For many business owners the real money they make from their company is when they go to sell it. Leading up to that day much of the monetary benefit enjoyed tends to cover compensation for the time spent in the day-to-day running of the company rather than extraction of the value they’ve built in the business.
When the time comes to sell, business owners often approach accountants or business brokers to get a valuation for their business. However, no single valuation can capture the numerous factors that impact on price. This article, an extract from a more in-depth version on my site, covers one of them – the structure of the sale which, on its own, can have more of a material influence on price than the business’ earnings!
Asset sale vs. share sale introduction
To properly understand the difference between these two, we need to establish two facts which will be known to most business owners, but which I include here for purposes of completeness.
The first is that a limited company is a legal entity. It owns things and owes things. It can go bust. It stands separate to the owners of the business.
The second is that the owners of the business own shares in the business but own none of the assets in the business and they are responsible for none of the business’ liabilities.
Business sale transactions generally happen as either a sale of the shares of the business or a sale of the assets.
The former involves a transaction between the investor and the business owner. The investor pays funds into the owner’s personal bank account. This is payment for the shares of the business and a share transfer is lodged at Companies House to record the fact that the company has a new owner. The investor effectively steps into the shoes of the vendor. There is no change to the business operation - not to staff, to customers, to assets or to liabilities. There is no transaction to be recorded in the accounts of the business. The business continues without missing a beat. The investor gets a mandate to operate the bank account, a login to the business website and keys to the warehouse. He owns everything in the business.
An asset sale is a transaction between the investor and the business, not the business owner. The investor pays the agreed price into the business account, not to the owner personally. No transfer is recorded at Companies House. What does change is the business balance sheet – all the assets forming part of the sale are transferred to the investor and these asset accounts are adjusted accordingly (the balancing transaction being the payment the investor made into the company bank account). If 100% of the assets are sold, the business is still owned by the original owner but it’s a shell of a business, it’s one that holds mostly liabilities plus a chunk of cash in the bank which was received in exchange for all the assets it previously had on the books.
Which is better – asset or share sale?
There is no simple answer. Investors generally prefer to buy assets rather than shares as it’s a cleaner and easier transaction for them. Vendors prefer to sell shares as, for them, that is not only a cleaner transaction, but has tax advantages. Where a vendor is willing to structure the transaction as an asset sale he would typically extract a much higher price from the investor.
Key advantages of an asset sale
- Speed of transaction: As there is less due diligence for the investor to conduct and he doesn’t need to research the extent of liabilities which may be hidden, an asset sale can be accomplished in less time. There is less investigation for the vendor to conduct as well - he doesn’t need to vet the investor as he would when selling shares.
- Scope for selective sale: The sale could be structured to include only a partial sale of assets. Those assets that the vendor feels are being undervalued by the investor could be removed from the transaction to not form part of the sale
- No boardroom approval needed: Articles of Association and Shareholder Agreements sometimes prevent the sale of shares or impose conditions and restrictions. Sale of assets is generally a matter for management, not shareholders
- Option for offsetting losses: Where assets are sold at a loss such loss could be used to offset profits made elsewhere
- Tax advantages for the investor: The investor can afford to pay more for an asset purchase partly because he can extract some tax advantages from the purchase. While he pays a consolidated price for the assets acquired he determines the price at which each of those assets is entered in his books. This allows the allocation of higher prices for assets on which he can claim depreciation
Key negatives of an asset sale
- Loss of existing relationships: Existing customers, and their custom, do not transfer over to the investor. Their relationship is with the company, not the assets of the company. Similarly, relationships with suppliers, favourable terms agreed with them, credit lines they’ve made available etc. will all stay with the current business and can’t be acquired by the investor
- Some assets can’t be transferred either: Licences, permits, contractual rights etc. are often not transferable and all value in those assets is usually lost. Even eBay and Amazon reseller accounts, and some social media accounts, can’t be transferred from one company to another so reputation, followers, feedback etc. accumulated in those accounts is often lost
- Third party approval is sometimes needed: Some assets, such as the lease, can’t be transferred without a third party’s approval. In the case of the lease, it’s the landlord who needs to approve the transfer. This does not always proceed smoothly and there is no compulsion on these third parties to agree the transfer
- The seller could get taxed twice: If an asset is sold at more than the book value that results in a gain on which the seller’s company needs to pay tax. When the seller withdraws the remaining funds from the company he is taxed again, in his personal capacity this time
- TUPE Regulations apply: Buying the assets of a business usually triggers TUPE provisions (Transfer of Undertakings (Protection of Employment) Regulations 2006). The investor doesn’t have a choice but to take on the responsibility of retaining the employees on the same terms they enjoyed previously
- There may be VAT to be paid on the purchase: The sale could be considered the “sale of a business as a going concern” but if it doesn’t qualify, the investor is liable for VAT on the purchase (of most assets)
Key advantages of a share sale
- Simple: This is the simplest form of sale from the vendor’s point of view. Apart from recording the transfer of shares at Companies House, his handover responsibilities are determined only by what he has agreed with the investor
- Tax advantages: There are tax advantages for the seller as he can avail of Entrepreneur’s Relief. There are further tax advantages to be enjoyed if he takes all (or part) of his payment in shares of the investor’s company. There can be tax advantages for the investor as well. For example, if there are accumulated losses in the business the investor can, subject to some conditions, write them off against future profits generated
- The investor has the option of making changes to staff or downsizing as TUPE does not apply
- Everything transfers over: From customers to suppliers to contracts, everything passes into the investor’s control. No assets are lost, no relationships are lost, no third-party approvals are required for the transaction and there is no disruption to the business
Key negatives of a share sale
- Riskier for the investor: Taking on all the assets and the liabilities of the business presents one problem – while assets are usually well documented, liabilities can turn out in time to far exceed the figure shown on the balance sheet. It is up to the investor to assess and quantify these risks prior to paying his money. And it is easy to get this calculation wrong! Doing the due diligence also has cost implications. The investor needs to spend a lot more on professional advisers – from forensic accountants to corporate lawyers
- Not suitable in many situations: Share sales are not suitable in situations such as divestitures (where a company is streamlining by selling off non-core divisions)
- Taking on employees: While TUPE may not apply, the investor is taking on all the employees together with any disputes, ongoing disciplinary action and unresolved industrial tribunal cases
- Stamp duty: There is stamp duty to be paid on the acquisition of shares
Opting for one form over the other is a matter for negotiation between the vendor and investor. Circumstances of the individual business will play a key part in the decision and