Understanding the Legal Implications of Selling Your Business

Selling Business

Temporary closure of local businesses amid the Covid-19 pandemic has resulted in steep financial losses. Maybank Kim Eng senior economist Chua Hak Bin predicted a rise in business failures in the coming quarters. Faced with supply chain upheavals and revenue declines, SMEs are forced to shut down.

Although permanent closure is a typical option for unsuccessful ventures, selling your business is also another possible exit strategy.

 

Acquisition Structures to Sell Business: Asset Sale or Shares Sale?

Prior to the execution of an acquisition agreement, both seller and the buyer should carefully consider what acquisition structure to use. Typical deal structures are assets sale and shares sale.

Asset Sale

In an asset sale, the buyer purchases some or all assets of the company.  These assets include in tangible or intangible property, such as contracts, good will or intellectual rights. Corporate existence shall remain and corporate control shall remain vested in the original shareholders.  Buyers can be selective in asset sale. They can choose desired assets and avoid liabilities that are likely to remain after the completion of sale.

Shares Sale

In shares sale, the buyer acquires outstanding stock of the company from each selling stockholder. The company’s legal status remains as well as its operations.  Corporate ownership nonetheless transfers to the purchaser and concurrently acquires existing assets and liabilities of the company.

The main distinctions between these two deal structures are listed below:

  1. Mode of transfer of ownership

    Transfer of ownership in a shares sale is straightforward. A one-page instrument of transfer is sufficient to pass corporate control. By contrast, asset sale is more laborious. Transfer of assets like real estate and intellectual property requires third party consent and certain formalities.

  2. Employment Contracts

    Section 18A of the Employment Act provides that in a shares sale, employment contracts are deemed novated. The transferee assumes the previous employer’s rights, powers, duties and liabilities under the employment contracts. No employee consent is thus required as there is no change in employer identity.

    However, in a sale of assets, employee consent is crucial if stated in the seller’s collective bargaining agreement with a trade union. In such case, consultations among the seller, the relevant trade union and affected employees is necessary before the sale can take effect.

  3. Tax

    Acquisition of real property under a stock sale is subject to the stamp duty rate of 0.2%, whereas in an asset sale, the transfer of real property is taxed at a maximum duty of 3%.

 

Due Diligence Checklist:  Factors that Affect the Buyer’s Purchase-Making Decision

Before proceeding with the sale, buyers want clarity on the potential legal risks of acquiring its target company. As a precautionary measure, they conduct due diligence. Due diligence refers to the in-depth investigation of the corporate affairs of the target company, particularly its finances, legal and business operations.

During this appraisal process, you must be prepared and address potential red flags that might be off-putting for the buyer. The better prepared you are, the smoother the negotiations process will be, and the higher the valuation for your company.

Factors raised in the due diligence report that affect the buyer’s purchase-making decision are the following:

  1. Compliance and Good Standing

    A business must be validly formed and statutorily-compliant. A delinquent enterprise wards off buyers, as it is exposes new owners to risks of penalty or potential legal problems. Conversely, good standing and reputation yields brand equity and good will among clientele. Businesses with these invaluable assets are sought-after, and are likely to receive higher valuation from the purchaser.

  2. Assets and Liability

    Buyers also take into account the assets and liabilities. Neglect in ascertaining the outstanding obligations of a target company has disastrous consequences. Failure to uncover the unpaid debts and tax liabilities of the previous owner makes the buyer vulnerable to inheriting the liabilities unknowingly.

  3. Financial Standing

    Buyers assess financial metrics to ascertain business viability. These include cash flow, operating costs and profitability. As seller, it’s important to be transparent and render a truthful account of the company’s current financial position. Keep financial statements and accounting records updated. Preparation of all relevant paperwork simplifies the process and enables the buyer to gauge whether company acquisition is worth pursuing.

  4. Employees

    Buyers usually inspect the existing contracts of the target company. They want to know the rights and obligations of the previous owner under these undertakings and if there are change-of-control clauses that might result in contractual breach.

 

Hire a Professional Corporate Services Provider to Simplify the Negotiation Phase

Selling a business entails a lengthy, complicated negotiation process. Seek professional advice to safeguard your rights as a seller. A trusted corporate services provider can help to incorporate the right contractual terms such as warranties, indemnities and guarantees into your acquisition agreement.

Posted in Corporate Services.