New Owner Liability Issues While Purchasing a Business

The baby boom generation is heading for retirement, and that’s creating many opportunities for entrepreneurs looking to purchase existing businesses. However, the acquisition of an existing business can bring liability issues that have the potential to cause serious losses for the buyer. Properly structuring the transaction and conducting thorough due diligence before purchasing can go a long way toward protecting you as a buyer.

Asset Purchase

An asset purchase involves buying individual assets such as buildings, vehicles, equipment or inventory. From a buyer’s perspective, an asset purchase can be much more attractive than buying the entire company. This is because the buyer gets to pick and choose what part of the business he or she wants to buy.

An asset purchase is also more attractive for the buyer from a taxation point of view because the purchase price can be deducted from income over several years as depreciation, according to Small Business BC, a government-funded, non-profit organization.

Asset purchase and liability

Generally, in an asset purchase, the purchasing company is not liable for the selling company’s debts, obligations, and liabilities. However, there are exceptions, such as when the buyer agrees to assume the debts, obligation or liabilities. In practice, you would accept to assume some or all of the seller’s debts and liability in exchange for a lower sales price.

Stock Purchases

If you acquire a business through a stock purchase, that is, buying all or substantially all of the company’s stock from its shareholders, your company “steps into the shoes” of the other company, and business continues as usual. The buyer takes on all of the seller’s debts and obligations, whether they’re known or unknown at the time of the sale.

A known liability might be a business loan that is recorded in the company’s books. An unknown liability might be money owed to employees or contractors that have not been properly recorded and has been overlooked by both the seller and the buyer. But, the most dangerous unknown liability often arises from the seller’s pre-sale activities.

For example, if the seller had been making and selling paint for 15 years before the buyer acquired the company through a stock purchase, the buyer can be liable for the injuries sustained by a painter who claims that the seller’s paint contained toxic chemicals, even if the painter’s injuries do not show up until several years after the stock purchase.

Regarding taxation, sellers will probably prefer a sale of shares. That’s because the vendor may be eligible for a lifetime capital gains exemption of more than $800,000 when selling shares of a small business.

How can a buyer be protected?

As a buyer, the most important thing you can do to protect yourself when buying a business as a whole or in parts is to conduct due diligence. You should begin by doing a series of searches in government databases, focusing on the province where the company and its operations are located.

  • Check that the business has paid all its taxes
  • Obtain the registration documents to ensure buildings and vehicles are owned by the seller
  • Check for pending lawsuits, human rights complaints or bankruptcy filings
  • Contact the Workers Compensation Board to make sure the seller is in good standing
  • Contact the municipal government to determine if the company has appropriate licences and if the current use of the property is permitted

You’ll also want to examine a number of documents:

  • Incorporation documents
  • Company minutes
  • Contracts
  • Inventory lists
  • Audited financial statements

Make sure you obtain good legal advice before moving forward with any deal. The University of Calgary’s Legal Centre for Business & Technology’s website provides a good primer on the legal aspects of making an acquisition or selling a business. 

Consider an indemnity agreement

Even if you and your team have gone over every piece of documentation, you could still be liable for something the seller did or failed to do before handing over the business. You can protect yourself by getting an indemnity agreement from the seller, promising to be responsible for any unforeseen liability that could arise for a period after the sale. From the seller’s perspective, this could be a concession to convince the purchaser to do a deal.

Leave a Reply