I am negotiating to purchase a business and my business advisor has strongly suggested I structure the deal as an “asset purchase”. Why is this preferable?
There are two principal ways to structure the agreement of purchase and sale of a business: as an asset purchase or as a share purchase. An asset purchase is just that, a purchase of listed assets without taking on liabilities of the business. A share purchase, by contrast, is the purchase of the shares of the corporation that carries on the business and owns the assets. There are a number of considerations as to which form of purchase is preferable. In this article, we want to focus on why your advisor has strongly recommended an asset purchase.
Liability
A properly structured asset purchase agreement will allow you to purchase all of the desirable assets of the business you wish to acquire while leaving out the unwanted liabilities. Your advisor has likely identified the business as one (by its nature or by the disclosure you’ve obtained) in which there are significant potential liabilities that may be avoided through an asset purchase agreement. For example, if the owner of the business has been pocketing cash payments or using corporate assets for personal use, the business may be exposed to reassessments and penalties by the Canada Revenue Agency. A purchase of shares would mean that you, through the purchased corporation, are exposed those claims.
Exceptions
There are some exceptions to the avoidance of liability by an asset purchase. For instance, if the purchased business employed unionized labour, a collective agreement and any ongoing liabilities thereunder will follow the purchased business, even if structured as an asset purchase. Your legal counsel can assist you to identify and understand the relevant risks and how to avoid them where possible or otherwise obtain protection.
Frequently Asked Questions
I am the sole proprietor of a profitable construction business that I want to expand. I’m nervous about the risk associated with the business and its expansion. Should I incorporate?
We would strongly recommend incorporation. Incorporation provides you with limited liability to protect your personal assets from creditors, and tax advantages that will help you grow your business and your wealth.
Limited Liability
A corporation is a legal entity distinct from its shareholders. The obligations, debts and liabilities of the business are those of the corporation and not of its shareholders. The protection from creditors is a significant advantage, particularly for businesses that are inherently risky. As the sole proprietor you are currently liable for every debt, liability, obligation and claim against your business. In your construction business, an inadvertent error or mistake by a sub-contractor, or simply the failure of the project caused by others, could result in huge liabilities for which you are personally exposed to creditors, risking loss of your house, savings and other assets. Incorporation of your business creates a significant barrier of protection. (Note: there are statutory and other limited exceptions to the protection provided by a corporation)
Income Taxes
Active business income earned by a corporation is taxed at a much lower tax rate, approximately 15.5% in Ontario on income up to the small business limit of $500,000. This presents two wealth planning opportunities. Firstly, a growing business requires working capital. As a sole proprietorship, growing working capital is hard because profits are taxed at your personal marginal rate of taxation which may be in excess of 50%. By incorporating, you can grow your working capital, and thus expand your construction business, at a much faster rate because of the low rate of corporate tax. Secondly, by leaving profits in the Corporation in excess of your personal needs, you can grow your retirement savings in the corporation at a much faster rate. (In subsequent publications, we will talk about how to creditor-proof these savings).
Tax Splitting
A corporation provides for legal tax splitting with members of your family, if they are made shareholders of your corporation. The shares of your corporation may be structured so that you remain in control of the corporation notwithstanding shares issued to family members.
I am a practicing family physician with two young children. My accountant mentioned the idea of incorporating my practice into a professional corporation. How does this work?
As a physician, you are generally permitted to create a physician corporation. The Ontario Business Corporations Act (OBCA) and the Regulated Health Professions Act govern physician corporations. Once incorporated, a Certificate of Authorization from the College of Physicians and Surgeons of Ontario (CPSO) is required for your professional corporation to practice medicine in Ontario.
There may be significant benefits to incorporation arising from income splitting through the payment of dividends to adult shareholders and the deferral of tax through retention of excess cash and investing in the corporation.
A professional corporation carries on the practice of medicine with you as both a shareholder and employee of your corporation. It is important to note that under the provisions of the OBCA, a professional corporation does not shield the shareholders from professional liability as acts of a professional corporation are deemed to be acts of the shareholders. Non-voting shareholders who are not members of the CPSO are exempted from any professional liability.
All voting shares of the corporation must be held by a member of the CPSO. Non-voting shares can be held by a parent, spouse or child (and minor children must have their shares held in trust). Professional corporations are only permitted to carry on the practice of the profession or activities that are related to or ancillary to the profession. Furthermore, a professional corporation is permitted to invest its surplus funds in passive investments.
A Lawyer with experience in incorporating professionals can help you set up your professional corporation such that your objectives may be realized.
I run a small business and I have several small contracts that I am currently in the process of negotiating. Are these worth bringing to a Lawyer for review?
Depending on the type of contract, there are a number of areas a Lawyer’s expertise can provide guidance, including contracts relating to employment or contractor relationships, borrowing and secured transactions, equipment leases, and other commercial agreements. Simply because a document is short, this does not mean there aren’t important clauses or terms that require careful consideration.
Contracts often contain important clauses relating to the limitation of liability, indemnification, and the waiver of important legal rights. Such clauses can have legal and financial implications for you or your business down the road. Understanding these implications is crucial and one of the services a Lawyer can provide.
A Lawyer can meet with you for a short consultation in order to review your contractual document and answer any questions you might have. By communicating to the Lawyer your expectations of the proposed contract, a Lawyer can work with you to achieve your goals as well as highlight and help you understand risks and liabilities that you or your business may be taking on as part of the contract.
If you have some questions about a contract and feel you may benefit from meeting with a Lawyer call and ask to set up a meeting.