Corporate Finance Advisors
After more than 25 years working on M&A transactions, first as a corporate tax and M&A lawyer and now as an M&A advisor, I have seen many transactions where Buyers and Sellers reach an agreement on the value of a business, only to discover that they have very different expectations about how the transaction should be structured.
The Seller believes the business is worth $10 million.
The Buyer agrees.
So, they have a deal, right?
Not necessarily.
One of the most important questions remains unanswered: Is the Buyer purchasing the shares of the company or the assets of the business?
That distinction can have a significant impact on the taxes payable by the Seller, the liabilities assumed by the Buyer, the complexity of the transaction and, ultimately, the amount of money the Seller receives.
In some transactions, the difference in after-tax proceeds can be substantial.
For business owners contemplating a sale, understanding this distinction before negotiating a letter of intent can be just as important as agreeing on the purchase price itself.
In a typical private-company M&A transaction, a Buyer can acquire a business through one of two principal structures.
In a share sale, the Buyer purchases the shares of the corporation that owns and operates the business. The corporation generally continues to own its assets, employ its employees, maintain its contractual relationships and remain responsible for its existing liabilities. What changes is the ownership of the corporation.
In an asset sale, the Buyer purchases specified assets of the business directly from the corporation. Those assets may include equipment, inventory, intellectual property, customer relationships, contracts, goodwill and other operating assets. The Buyer generally assumes only those liabilities it agrees to assume, subject to applicable law and the terms of the transaction.
The distinction sounds straightforward.
However, the financial, tax, legal and operational consequences can be very different.
From the Seller's perspective, a share sale can offer several important advantages. First, the Seller is disposing of an ownership interest in the corporation rather than having the corporation sell its underlying assets. For an individual shareholder in Canada, a share sale may qualify for the Lifetime Capital Gains Exemption (LCGE), provided the shares meet the applicable requirements for qualified small business corporation shares. The potential tax savings can be significant.
However, the LCGE eligibility is not automatic. Among other things, the corporation must satisfy specific asset-use and holding-period requirements. A business owner who has accumulated substantial excess cash, investments or other non-operating assets within the corporation may need to undertake appropriate tax planning well before a sale.
Second, a share sale may offer a more straightforward path to realizing the Seller's investment in the business. The purchase price is generally paid to the shareholders for their shares, rather than to the corporation for its assets. This distinction can be important because an asset sale may create tax liabilities at the corporate level, followed by additional tax considerations when the remaining proceeds are distributed to shareholders.
Third, a share sale may provide greater continuity for the business. Because the corporation remains the same legal entity, many of its existing contracts, licences, employment relationships and operating arrangements may continue, subject to applicable change-of-control provisions, regulatory requirements and third-party consents. That continuity can be commercially valuable, particularly where customer relationships, licences or contracts are central to the value of the business.
For these reasons, many Canadian business owners enter an M&A process with a strong preference for a share sale, but Buyers often see the transaction differently.
From the Buyer's perspective, an asset sale may offer greater flexibility and protection.
In an asset sale, the Buyer can generally identify the assets it wishes to acquire and negotiate which liabilities it is prepared to assume. For example, the Buyer may want the operating assets, customer relationships, inventory and goodwill of a business without assuming certain historical tax liabilities, shareholder obligations, litigation exposures or unrelated corporate liabilities.
An asset sale can therefore help the Buyer limit its exposure to aspects of the Seller's corporate history. That does not mean an asset purchase eliminates all potential liabilities. Employment, environmental, tax, successor-liability and other statutory obligations may still arise depending on the circumstances. Nevertheless, an asset sale can provide the Buyer with greater control over the allocation of transaction risks.
There is also an important tax consideration. When a Buyer purchases assets, the purchase price is generally allocated among the acquired assets, subject to applicable tax rules. That allocation may establish new tax costs for the acquired assets, potentially allowing the Buyer to claim future depreciation or amortization deductions where permitted.
In a share sale, by contrast, the Buyer generally acquires the shares with a tax cost equal to the share purchase price, while the underlying assets remain in the corporation at their existing tax costs.
That difference can make an asset purchase more attractive to a Buyer, even where the headline purchase price is identical.
Consider a privately held Canadian business with an agreed purchase price of $10 million.
The Seller receives two offers:
Offer A — Share Sale
The Buyer offers $10 million to acquire all of the issued and outstanding shares of the corporation.
Offer B — Asset Sale
The Buyer offers $10 million to acquire substantially all of the operating assets of the business.
At first glance, both offers appear economically equivalent. They are not necessarily equivalent.
Under Offer A, the shareholders generally receive the purchase price directly and calculate the tax consequences of disposing of their shares, taking into account their adjusted cost base, available exemptions and other relevant tax considerations.
