The first thing to get right in company sales is to find out whether the purchaser is buying the shares in the company or the assets out of the company.
A company is a separate legal entity and it (not the shareholders) owns its assets. The shareholders own shares in the company which in turn owns the assets.
Consequently if the shares are being sold then the vendors are the shareholders.
But if the assets are being sold then the vendor is the company.
Often a purchaser will want to buy the assets from the company, because they are easily identifiable and the purchaser does not have to worry about what else may be inside the company.
A vendor on the other hand will generally want to sell his shares in the company because it is considerably more tax effective for him to do so.
PURCHASER BUYS THE ASSETS OUT OF THE COMPANY
If the parties agree to do an asset sale then the Vendor will be the company and it will be selling certain nominated assets such as Plant, Stock and Goodwill. It may also be selling its Debtors or the Purchaser may agree to collect the Debtors and pay them to the vendor company as part of the sale price.
Normally in an asset sale the vendor company retains the liabilities and uses the sale proceeds received to pay them off. Once the liabilities are paid off the remainder of the sale proceeds are retained in the company, or paid out to the shareholders as dividends, or the company is liquidated and the cash paid to the shareholders. These last two alternatives have significant tax implications.
PURCHASER BUYS EVERYTHING INSIDE THE COMPANY
When a purchaser buys the shares in a company he buys the company and everything inside it. Unless specifically excluded in the share purchase agreement (“SPA”), this includes stock, creditors, liabilities, plant & machinery, employment obligations, lawsuits, claims, real estate, cars, goodwill, IPR (intellectual property rights) and cash.
This means that a company should be groomed for sale before the sales memorandum is issued. If there are any problems or issues within the company such as loans to directors or claims by employees, then generally these should be solved before issuing the sales memorandum or should be fully disclosed within it. A purchaser will inherit all of those problems and liabilities if he buys the company so he needs to know about them before doing the deal and he may discount the value he places on the company in order to take account of those problems.
Similarly there may be surplus cash balances or loans from directors or banks which may need to be distributed or repaid before completion or to be specifically identified in the Sales Memorandum either to increase or to justify the asking price.
REASONS FOR A SHARE SALE
The reason why a vendor will be so keen to sell his shares rather than for the company to sell its assets is principally tax. In essence if a vendor sells his shares then, provided the company fits within certain criteria set out by HMRC, he will pay Capital Gains Tax at the rate of 10% on the gain between what he paid for the shares and what he sells them for less transaction costs. This is known as Entrepreneurs Relief. (There are some exceptions to this rule but generally in the case of a typical owner/manager, this is the case).
On the other hand, if a company sells its assets then it will pay corporation tax on the gain it has made on the asset sale (there is no capital gains tax for companies) being the premium paid over their book value. The cash then sits inside the company and can generally only be distributed to the shareholders by way of dividend or by liquidating the company and distributing the cash reserves to the shareholders.
ADVANTAGES OF A SHARE SALE
These are some of the advantages of pursuing a share sale:
- Appearance of continuity of business. A change of name or trading style may give the impression that the business has changed hands or worse, gone bust and done a phoenix.
- There may also be customer and supply contracts which will be difficult to re-write in the name of a new company.
- It may be easier to get a landlord to agree to the change of shareholding rather than having to enter into an assignment of the property lease; and it will almost certainly be considerably less expensive in terms of legal fees.
- Intellectual Property Rights (“IPR”) traditionally are messy and complicated, particularly copyright in software. It may be almost impossible to create a chain of title and even more difficult to get all parties to agree to an assignment from the company to the purchaser. It may be considerably easier to “let sleeping dogs lie”.
- A purchaser may prefer to leave the company’s banking arrangements in place; this is particularly the case in respect of leased plant and machinery and term loans. Although a bank will normally want to be satisfied as to the probity and credit-worthiness of the purchaser.
- The company may have historical tax losses inside it, which a purchaser may find useful. A vendor may try to increase the price because of these tax losses although that is difficult to do and most purchasers will not pay a premium for them..
- There may be other contractual arrangements also in place with the company which could be difficult to assign to a new company, such as options arrangements with staff, other employment contracts, future royalty contracts, licences etc.
TAX & STAMP DUTY
As stated previously the sale of shares in a company for which the vendor gets Entrepreneur’s Relief, attracts a 10% flat capital gains tax rate provided the shares have been held for more than 1 year.
If a company sells its assets then it pays corporation tax on the gain and the shareholders pay income tax on any dividend distribution of the asset sale proceeds.
Stamp duty is 0.5% on a sale of shares and on other property (such as debtors and real estate) it is a sliding scale up to 7%.
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