Buying a business? How to protect yourself from potential liabilities

Purchasing shares comes with a very different set of responsibilities compared to purchasing assets

4 minutes read

If you’re looking to purchase an existing business, your timing is good. The baby boom generation is heading for retirement, creating opportunities for entrepreneurs looking to acquire a business.

But acquiring an existing business can come with liability issues that have the potential to cause serious losses. Properly structuring the transaction and conducting thorough due diligence before the purchase can go a long way toward protecting you as a buyer.

A big part of properly structuring the transaction will be to decide whether you want to simply purchase the company’s most interesting assets, or instead purchase the company as a whole by buying its shares.

Reduce your liabilities by purchasing the company’s assets

An asset purchase involves buying individual assets such as buildings, vehicles, equipment or inventory, rather than the whole business.

From a buyer’s perspective, an asset purchase can be much more attractive because you get to pick and choose what part of the business you want 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.

Generally, in an asset purchase, the purchasing company is not liable for the seller’s debts, obligations and liabilities. But there are exceptions, such as when the buyer agrees to assume the debts, obligation or liabilities in exchange for a lower sales price, for example. Be sure to complete your due diligence before deciding to go this route.

Purchasing a company’s stocks: The sellers preferred approach

If you acquire a business through a stock purchase, that is, buying all or most 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 has not been properly recorded and has been overlooked by both the seller and the buyer. But, the most dangerous unknown liabilities often arise 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.

The most dangerous unknown liabilities often arise from the seller's pre-sale activities. 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.

In terms of 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 in 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.

  • Search the Personal Property Security Registry (the Register of Personal and Movable Real Rights in Quebec) to determine whether there are any liens on the assets you are about to purchase.
  • Check that the business has paid all its taxes.
  • Obtain the registration documents to ensure buildings and vehicles are owned by the seller.
  • Ensure that there haven’t been any registrations pursuant with Section 427 of the Bank Act.
  • 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 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 and financial advice before moving forward with any deal.

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.

The content of this article is provided for general information purposes only and does not constitute legal advice. Readers are encouraged to consult their own legal counsel to obtain the legal advice they need regarding any particular legal matter.