Considering purchasing a business by way of shares and unsure of where to start? This article will outline some of the main issues to consider when deciding to proceed with such a transaction.

Purchasing the shares of a business is when a purchaser opts to buy all the voting shares of the corporation(s) that own(s) the business to acquire a controlling interest. It usually also involves the purchaser being transferred all of the other outstanding and issues shares of such corporation(s). There are significant legal and tax implications that one must consider before entering into this type of transaction. A corporate accountant should be involved to discuss and advise on the tax issues. Share transactions should always involve both the purchaser’s corporate accountant and lawyer.

Due Diligence

Although every business transaction will involve some due diligence being conducted by the purchaser, share purchase transactions often require a more extensive amount of due diligence as the purchaser needs to learn of all of the corporation’s liabilities and assets in order to make an informed decision and structure the deal appropriately. The vendor will likely require the purchaser to sign a confidentiality or non-disclosure agreement prior to providing any due diligence material concerning the business or the corporation. Although the type and extent of due diligence will vary from one transaction to another, standard due diligence will usually involve reviewing the following:

• the corporation’s financial statements and tax returns;
• all material contracts and agreements involving the corporation (e.g., employment and independent contractor agreements, supplier and customer agreements, shareholder agreements, loan and security agreements, leases, insurance policies, etc.);
• all applicable governmental licences and permits;
• the results of public searches, including corporate profile reports, personal property, litigation, insolvency, Bank Act, Execution Act, intellectual property, real estate, etc.;
• the minute book of the corporation(s) 

The due diligence process should involve both the purchaser’s lawyer and accountant, and depending on the type of business being purchased, possibly other advisors too (e.g., financial consultants, insurance advisors, other industry professionals). This due diligence step also helps provide the foundation for which conditions (if any) and vendor representations/warranties the purchaser wishes to include in the share purchase agreement (SPA).

Excluded Liabilities and Assets

The due diligence process is such a significant part of any share purchase transaction because a purchaser needs to reveal all of the corporation’s assets and “skeletons” in order to enable it to evaluate which existing debts, liabilities, obligations and assets it is not willing or able to assume as part of the transaction. The SPA needs to expressly stipulate the specific liabilities and assets that are not part of the deal. With respect to the excluded liabilities, there need to be provisions around how such liabilities are to be discharged/removed or assigned to the vendor (with indemnity obligations in favour of the purchaser) on or prior to closing. Similarly, for excluded assets, the SPA should set out how these assets are to be retained by the vendor, whether by transfer or assignment from the corporation to the vendor on or prior to closing.

Purchase Price and Payment

Determining the fair value of the shares being purchased is typically the first step in establishing the purchase price. This valuation process involves evaluating the business’ key financial information and assets and is most accurately conducted by a professional business valuator to produce an independent assessment.

Along with determining the value of the shares and agreeing on the purchase price, you will need to negotiate the payment procedure. The payment procedure outlines how and when the purchaser will provide compensation for the shares. Such compensation could be paid all on closing, over time, or after certain metrics are met, depending on how the parties wish the deal to be structured. For instance, if a purchaser believes that it will be difficult to finance and pay the entire purchase price on closing, it could be negotiated that a portion of the purchase price can be deferred and paid overtime, with security for the unpaid amount being granted to the vendor. Not only can this deferred payment arrangement be beneficial for the purchaser, but it may also benefit the vendor from a capital gains tax perspective and if there is interest to be earned on the unpaid balance.

Purchase price adjustment clauses are also very common in share purchase transactions. One of the most common adjustments is for working capital. This type of adjustment is meant to ensure that the corporation has enough working capital funds to continue the day-to-day operations in the post-closing period of a purchase so that the purchaser does not have to immediately input capital for the business to keep operating.

Employees

In a share purchase, the purchaser will be acquiring all the existing employees of the corporation, including any accrued liabilities owing to such employees, unless otherwise expressly excluded in the SPA. The purchaser will certainly want to obtain a list of all employees, and the list should also contain all particulars regarding their employment, such as start date, salary/wage, vacation and bonus entitlement, etc.

An employer obligation that is often hotly negotiated upon is employee severance. It is not always known whether, following the transition of the business to the new owner/purchaser, all employees will continue their employment. For longer-term employees that the purchaser plans on terminating on or following closing, there may need to be some negotiation at the outset as to the allocation of the severance costs between vendor and purchaser, which allocation would form part of the employee provisions in the SPA.

Representations, Warranties and Indemnities

A significant component of the SPA is the representations and warranties. These are assurances given by the parties to one another in order to induce the other to enter into the agreement and are meant to allocate risk among the parties. They also play a role in providing the basis for indemnification rights.  

The specific representations and warranties given by the parties will vary from transaction to transaction, depending on the type of business and other factors. Some standard representations and warranties given by vendors in share purchase transactions relate to the status of title and ownership of the vendor’s shares being purchased, litigation and claims against the corporation or business, the corporation’s financial statements and tax returns, residency of the vendor, and details of contracts and leases involving the corporation.

An indemnity provision in a share purchase agreement typically provides that, if there is an occurrence of an event, such as the discovery of a misrepresentation made by one of the parties or a third party claim arising under the SPA, the party at fault promises to cover the innocent party’s losses sustained as a result of such event. An indemnity clause will afford the parties the ability to allocate any risk and is often a heavily negotiated part of the SPA.

Some other notable considerations for purchasers in these transactions include:

• Through what vehicle will the purchaser be purchasing the shares? In his or her personal capacity or through a newly formed corporation?
• Is the purchaser buying all the outstanding and issued shares of the corporation? If not, will it be a majority shareholder? Who are the other shareholders? Are there multiple classes of shares with different rights? Is there a shareholders’ agreement or will one need to be prepared?
• Are there existing shareholder loans that will need to be repaid or shareholder guarantees that need to be discharged?

Each proposed transaction gives rise to its own unique issues, topics of negotiation and possible solutions. There is no completely “standard” deal or “one-size fits all” approach. The vendor and the purchaser need to identify the aspects of the transaction that are important to them at the early stages to ensure that they are fully negotiated upon and drafted appropriately into the SPA.

If you have any questions regarding the purchase or sale of shares in a corporation, please contact Stephen Sforza at stephen@durhamlawyer.ca  or at his number (905) 668-4486 ext. 239.

“This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situation and needs.”

*This blog was co-authored by Angela Victoria Papeo*