Selling a software business. What is the difference between a share sale and an asset sale?
Software businesses are incredibly broad in nature, ranging in size from small businesses with a few employees to very large businesses with tens of thousands of employees, contracting with anyone from individuals to multinationals and governments, and providing anything from games to defence services.
However, when selling, or buying, a software business, the choice of structure will be the same as for other business sales: if the business is run through a company, the choice will be between a share sale and an asset sale. While both structures are capable of achieving broadly the same commercial objective, there are fundamental differences in both the legal effect and tax treatment of the two methods. Tax is usually the main driver, but legal considerations can also be important.
Businesses run through partnerships or by sole traders can only be sold through asset sales.
In a share purchase/sale, a buyer will acquire all or the majority of the issued share capital of a company (known as the “target”). Shares are legally transferred by stock transfer form and typically the terms of the transaction are documented in a “share purchase agreement”.
When a share sale completes, the target company itself does not change; rather, it continues to trade as it did prior to completion, except with a new owner. The buyer acquires the company subject to all liabilities, whether, past present or future, and whether known or unknown. Accordingly, it is usual practice for the buyer to seek contractual protection in respect of the company’s shares, its underlying assets and liabilities, by including extensive seller warranties and, in some instances, indemnities in the share purchase agreement.
In asset purchases/sales (sometimes also called business purchases or sales) a buyer acquires a collection of specified assets from the target, and assumes agreed liabilities. For tax reasons, often the whole or substantially the whole of the business is purchased ‘as a going concern’, so the business continues to trade, for the most part, just as it did prior to the sale. Alternatively, just some assets of a company can be purchased and liabilities assumed.
Exactly which assets and liabilities of the target business will be transferred to or assumed by the buyer will be a matter for the parties to negotiate (except in relation to employees where the operation of laws known as TUPE effectively transfer the employees with the business). Assets commonly transferred in the sale of a software business include: goodwill; IT and IT systems; licences; intellectual property rights; and customer and supplier contracts. Usually, any liabilities attaching to these assets pass with them to the buyer. The terms of the deal are typically contained within an “asset purchase agreement” or “business purchase agreement”.
Following the asset sale, ownership of the target company does not change and the target continues to exist. If the target company has sold the whole of its business it will now be a “cash shell” – a company with no assets except the cash proceeds of the asset sale.
Complexity vs flexibility
The documents and processes needed for an asset sale are often more complex than for a share sale, particularly with businesses such as software, where the main assets are intangible, such as intellectual property and rights under licence agreements. These will need separate documents to perfect their transfer. In other areas of the business, more consents and approvals are likely to be required than on a share sale (where change of control restrictions are the main issue); for example, getting landlord’s consent to the assignment of any property lease and consent, where needed, from any software supplier or owner in relation to the product.
There is, in theory, a greater amount of flexibility for the buyer on an asset purchase as it can ‘pick and choose’ what assets and liabilities to acquire, but in practice, unless the seller is in financial difficulties or otherwise in a poor negotiating position, most sellers (particularly if individuals) prefer share sales as the tax benefits far outweigh those under an asset sale (see below for further details). If the sellers can’t get a share sale, they will at least want to transfer all of the assets and liabilities with the aim of achieving, as far as possible, a “clean break” on their sale.
The transaction process
Due Diligence: As part of an asset sale or share sale, a buyer will want information about the business. This information gathering exercise is called “due diligence”. If only some but not all of the assets of a business are being sold, then this may be less involved for an asset sale than for a share sale. The warranty protection required in a limited asset sale (i.e. how many contractual assurances you will be required to give about the state of the business and assets) may also be reduced to reflect any decrease in areas of potential risk.
Price and Payment: In a share sale, the purchase price is normally adjusted after completion – through completion accounts (often with certain conditions), or earn-outs for example, meaning the parties do not have certainty over the purchase price. On the other hand, if the sale is of particular /limited assets, the purchase price is more likely to be known at completion, giving both parties comfort.
Tax issues play a significant role in how a transaction should be structured. Generally speaking, the tax advantages of a share sale to a seller (particularly where the seller is an individual) are likely to be far greater than the tax advantages of a share sale to a buyer. Conversely, an asset sale will often be more tax efficient for the buyer than the seller. A more detailed analysis of the tax implications of a share sale versus an asset sale can be found in our tax considerations note .
Each transaction will have its own unique set of facts and issues requiring careful consideration at the outset of any deal.