LEGAL METHODS FOR PURCHASING A BUSINESS IN ONTARIO

There are generally two methods of purchasing a business in Ontario. The first method is through an asset purchase and the second method is through a share purchase transaction. In an asset purchase transaction, the purchaser buys all or some of the assets of a business, which may include inventory, contracts, intellectual property, equipment, and goodwill. In a share purchase transaction, the purchaser buys all or a portion of the corporation’s outstanding shares. Listed below you will find more information on asset and share purchase transactions.

ASSET PURCHASE TRANSACTIONS

An asset purchase transaction involves the acquisition of some or all the assets of a business and is usually the more appealing option for the buyer because the buyer can choose specific assets they want to purchase. Asset purchase transactions may also be appealing to the buyer because the buyer generally does not assume liability for the conduct of the vendor corporation prior to the date of closing. Of course, there are exceptions to this and in specific circumstances, common law or statute may stipulate that despite an asset sale transaction, liability flows through to the buyer for the conduct of the corporation prior to the date of closing. In certain situations, the buyer may expressly assume liability for certain conduct of the target corporation prior to the day of closing. Moreover, there may be specific tax advantages available to the buyer or seller in an asset transaction. For the purpose of this article, we will not get into details about the specific tax consequences of an asset purchase transaction. As always, it is highly recommended that you obtain advice from an experienced accountant or business lawyer prior to placing an asset purchase offer.

STEPS IN AN ASSET PURCHASE TRANSACTION

STEP 1 – LETTER OF INTENT (OPTIONAL)

After deciding to purchase a business through an asset purchase transaction, the buyer will usually draft a letter of intent setting out the proposed purchase price, any key provisions, terms of the sale, and potential closing date. Generally, the letter of intent will not legally bind either party unless the letter of intent specifically sets out that its provisions are to be binding on the parties. Alternatively, buyers can opt for a hybrid letter of intent, where certain clauses, such as confidentiality and exclusivity agreements will be binding whereas other terms may not be binding. In our experience, most letters of intent we have seen are hybrid to ensure confidentiality provisions bind the parties in the event the transaction is not completed.

STEP 2 – DRAFTING THE ASSET PURCHASE AGREEMENT

While asset purchase agreements are sometimes drafted by real estate agents or business brokers, it is highly encouraged to have an experienced business lawyer review your existing asset purchase agreement or draft the agreement for you. A well-drafted asset purchase agreement can save both parties a lot of time and money by reducing negotiations and hurdles as the transaction moves toward closing. Essential terms of an asset purchase agreement include but are not limited to defining important terms, outlining the specific assets being purchased, setting out the purchase price, agreed-upon covenants, representations and warranties, indemnification clauses, and any additional requirements to close the transaction. It is important that the terms of the contract are carefully negotiated by the parties or their solicitors prior to proceeding to the next step, due diligence.

STEP 3 – DUE DILIGENCE

Conducting due diligence is one of the most important steps prior to the closing of the transaction. Depending on the transaction, the purchaser and their professional representatives must determine the extent and length of due diligence. To obtain optimal results for buyers, due diligence should be approached from a legal, accounting, and business perspective. The legal due diligence involves various searches and reviewing documents conducted by business lawyers to ensure the assets do not have any unknown leases, liens, or liabilities and that the buyer is aware of any potential risks associated with purchasing the assets. Accounting due diligence encourages the client to work with an experienced accountant to review the financial statements of the target corporation, assess tax liability related to the transaction, and receive advice on the tax consequences of purchasing the assets. Business due diligence is crucial in an asset purchase transaction and can only be carried out by the client and their business advisor(s) which generally entails having access to the premises to observe how business is carried out through the due diligence process. Lastly, during the business due diligence process, it is advantageous for the buyer to build a strong relationship with the seller and the staff as this can foster improved negotiations and speed up the closing process. In our practice, we always recommend that the buyer and the seller maintain a strong relationship and carry out certain negotiations directly. This allows for a better relationship between the buyer and the seller, ultimately yielding improved results throughout the transaction process.

STEP 4 – CLOSING/ POST-CLOSING MATTERS

Following a sufficient due diligence review, both parties may proceed with the closing, which includes exchanging closing documents and money and transferring possession of the assets to the buyer. Some asset purchase transactions may include post-closing matters such as post-closing covenants. For example, if there is a covenant that requires the seller to train the buyer on the ongoing operations of the business after closing, there may be a hold-back of a portion of the sale price that will only be paid out once the covenant is completed. Other post-closing matters may include filing documents with accountants and various government agencies.

