or loss treatment. If the seller has previous capital losses, they may be able to offset the gains from the sale of the shares against their available capital losses. Usually, the most significant benefit to selling the shares is that the seller can take advantage of the Lifetime Capital Gains Exemption to avoid or reduce the amount of capital gains tax paid on the sale. These tax mechanisms can make a huge difference in the proceeds that the seller actually realizes.
On the other hand, Buyers often see greater advantage in purchasing the assets of the business because the buyer can avoid assuming outstanding liabilities or obligations of the seller. From a tax perspective, the buyer also benefits from the ability to acquire depreciable assets for which the depreciation can be expensed each year. But the considerations do not stop there. If the parties have agreed to complete an asset transaction, the allocation of the purchase price among the assets will impact the tax liabilities for both the seller and the buyer. Here again, the seller and buyer encounter competing interests as the seller will benefit from allocating more of the purchase price towards assets with lower depreciation rates, non-depreciable assets and goodwill. Conversely, the buyer will generally want to allocate the purchase price towards assets with high depreciation rates.
Regardless of the structure chosen, advance planning is essential in order for the seller to maximize their proceeds. For example, the seller must take steps to ensure that they will qualify for the Lifetime Capital Gains Exemption, if the availability of the exemption is a key consideration in the sale. The seller must carefully consider who they are selling their business to, as a sale to a non-resident or to a public corporation may disqualify the seller from accessing the exemption. Further, the accumulation of assets which are not actively used in the business, such as excess amounts of cash, may disqualify the seller from accessing the exemption. In such cases, “purification strategies” can be utilized to prepare the business so that the seller will qualify for the exemption, however, this involves planning and time.
When deciding to sell your business, we strongly recommend consulting with your accountant or tax planner to seek advice on the appropriate structure of the sale, the timing and the price, as well as to implement “purification strategies”, where required, prior to selling the business. Once you have developed a tax efficient strategy to sell your business, we then recommend that you consult KH/Dunkley Law Group for advice on the legal structure of the transaction. We can assist you in drafting the Letter of Intent and/or the sale agreement to create the required structure and protect your interests. Most “template” agreements will not properly address the issues discussed above and do not contemplate the specific nuances of your transaction.
We at KH/Dunkley Law Group always do our best to provide useful information and point out the important considerations that will assist you with the tax planning part of the process. The experienced lawyers at KH/Dunkley Law Group always provide relevant advice regarding ongoing liabilities and obligations after the sale has been completed, and we take the time to assist you in drafting a sale agreement that protects your interests and achieves the desired tax outcomes.
If you are, or someone you know is, selling a business, feel free to contact KH/Dunkley Law Group to discuss how we can assist and support you through the process.
Written by Khalil Haji
Barrister & Solicitor with KH/Dunkley Law Group