Share purchase business sales: buyer beware

Buying a business through a share purchase has some distinct advantages but, as Claire Tyler points out, it pays to do your homework.
 
A business owner agreed to sell her business to a friend. The friend agreed to purchase the business through purchasing the shares in the owner’s company because it appeared to be the simplest way of doing things. 

The two had a good relationship, so the friend did not do much due diligence or investigation into the company. They also did not take legal advice about the transaction and prepared an Agreement to transfer shares themselves. 

A few months after the transaction, the friend realised a nasty secret about the company. It owed huge debts to the IRD for unpaid tax. This was a significant problem for the friend who effectively inherited these debts as the sole director and shareholder. The parties did not include in their agreement any warranties about tax or other debts of the company.

What is a share purchase?
Where a business is owned by a company, one way the business can be purchased is through buying the shares in the company. While this method is less common than buying the assets of the business, it can provide some distinct advantages, provided the buyer understands the consequences.
Firstly, it is important to understand that a company is a legal entity. Companies are often used to own and run businesses.  

Unlike an asset sale, the agreement to buy the company’s shares is not an agreement with the company itself, but with the company’s shareholder(s). 
Here, the purchaser agrees to buy all or some of the company’s shares from the current shareholder(s) and (depending on the extent of the shareholding they buy) effectively takes control of the company – accepting all of its rights and assets, but also its obligations and liabilities. The purchaser (as a shareholder) would then generally appoint themselves as a director of the company (depending on the the extent of their shareholding and/or any relevant shareholders’ agreement/constitution provisions).

Advantages
Share sales tend to be more common, and are advantageous, where flexibility is required, for example where there is a ‘stepped’ or gradual sale, or where an employee is buying part of a business.

Another advantage of a share purchase is that the company’s contracts, licenses, leases and employment agreements are, on its face, not required to be assigned or novated to the purchaser. This is because the company is still the same party under these agreements – the purchaser has just taken control of the company. 

This advantage can potentially save the purchaser significant amounts of money. 
However, this advantage should not be assumed in all circumstances. Many agreements now treat situations where there has been an effective change in the management or control of a company (i.e. as a result of the share sale) as being an assignment and require the consent of the other party. 

This can significantly erode the benefit of a share sale – careful consideration of the company’s agreements is needed before purchasing.

Disadvantages
As indicated above, a significant down-side of a share purchase for a purchaser is the uncertainty of the company’s obligations and liabilities that the purchaser takes over (including current and historical tax obligations). 

Given that the purchaser is effectively stepping into the shoes of the company, the purchaser potentially inherits significant hidden liabilities and obligations. Accordingly, a thorough (and potentially expensive) ‘due diligence’ process will be needed before the sale proceeds, along with a robust Agreement for Sale and Purchase of shares.
In relation to stepped share sales (where the purchaser agrees to purchase more shares at a certain time in the future), these can lead to disputes between existing shareholders, the outgoing shareholder(s) and the purchaser, so it is vital to ensure you take professional advice to ensure all steps in the sale are clearly documented between all parties.

Summary
Overall, while buying a business through a share purchase may not be the best option for all business sales, there may be circumstances where this method is appropriate for the parties. It is vital to take professional advice before agreeing to buy a business or part of a business in this way.

Claire Tyler is a commercial lawyer at Rainey Collins.