Investing in an existing business - the two main options.

Understanding the difference between buying a business and purchasing shares in an existing business owned by a company is essential, as these differences are both significant and can be confusing. For instance, what happens to the cash in the business’s bank account on the day of the sale? This generally depends on whether you are buying the business or the shares in the company.

This article aims to clarify the primary differences between buying a business and acquiring shares in a company to aid you in making informed decisions.

When acquiring a business, I generally recommend buying the business itself rather than the shares. This approach provides a clean slate, free from the historical risks associated with the previous owner. Purchasing shares can be advantageous, but it is usually more suitable when the owner is only selling a portion of the business, not the entire entity.

For the sake of simplicity, the following assumes the business is structured as a company. A company is a separate legal entity from its shareholders, with shares representing their ownership stake.

Buying a Business

Purchasing a business means buying its assets rather than the company itself. This is a key distinction: the business and the company do not automatically go together. The sale typically involves trading stock, work in progress, fixed assets, and intangible assets like goodwill, which includes customer relationships, potential future income, branding, and reputation. Each component has its price, which together constitutes the total purchase price of the business.

When buying a business, you are not buying the company, so you do not assume its bank account balance or any other non-business related assets or any liabilities; these remain with the vendor’s company even after the business sale.

A business sale is formalised through a business sale and purchase agreement, like a real estate transaction. This agreement details the purchase price and transaction terms, such as a due diligence period and conditions about financing, leases, contracts, and employment conditions. A solicitor typically prepares this document, and your advisor reviews it with you to ensure the commercial terms a correct.

The purchaser would most often form a new company to acquire the business. This strategy avoids any historical risks of the previous owner. For example, if the previous owner had unpaid taxes, the new owner is not responsible, as they operate through a new entity. These historical risks stay with the vendor’s original company.

After the sale, the vendor retains their original company, which might still hold bank accounts, debtors, retained earnings, and other assets not included in the business sale. The company might also have outstanding liabilities and retained earnings, which are after-tax profits, which must be distributed before winding up the company. The vendor can choose to either dissolve the company or keep it for future use.

In a business purchase, the payment is made to the vendor’s company, highlighting a key difference from buying shares in the company from a shareholder.

Buying Shares in a Company

When purchasing shares in a company, you are buying a stake in the company, which includes all of its assets and liabilities. This encompasses trading stock, work in progress, fixed assets, intangible assets, cash in the bank, outstanding debts, and accrued liabilities such as holiday pay.

Purchasing shares can have significant tax consequences, such as the loss of imputation credits or extinguishing of carried-forward losses. It is advisable to seek specialist tax advice before making any such shareholding changes.

In a share purchase, a share transfer document is prepared to detail the number of shares sold, the sale price, and the involved parties. The payment for the shares goes to the shareholder, not the company itself. For instance, if Sally buys shares from Bob, the payment goes to Bob, and the company remains unaffected.

Buying shares allows the company to continue its operations without changes. All assets, liabilities, contracts, and employee details remain with the company.

Issue of New Shares

In addition to buying shares, a company can issue new shares to investors. In this case, the company receives the cash from the investor, unlike in a share sale where the payment goes to the existing shareholder. For example, if ABC Limited issues new shares to Sally, the company directly benefits from the funds, not Bob.

Conclusion

To determine the best option, it is important to consider the specific details of the transaction and the goals of both the buyer and the seller.

If you are considering a sale or purchase of a business currently, reach out to me at SAS. With my own experience and having worked with many other businesses on such transactions, I can help guide you to get the commercial outcomes you need.