Prospective purchasers of a business have different options for what part of the business they wish to purchase. What will dictate the content of the purchase and sale agreement will depend in part on the business needs of the purchaser as well as in what capacity the seller wishes to liquidate their business. Generally, there are two options that exist when a purchaser wishes to acquire the business of another party. An asset sale is where the transaction is limited to the assets of the corporation, but the underlying corporation and the shares themselves are not being acquired by the purchaser. For example, if construction company A wishes to only acquire the machinery and equipment owned by construction company B without taking on all or some of the goodwill, contracts, liabilities, employees, and other aspects of the business, they would likely try to pursue an asset sale. On the other hand, if construction company A wanted to acquire B’s business and continue its operations by taking on all of its contracts, goodwill, employees, as well as its assets, company A would likely pursue a share sale. These two different corporate sale structures have some overlaps, but also some very different and highly important implications that must be addressed prior to reaching any agreement.
Asset Sale Due Diligence
Regardless of sale type, due diligence will need to be done by the parties to ensure that there are no factors that affect or encumber the contents of the sale that have not been identified. For an asset sale, due diligence is generally limited to the assets being purchased. If the assets being purchased are equipment or machinery, a thorough search of any personal property registrations, encumbrances, liens, lawsuits and litigation records, financial debt obligations, licenses, permits or other limiting factors need to be ascertained by conducting a search with all the relevant bodies. Physical inspection may also be highly relevant to ensure condition and operating capacity. Due diligence for intellectual property assets require searching at the Canadian Intellectual Property Office, and may extend to international searches if the assets have operated or are to operate outside of Canada. If the assets being purchased are land, land titles searches will be required to ensure there are no liens, caveats, or other encumbrances that impact the land which the buyer may not otherwise know about.
Share Sale Due Diligence
For a share sale, because the purchaser is acquiring the whole of the business including all of its contracts, liabilities, employees, assets, goodwill, and underlying corporate structure, the due diligence is typically more extensive. In addition to all of the sources of due diligence listed above for asset sales which are just as relevant in a share sale, due diligence here will also involve looking at all of the corporate documents and minute books. The bylaws of the company, the rules between shareholders, the rules of share sales and transfers to other parties, any unanimous shareholder agreements, the articles of incorporation, ensuring past agreements have been properly executed, agreed upon and signed by directors, the status of the shares to see if they are in a position to be sold, and any other corporate document about the corporation itself that speaks to its organization which may affect its value.
An additional source for due diligence are the commercial contracts of the corporation. A potential purchaser may wish to review all of the material commercial contracts to assess the company’s strength moving forward. If many of the most lucrative contracts are set to expire soon without any assurance of re-signing and continuing business, this can vastly affect the valuation of the company, even if their revenue source is currently at a strong level. Court searches for any outstanding litigation is highly relevant not only for assets at issue, but also for the company itself. If the company is currently being subjected to litigation or will be in the future, it is important to ascertain the details to assess whether the current valuation has adequately accounted for such costs.
Due diligence may also be specific to the proposed transaction, which may not be relevant in every case. For example, there may be regulatory concerns pertaining to environmental regulations or governing administrative bodies such as provincial health care boards. The company may have outstanding compliance concerns with these regulators, or the approval of such administrative bodies may be required for the proposed transaction. A purchaser would want to ensure compliance is not at issue, and that approval has been obtained. For example, environmental assessments and testing for pollutants can be very cost prohibitive and might not be relevant in a large number of transactions.
Lastly, it should be noted that the decision to proceed by either an asset or sale transaction should take into consideration the tax implications of each, as well as the legal consequences. It is imperative that the appropriate advice is sought from a knowledgeable tax expert in conjunction with obtaining legal advice on any given deal.
These sources of due diligence are by no means exhaustive and there may be other relevant areas to explore. If you are thinking of purchasing or selling a company and have any questions related to due diligence or would like assistance with the sale process, please contact one of Forum Law’s lawyers as soon as possible.