Under Offer B, the corporation receives the purchase price and may recognize taxable capital gains, income or recapture of depreciation depending on the assets sold and their tax costs. The shareholders must then determine how to extract the proceeds from the corporation, potentially triggering further personal tax consequences.
Canadian tax integration rules may mitigate some of these differences, but the final result depends on the corporation's tax attributes, the purchase price allocation, the shareholders' circumstances and the manner in which the proceeds are distributed.
The important point is that a $10 million asset sale and a $10 million share sale may produce materially different after-tax proceeds for the Seller.
A Seller who focuses exclusively on the headline purchase price may discover that the economically superior offer was not necessarily the one with the highest stated price.
That is why I believe Sellers should evaluate competing offers on an after-tax, risk-adjusted basis rather than simply comparing purchase prices.
In an asset sale, the parties must determine how the purchase price will be allocated among the assets being acquired.
Depending on the business, those assets may include:
The allocation can have different tax consequences for the Buyer and Seller. For example, a Buyer may prefer a greater allocation to assets that generate favourable future tax deductions. The Seller may prefer an allocation that produces a more favourable tax result on the disposition. These preferences do not always align.
The allocation must be commercially supportable and consistent with applicable tax requirements, but within those constraints, it can become an important part of the transaction negotiations.
A properly negotiated asset purchase agreement should address the allocation clearly and require appropriate consistency in the parties' tax reporting.
From personal experience over the years, I can tell you that leaving the allocation unresolved until closing can create unnecessary disagreement at precisely the time the parties should be focused on completing the transaction.
One of the principal concerns for Buyers in a share transaction is that they are acquiring the corporation with its history. That history may include liabilities that are not immediately apparent from the financial statements. Examples include unpaid taxes, employment-related claims, customer disputes, environmental obligations, regulatory compliance issues, pending litigation or contractual obligations.
This is why due diligence is so important in a share purchase. The Buyer must understand not only what the business earns and owns, but also the risks embedded within the corporation. Those risks are typically addressed through a combination of due diligence, representations and warranties, indemnities, purchase price adjustments, escrows, holdbacks and, where appropriate, representations and warranties insurance.
An asset sale may reduce certain historical exposures, but it can introduce other challenges, including the need to transfer individual contracts, obtain consents and establish new operating arrangements.
Neither structure eliminates transaction risk.
The objective is to identify the risks, determine who should bear them and negotiate appropriate protections before closing.
Transaction structure is not simply a tax or legal question. It can have a direct impact on whether the business can continue operating without interruption following closing.
Consider a company whose value depends heavily on long-term customer contracts. In an asset sale, those contracts may need to be assigned to the Buyer. If assignment requires customer consent, the parties may face additional negotiations, uncertainty or closing conditions. In a share sale, the corporation remains the contracting party, but a change-of-control provision may still require notice or consent.
Similar issues can arise with leases, financing agreements, supplier contracts, software licences and professional or regulatory authorizations.
Employee matters can also differ materially between the two structures. In a share sale, employees generally remain employed by the same corporate employer. In an asset sale, the parties must carefully address offers of employment, continuity of service, accrued entitlements, pension and benefit obligations, and potential statutory or common-law liabilities.
For businesses operating in regulated industries, the ability to transfer or maintain required licences and approvals may significantly influence the preferred structure.
A transaction that appears attractive from a tax perspective may be commercially impractical if the necessary contracts, employees or regulatory approvals cannot be transferred or maintained. That is why the transaction structure should be evaluated against the actual operating requirements of the business.
In Part 1 of this series, I discussed why working capital adjustments can materially affect the Seller's ultimate proceeds. Those issues remain important regardless of whether the transaction is structured as an asset sale or share sale.
In a share sale, the Buyer may acquire a corporation with its existing cash, debt, accounts receivable, inventory, accounts payable and other working capital balances. The share purchase agreement must clearly establish how those items are treated in determining the final equity purchase price.
In an asset sale, the parties must specify which operating assets and liabilities are included in the transaction and which remain with the Seller. For example, does the Buyer acquire accounts receivable? Is inventory included? Are customer deposits transferred? Does the Buyer assume accounts payable or accrued liabilities? These decisions can materially affect the economics of the transaction. A purchase price of $10 million with normal working capital included is not necessarily equivalent to a $10 million purchase price where the Seller retains significant receivables or must deliver additional assets. The parties must therefore negotiate not only the price and structure, but also precisely what is being transferred and what obligations accompany it.
One of the mistakes I have seen in M&A transactions is treating structure as a technical matter that can be left to the lawyers and accountants after the commercial terms have been agreed upon. That approach can create significant problems.
