There are usually two main ways to dispose of a business, either by selling the shares in the company or by selling the business. However, there is no single right way to do a generation change or a business sale. Due to liability issues, it is common that if you are the seller, you want to sell the shares and if you are the buyer, you want to buy the business.
The difference between a share deal and a business deal could be described as follows. Even if the seller owns all the shares in a limited company, he or she does not personally own the business and the assets acquired. They are owned by the limited company itself. Thus, when the business is sold, the seller is the company, not the entrepreneur, and the money from the sale also goes to the company. There is also a separate article on the valuation of a company on our website.
Pre-transaction arrangements
It is often worthwhile to convert a general or limited partnership into a limited company first and then sell the shares. It is usually easiest and most advantageous from a tax point of view to transfer a business to a limited company. The remainder of this article will focus only on the transfer or sale of shares in a limited company.
Companies often have accumulated assets that are not necessarily part of the business being sold in a takeover. Such assets may include investments, real estate or leisure homes, which are to be excluded from the acquisition. Such assets do not pose a problem in a business transaction. However, if a takeover is to take the form of a sale of shares, one option may be to split the company into two separate companies by way of a demerger. On the other hand, if the company has substantial assets in bank or investment accounts, the company's balance sheet can be 'reduced' by paying additional dividends or by acquiring own shares in the company for the company. In the latter practice, the excess assets of the company are distributed to the owners, thereby reducing the purchase price paid by the buyer, often financed by debt.
Distribution
In this case, the business to be ”sold” is left to another company and the other assets to another company. A commercial building or real estate can be left in another company and rented to the buyer of the business company. This arrangement reduces the amount of financing needed by the buyer and the seller retains ownership of the premises and receives rental income from them in the future. The division of a limited company has no tax consequences if there is no change in the ownership of the company. The tax authorities have recently tightened their interpretation of the tax treatment of mergers and acquisitions, so the seller of a company should be prepared for the possibility that it may be necessary to seek a preliminary ruling from the tax authorities before the division. You should allow a couple of months for this.
Shares in companies created by a division are treated for tax purposes in the same way as shares in the old company. The amendment to the Companies Act simplified the division procedure and the division can now be completed in less than six months. There is also an article on the division of a limited company on our website.
Acquisition of own shares for the company
The repurchase and redemption of own shares is decided at the General Meeting. In a private limited company, a simple majority of votes is sufficient for a decision. When repurchasing own shares, the Companies Act is based on the principle of equal treatment of shareholders, whereby each shareholder is repurchased in proportion to his/her existing shareholding. However, own shares may also be acquired in other proportions under certain conditions. This is called a directed acquisition.
A prerequisite for a directed acquisition or a corresponding authorisation decision is that there is a weighty financial reason for it from the company's point of view and that a 2/3 majority of the votes cast and the shares represented at the General Meeting are in favour. Since a directed acquisition implies a disproportionate use of the company's funds for the benefit of shareholders, when assessing the acceptability of a directed acquisition, particular attention must be paid to the relationship between the consideration offered and the fair price of the share. The payment of any excess price may constitute an illegal distribution of assets.
According to the Companies Act, it is prohibited to acquire shares in such a way that the company's free equity would become negative as a result of the acquisition. The acquisition of shares must be covered by the company's distributable assets and, if necessary, the company's share capital may also be reduced.
When a company acquires its own shares from shareholders for consideration in a transaction under Chapter 15 of the Companies Act, the transfer price received by the shareholder is, as a general rule, taxed on the basis of the transfer tax provisions. The shareholder will have to pay capital gains tax on the capital gain. The capital gain is taxed as capital income. In 2024, the capital gains tax rate will be 30 % up to EUR 30,000. For capital gains above €30,000, the tax rate will be 34 %.
The tax authorities have recently tightened their interpretation of the tax treatment of various corporate arrangements, including the acquisition of own shares, so companies and their owners should be prepared for the possibility that it may be necessary to seek a preliminary ruling from the tax authorities before acquiring own shares in the company. You should allow a couple of months for this.
On the acquisition of own shares for a company and the main features of its taxation also has its own article on our website.
Business or substance trade
In a business transaction, the buyer usually buys the business and the fixed and current assets that he or she needs to continue the business. The fixed assets and inventories transferred in the transaction are often paid for at fair value. The soft assets of the company, its business, name, staff and their skills, suppliers, customers, product development, distribution channels, etc. are paid for at their business value, i.e. the goodwill value. In a business-to-business transaction, the purchase price remains with the selling company and its transfer to private use, if desired, must be planned separately. With the money received, the seller can pay off the debts of the business and either close the business, distribute the profits as dividends or otherwise, or keep the business as an investment company.