SHARE PURCHASE TRANSACTIONS

In a share purchase transaction, the purchaser acquires all or some of the outstanding shares of the target corporation. Unlike an asset purchase transaction, the buyer in a share purchase transaction assumes all liabilities of the corporation upon closing, including unknown liabilities. A share purchase transaction can be less complicated as it does not involve the transfer of individual assets. Generally, the seller prefers to sell shares of the corporation rather than its assets because of certain tax advantages that may be available to qualifying small business corporations.

For the purpose of this article, we will not get into details about the specific tax consequences of a share purchase transaction. As always, it is highly recommended that you obtain advice from an experienced accountant or business lawyer prior to proceeding with a share purchase transaction. Below you will find information about the steps involved in a share purchase transaction.

STEPS IN A SHARE PURCHASE TRANSACTION

STEP 1 – LETTER OF INTENT(OPTIONAL)

After deciding to purchase a business through a share purchase transaction, the buyer will typically draft a letter of intent setting out the proposed share purchase price, any key provisions, terms of the sale, and a potential closing date. Typically, the letter of intent will not legally bind either party unless the letter of intent specifically sets out that its provisions are to be binding. Alternatively, buyers can opt for a hybrid letter of intent, where certain clauses like confidentiality and exclusivity agreements will bind the parties, while other terms will not. In our experience, most letters of intent we have seen are hybrid to ensure confidentiality provisions bind the parties in the event the transaction is not completed.

STEP 2 – DRAFTING THE SHARE PURCHASE AGREEMENT

A share purchase agreement sets out the essential terms agreed to by the parties including the purchase price, the number and class of shares being purchased, representations and warranties, covenants of the parties, conditions of the transaction, the location and time of closing, indemnification clauses, any holdbacks or adjustments, information about employee benefits and bonuses, and any other requirements of the parties to close the transaction. The share purchase agreement should always be drafted by an experienced business lawyer to ensure all important terms are included and the terms remain enforceable. A well-drafted share purchase agreement will benefit both parties by reducing negotiations throughout the closing process, ultimately saving time and money. Once the terms of the contract are carefully negotiated by the parties or their solicitors, they can proceed to the next step, due diligence.

STEP 3 – DUE DILIGENCE

The due diligence process in a share purchase transaction is generally more extensive than in an asset purchase transaction and should again be approached from a legal, accounting, and business perspective to obtain optimal results. Legal due diligence conducted by an experienced business lawyer is especially important because the buyer assumes all liabilities of the corporation in a share transaction. The buyer’s solicitor should review every contract the corporation has entered into, review the minute book of the corporation, and conduct various searches to identify potential liabilities. For this reason, it is highly recommended to hire an experienced business lawyer who can assist with legal due diligence and bring any liens and liabilities to the buyer’s attention. Accounting due diligence encourages the client to consult an experienced accountant to review the financial documents of the target corporation, asses the tax liability of the transaction, and receive advice regarding the tax consequences of the share purchase transaction. Lastly, during the business due diligence process, the buyer should try to build a strong relationship with the seller and the staff of the target corporation, as this can foster improved negotiations and expedite the closing process. We always recommend the buyer and seller maintain a strong relationship and directly carry out certain negotiations, which can ultimately yield improved results throughout the transaction.

STEP 4 – CLOSING/POST-CLOSING MATTERS

Once the buyer and buyer’s solicitor are satisfied with the due diligence, they can then proceed to close the transaction, which includes exchanging documents, payment of closing funds, and the transfer of the purchased shares. Some share purchase transactions may include post-closing matters, like post-closing covenants. For example, if there is a covenant that requires the seller to train the buyer on the ongoing operations of the business after closing, there may be a hold-back of a portion of the sale price that will only be paid out once the covenant is completed. Additional post-closing matters may include filing documents with accountants and various government agencies.

If you are planning on buying or selling a business,  contact us today to set up an initial consultation.

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Disclaimer:The information contained in this article is not to be construed as legal advice. The content is drafted and published only for the purpose of providing the public with general information regarding various real estate and business law topics. For legal advice, please contact us.

About the Author:

Shahriar Jahanshahi is the founder and principal lawyer at Jahanshahi Law Firm with a practice focus on representing business star-ups and investors in the province of Ontario. For further information about Shahriar Jahanshahi, click here.

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