Suppose a Seller agrees to a $10 million purchase price, believing the transaction will be structured as a share sale. The Buyer then delivers a draft asset purchase agreement. The Seller's accountant determines that the asset sale will produce materially lower after-tax proceeds. The Seller asks for a higher purchase price to compensate for the difference. The Buyer responds that the parties already agreed on $10 million. Both parties may believe they are acting reasonably, yet they are no longer negotiating the same economic transaction. That disagreement could have been avoided by addressing structure during the letter of intent negotiations.
In my view, the LOI should identify the intended transaction structure and, where appropriate, address the principal assumptions underlying that structure.
If the parties are considering alternative structures, they should understand the potential tax and economic consequences before committing to a purchase price.
A well-prepared LOI does not need to resolve every legal and tax issue. It should, however, establish a sufficiently clear commercial framework so that the parties are negotiating the same transaction.
Not every transaction fits neatly into a traditional asset sale or share sale. Depending on the circumstances, the parties may consider pre-closing reorganizations, the separation of non-operating assets, the sale of selected assets, or other structures designed to address the competing objectives of Buyer and Seller. For example, a Buyer may be concerned about certain historical liabilities within the corporation, while the Seller strongly prefers a share sale for tax reasons. Rather than allowing that disagreement to derail the transaction, the parties may be able to address the Buyer's concerns through additional due diligence, specific indemnities, escrows, insurance or an appropriate pre-closing reorganization.
In other circumstances, an asset sale may be the more practical solution, provided the purchase price and other terms adequately reflect the Seller's tax and economic position.
These alternatives require careful consideration by your qualified tax and legal advisors. They may also involve timing, regulatory, anti-avoidance and implementation risks.
The objective should not be to force a particular structure onto every transaction. The objective should be to identify a structure that produces commercially acceptable economics for both parties while appropriately allocating the transaction risks.
At Minerva Valuations, one of our principal objectives when advising Sellers is to maximize the amount of purchase price received at closing while minimizing unnecessary post-closing financial and legal risk.
In transactions we have advised on, we have been able to structure deals with approximately 80% to 95% of the purchase price payable at closing, reducing the Seller's exposure to deferred consideration, earnouts, vendor financing and other post-closing contingencies.
However, maximizing cash at closing is only part of the equation.
A successful M&A transaction should also take into account the Seller's after-tax proceeds, the allocation of liabilities, working capital adjustments, transaction expenses, indemnification obligations and the certainty of receiving the agreed consideration.
A Seller who receives a higher headline purchase price but assumes significant tax costs, contingent payment risk or continuing liabilities may ultimately be worse off than a Seller who accepts a slightly lower price with more favourable terms.
That is why I encourage business owners to consider three questions when evaluating an offer:
Those questions provide a much more complete picture of the value of a proposed transaction.
After more than 25 years working on M&A transactions, I have come to appreciate that the best deal is not always the one with the highest headline valuation. It is the transaction that delivers the best overall economic outcome, with an appropriate balance of price, tax efficiency, certainty, risk and execution.
An asset sale may be preferable in one transaction.
A share sale may be preferable in another.
The correct answer depends on the business, the parties, the applicable tax rules and the commercial objectives of the transaction. But one principle remains constant: A purchase price tells you what a Buyer is prepared to pay. The transaction structure helps determine what the Seller actually keeps. That distinction should be understood before the letter of intent is signed, not discovered when the definitive agreements are being negotiated.
At Minerva Valuations, our M&A Advisory team works with business owners throughout the transaction process, from understanding business value and preparing a company for market through transaction structuring, buyer negotiations, due diligence and closing.
Working alongside our valuation and financial advisory professionals and our clients' legal and tax advisors, we help business owners evaluate not only the headline purchase price, but also the transaction terms that ultimately determine the economic outcome.
If you are considering selling your business and would like to understand how transaction structure could affect your proceeds, we would be pleased to have a confidential conversation.
This is Part 3 of my three-part M&A Deal Economics series.
In Part 1, Working Capital in M&A: Why the Purchase Price Is Only Part of the Deal, I examined how working capital targets and post-closing adjustments can affect the Seller's final proceeds.
In Part 2, Earnouts in M&A: Bridging the Valuation Gap Without Creating the Next Dispute, I discussed how contingent purchase consideration can help complete transactions while introducing important financial and legal risks.
In Part 3, we have examined how the choice between an asset sale and a share sale can materially affect taxes, liabilities, execution and the Seller's ultimate proceeds.
Together, these three issues reinforce one central lesson:
In M&A, negotiating the right price is important. Negotiating the right deal is what ultimately protects and maximizes value.
Ronald McKenna, LL.B.
Managing Director, M&A & Corporate Advisory
Minerva Valuations Inc.
This article provides general information and does not constitute legal, tax or accounting advice. Transaction structures and tax consequences depend on the particular circumstances and applicable law. Business owners should obtain advice from qualified professional advisors before implementing a transaction.
