Purchase and Sale of a Business

Purchasing a Business

Before buying an existing business, you must carefully evaluate the overall soundness of the business. Your accountant and corporate lawyer can help guide you through the evaluation process.

You should inspect the financial statements and tax returns for at least the past 3 years. If these are an accurate reflection of the business activities, financial statements will show you whether the business is growing or declining. Also, check the accounts payable and receivable. If bills are not being paid on time, there could be a cash flow problem. You must ensure that there are no liens against the business for unpaid bills, or against assets that you are purchasing. Review the accounts receivable and make special note of any overdue accounts, for example, older than 90 days.

Employees are also a key part of any business. Investigate how long key employees have been with the business and whether they intend to stay under new ownership. Determine how long it will take to train a replacement if they should decide to leave when you take over the business. If the workforce is unionized, have your lawyer review the current collective bargaining agreement and take note of its expiry date, to ensure that you know what your obligations are under the bargaining agreement and under Ontario's labour laws.

In many businesses, 20% of the customers generate 80% of the revenue. You should review the existing customer base and identify the top customers. Evaluate whether these customers are likely to stay with the business and the risks you face if they don't. What strategies will you employ to retain these key customers?

Ensure that any registrations, licenses, and other legal documents can be transferred. Also check into any local or municipal licenses, taxes and by laws that affect the running of the business. Consider the location, parking and condition of the building(s) in which the business is located, including any maintenance or repairs needed. It is crucial to consult with an experienced corporate lawyer when considering the purchase or sale of a business.

Shares or Assets?

There are two methods used to purchase a business. The purchaser can:

• acquire the underlying assets of that business; or
• purchase the shares of the corporation that owns the assets and operates the business.

On a purchase of shares, the entire purchase price is allocated to the shares, which then become the capital property of the buyer. All property, debts and obligations of the corporation will stay with the corporation and are assumed by the new shareholder. Because some of these obligations may be hidden, it is important to perform due diligence enquiries, to ensure that the corporation whose shares are being purchased is in the condition which has been represented by the vendor. A sale of shares may create immediate capital gains tax consequences for the vendor, and have long term capital gains tax consequences for the purchaser. These tax consequences may affect negotiations surrounding the purchase price and how it will be paid.

Acquiring the assets of a corporation is more complicated from a tax point of view, since both the purchaser and vendor will try to allocate the price of the assets to their advantage. For the purchaser, it is a good tax strategy to allocate as high a portion of the purchase price as you can reasonably justify, to inventory and capital equipment, which can later be depreciated. The cost of various assets such as buildings, machinery, equipment, computers and vehicles can be depreciated (for tax purposes, this is called a Capital Cost Allowance) and may be deducted from the income of the business over time.

The purchase and sale of a corporation's shares or assets is potentially very complicated and you must get professional advice from an accountant and corporate lawyer before making such an agreement.

Commercial Leases

When leasing a property for your business, you may either deal with a leasing agent who represents a wide variety of properties, or directly with the owner or property manager. Be sure to have your lawyer review any offer to lease agreement or lease agreement before you sign it.

The lease agreement will include such matters as the length of the lease, rental payments and common area charges. It should also disclose the items which are the financial responsibility of the landlord and those that are to be paid by the tenant. Maintenance services such as janitorial and landscaping are sometimes included in the rent. Hydro, gas, telephone and other utility expenses are usually not included. The landlord's property taxes, insurance costs, and costs of various repairs to the building may or may not be included.

A lease which includes all of the expenses of operating the premises in the monthly rental charge is referred to as a gross lease. When various expenses of operating the premises are added onto the basic monthly rent, this is called a net lease or net-net lease, depending on what additional charges are included or excluded from the basic rent. A triple-net lease is one in which the tenant agrees to pay for all of the utilities, maintenance costs, repairs, insurance and property taxes of the building in addition to the basic monthly rental charge. These additional expenses can be very substantial, so it is important to know exactly what you and the landlord will each be responsible for paying.

Be sure that the lease states who is responsible for renovations or upgrades to the leased premises. Often, any fixtures that you add become part of the building and are considered the property of the landlord once the lease is terminated. Don't be afraid to negotiate the best deal possible on a lease. If you lease for more than one year, or you are the major tenant in a building, or are leasing a large amount of space, you can often get a better deal.

Check local zoning by laws to ensure that you will be allowed to operate your business on the premises. Property and buildings are zoned by the type of business activity allowed, such as industrial, office, retail and medical-dental. Any property you consider should be zoned for your proposed use. In addition, you should ensure that the landlord does not have any restrictive covenants in his or her leases with any other tenants in the complex, which might prohibit you from competing with another tenant.

Before you enter into a lease agreement you should take into account all aspects of the building. Consider the location. Is it easily accessible for customers, employees and suppliers, including people with disabilities? Is there enough parking? Is there a loading dock for shipping and receiving? Is there room to expand if your business grows?

There are many reasons why leasing is an excellent option for most businesses. Do your homework, consult one of our lawyers who is experienced in commercial leasing, and negotiate the best deal possible.