Because of the potential historical risks and the ease of doing so, a buyer often prefers to buy a business rather than the entire share portfolio of a company. In this case, the buyer is only responsible for the future of the company and his risk is limited. In addition, the buyer will be able to depreciate the goodwill of the acquired business over a period of ten years.
If the business to be acquired is subject to authorisation or if the products or production methods to be acquired require official permits or approval by the authorities, it is important to ascertain in advance, especially in the case of a business transaction, whether these permits can be transferred or whether the acquirer of the business must reapply for them. In addition, negotiations with the authorities should clarify and ensure how the business can continue while the authority deals with the business acquirer's licence applications.
Share trading
In a share sale, the shares that entitle the buyer to ownership of the company are sold, i.e. the entire company with its liabilities and obligations. The entrepreneur receives a debt-free price for his company. The buyer assumes the entire burden of the company's history, including contracts, work in progress, and any liabilities from previous contracts and work. In addition, subsequent tax audits may reveal liabilities that no one may know about at the time of the transaction.
In a share deal, the buyer has a higher risk than in a business deal because he cannot choose which parts of the company to buy. In a company sale, the seller knows the company and the buyer depends to a large extent on the information the seller gives him about the company. These liabilities and contractual risks are minimised by requiring the seller in a share deal to take out various types of insurance on the business and the contracts. The seller is therefore required to provide a lot of guarantees in a business transaction. If, after the transaction has taken place, it later turns out that the assurances were not correct, this can lead to a price reduction or even the cancellation of the transaction. The seller should also be prepared for the possibility that the buyer is likely to require the seller to impose a non-compete clause for several years and possibly to remain available to the business during the takeover.
Business contracts in the event of a change of ownership
The general rule in contracts is that without the consent of the other party to the contract, you cannot be released from the contract and substitute another party. The transfer of shares in a limited company does not affect the company's status as a party to the contract under existing contracts. Under the terms of the contract, a change of ownership may entitle the other contracting party to terminate the contract if this is expressly agreed. In the case of a transfer of a business, the seller is the company, whose ownership does not change.
The transfer of a business usually involves a business combination, including the lease, purchase, resale and other contracts that form part of the business. In a business transaction, the party to the contract changes in the transferred contracts, so the change of counterparty in any transferred contract must be agreed by the other party to the contract. The amount of work and the impact of this step in the completion of a transaction should not be underestimated.
If the shares in the company are sold, the various contracts of the company continue as they stand. If, on the other hand, the business is sold, the contracts are renewed because one of the contracting parties changes. The party to the contracts is no longer the selling company but the one that bought the business.
However, there are some exceptions:
Employment contracts will not be affected by the trading system. They will continue as they are, no matter how the transaction is conducted and no matter what is agreed between buyers and sellers. According to the law, a change of ownership is not a reason to terminate employment contracts.
Financing agreements often contain a clause allowing the financier to terminate the agreement and demand repayment of the loans if the ownership of the company changes.
Commercial leases are transferable without the landlord's consent, unless otherwise agreed in the lease. This is also the case in business transactions, despite a change of tenant.
It is therefore very important for both the buyer and the seller to familiarise themselves with the terms of the contract required in the business before the transaction. Experts call such a check legal due diligence, or DD.
As a general rule, it makes more sense for the future success of a company to trade in its shares or interests when it has a large number of important contractual relationships that would all have to be renegotiated in a business transaction. For other reasons, it may of course make more sense to do otherwise.
Employment contracts
Under the Employment Contracts Act, neither the employer nor the employee may transfer their rights and obligations under the employment contract to a third party without the consent of the other party. However, an exception to this is in situations of transfer of business, where the rights and obligations arising from the employment relationship are automatically transferred as such and mutually to the new owner or holder of the business. Under the Employment Contracts Act, a transfer of a business is understood to mean the transfer of the whole or part of the undertaking or business or of a functional part of it, i.e. there is no difference between a sale of shares and a sale of a business in this respect. However, the employee has the right to terminate his employment contract on the basis of the transfer of the business.
The new owner of the business must comply with the terms and conditions of employment as the transferor was obliged to comply with them before the transfer.
There is also a separate article on employment relations in mergers and acquisitions on our website.
Jari Sotka
Lawyer, MBA
Tel. 040 544 0610
[email protected]
Amos Attorneys at Law Oy
www.amoslaki.fi
The author has worked as a lawyer and advocate for more than 25 years, focusing throughout his career on preventing and solving legal problems for small and medium-sized enterprises.