Asset Purchase v Share Purchase

“I’ve been told I need a Shareholder’s Agreement - do you have a standard agreement I can use” is something we hear with frequency. It reflects an understanding by the client that a Shareholder’s Agreement is a “good thing”, but without an understanding of what that good thing is. Generally the response of legal counsel to this question is that there is no such thing as a “standard” Shareholder’s Agreement, let’s meet and talk. So what is it about Shareholder’s Agreements that are so valuable and why isn’t there a standard form, like a real estate agreement?

At a high level of abstraction, a Shareholder’s Agreement is a document that expresses the expectations of shareholders in respect of a corporation through legal obligations and rights. The task of the Lawyer in preparing the Shareholder’s Agreement is threefold - discerning what the expectations are (and those expectations are often not fully formed) –  providing counsel on the legal and tax implication on the various alternatives by which those expectations may be realized - and expressing those expectations in the form of contractual terms that bind the parties.

For example, shareholders in a narrowly held private corporation may have an expectation that on death the shares will be purchased. In the absence of a Shareholder’s Agreement, this expectation may not be realized. There is no statute or common law requiring or obligating a purchase. If the remaining shareholders are unwilling to agree to a purchase, the estate is left with the shares and a tax bill. Nothing of course prevents the parties from negotiating a purchase, but the relative bargaining power may have shifted in unpredictable ways, and planning opportunities, such as insurance funding, may have been missed. A Shareholder’s Agreement that addresses these expectations will reflect the parties prior expectations for fairness, and will create certainty.  Legal counsel will discuss alternatives including the corporate purchase of the shares, purchase by the remaining shareholders, and hybrids including spousal rollovers, the tax implications under the alternatives to the estate and to the remaining shareholders, the use of insurance funding, payment terms, security and so forth.

In family held corporations, expectations for succession (how management is succeeded) and liquidation (how the shareholding interests are turned into cash) are particularly difficult and require unique and sometimes innovative solutions. A Shareholder’s Agreement is a valuable tool in estate planning for resolving how competing expectations for liquidation and succession are accommodated.

My husband and I are the sole shareholders and directors of an incorporated retail business. We have been quite successful and are generating cash excess to business requirements. We do not want to pay the cash out to ourselves now, and pay high rates of tax, but at the same time this cash is a significant part of a retirement fund. We have no creditors, other than trade creditors payable in the ordinary course. How do we protect this cash for our retirement?

‍You are asking a good question. In the event of an unexpected economic downturn or legal claim against your active business corporation, the excess cash generated in the business could be exposed to potential creditors. Once the liability is crystalized, it may be too late to take action that will protect the cash. You have also correctly identified that the simplest solution –payment of the cash out to yourselves – attracts undesirable tax consequences.

A cost efficient solution is the creation of a holding corporation. The holding corporation structure, when designed properly, allows excess money from your active business corporation to be paid by dividend to the holding corporation, tax free. The holding corporation is a separate legal entity, and is generally insulated from claims against your active business corporation.

Care is required that the desired tax treatment is achieved in the structuring of the holding corporation. There are other financial planning considerations, such as ensuring the availability of the lifetime capital gains exemption, which must be addressed by the new structure. This type of corporate structuring may also be implemented as part of a broader strategy for business succession and included as part of your estate planning.

I am considering the acquisition of a business. Long term contracts between the business and third parties are important to the business. Do such contracts affect the decision to acquire shares or assets of the business?

‍There are a number of factors to be taken into account when purchasing an existing business including tax, liability, due diligence and employee matters. Your question relates to the contracts between the business and third parties. These contracts may include rights obtained by the business necessary to carry on the business, such as licenses or franchises, or the benefit of sale or service agreements for the supply of products or services that generate revenue for the business.

A fundamental difference between an asset purchase and a share purchase is that in an asset sale the contracts must be assigned (along with the transfer of assets) while in a share sale the contracts remain intact (since only the shares of the business itself are transferred).A comprehensive review of all important contracts is advisable as early as possible during the due diligence process to determine rights and obligations. If third party consents are required, consideration must be given as to the risk that such consents may not be available in a timely manner, or at all, and whether the transaction may be better structured to avoid the necessity for assignment. In some less common circumstances there is an outright bar to assignment and consents cannot be obtained (this is the case in some government procurements). The acquisition of the business in such circumstances may only be achieved through a share sale to avoid termination of such contract(s). It should also be noted that some contracts contain provisions that deem a change of control from a sale of shares to be equivalent to assignment, and triggering the necessity for third party consent.