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THE ACQUISITION PROCESS:

STRUCTURING THE DEAL, NEGOTIATING THE LETTER OF INTENT &
CONDUCTING DUE DILIGENCE

Initial Negotiations

The key terms and deal

structure are negotiated
and a meeting of the
minds is reached (such as
the purchase price, payment
terms, deal structuring as an
asset or share purchase, etc.)

Letter of Intent

A written agreement (binding or

non-binding) establishing or
confirming the fundamental
terms of the transaction is
drafted and accepted (before the
expense and time of negotiating and
drafting a definitive agreement is
incurred)

Regulatory & Third Party Issues

Certain transactions may require third party consent or
governmental approval

Closing
Documents are signed, purchase price is paid, etc.

Due Diligence

Investigation and searches

relating to the business
being
acquired
or
invested in (including legal,
financial and business due
diligence). This process
continues throughout the
entire transaction

Definitive
Agreement
Sets out the full terms
and conditions upon
which the transaction
will be completed (ie.
builds
upon
the
fundamental terms of the
letter of intent)

Financing

Post-Closing

Document distribution & clean-up, post-acquisition

integration, earn-outs, adjustments, etc.

Financing may come from a variety of

sources (including from banks, private investors,
venture capitalists, the capital reserves of the
purchaser, or the seller may finance the acquisition)

Initial Negotiations: Asset vs. Share Purchase Transaction

The initial question in any acquisition is whether the transaction should be structured as an asset purchase
or share purchase. The answer depends upon a number of factors, including: timing, risk allocation (i.e.
the liabilities, claims and encumbrances associated with the business), ease of implementation and tax
consideration.
In a share purchase transaction, the purchaser acquires the corporation itself, with all of the underlying
assets and liabilities. A share purchase is generally faster to complete and less complex than an asset
acquisition and it avoids many of the practical problems associated with a transfer of particular assets
(such as the common requirement to obtain consent from third parties - although this may be required in
certain cases - or to have the assets re-titled in the purchasers name). From a vendors perspective, a
share transaction may be more tax advantageous than an asset purchase. This is because no GST or PST

is payable on the sale of shares: tax liability is limited solely to taxes on any applicable capital gains
(which in itself receives favourable tax treatment in comparison to tax on income). Moreover, taxes paid
on capital gains may be minimized further if the business qualifies for a capital gains exemption as a
Small Business Corporation. On the other hand, the vendor in a share transaction is unable to retain any
existing losses (if any) in the corporation in order to off-set against future income.1
In an asset purchase transaction, the purchaser selects which assets of the business (and accompanying
liabilities) it wishes to purchase: it also gets to decide which assets and liabilities it wishes to exclude.
Liabilities unassumed by the purchaser, particularly unknown liabilities, will remain the responsibility of
the vendor. An asset purchase is often the more favourable structure for a purchaser or if the vendor is
selling one division of a corporation while maintaining another. A sale of assets will generally be less
favourable to the vendor from a tax perspective. This is because the sale is taxed at two levels: to the
corporation when it sells its assets; and, to the shareholder (i.e. vendor) when the profits are distributed by
the corporation. In an asset purchase, however, the vendor retains the ability to use existing tax losses in
the corporation.2

Letter of Intent
In many transactions, the purchaser and the vendor will execute a letter of intent. A letter of intent (which
is sometimes called a memorandum of understanding) is a written agreement between two or more parties
which is meant to confirm fundamental terms or indicate interest by a potential purchaser, as well as to
open a dialogue for negotiations. It is a relatively straightforward document setting out the proposed
terms of the transaction. If a deal is eventually consummated, the letter of intent may memorialize the
major terms upon which a definitive agreement will be based.
A letter of intent may be binding or non-binding or a combination of both. In most cases, the letter of
intent will contain binding provisions for example, terms with respect to non-disclosure, covenants to
negotiate in good faith or no-shop provisions granting the proposed purchaser with an exclusive right to
negotiate for a specified term even if the other sections of a letter of intent are non-binding. The
purposes of a letter of intent include:

clarifying the key points of a complex transaction for the convenience of the parties;
declaring officially that the parties are currently negotiating;
preventing the vendor from dealing with third parties while a transaction is being negotiated;
providing safeguards in case a deal collapses during negotiation; and,
binding a party to the terms of a proposed transaction even prior to the completion of all
applicable conditions (in the case of a binding letter of intent).

Due Diligence
Regardless of the structure of the transaction, a purchaser will ultimately be most concerned with the
condition of the business it is purchasing and the liabilities it is inheriting. As a result, in addition to
obtaining appropriate representations, warranties and covenants from the vendor in the purchase
agreement, a purchaser will seek to protect itself by conducting a due diligence review of the business and
its assets.

Tax losses, if they exist, should be a key consideration when negotiating not only the type of structure to be used,
but the substantive terms of the deal as well (ie. purchase price; etc).
2
Please note that the discussion of tax preferences is in general terms. Each particular transaction is different and
will result in each party having their own optimal tax structure, which may differ from the information provided in
this article. Optimal tax structuring requires that your professional team include both accountants and lawyers with
experience in tax planning.

A due diligence review is an investigation into the business, legal and financial affairs of a company. It
has three purposes: to ensure that there is complete disclosure in the relevant acquisition documents; to
evaluate the transaction (i.e. to ensure that a fair price is paid, risk is allocated fairly, etc.); and, to confirm
the status of title, material contracts, legal compliance and other pertinent matters. A due diligence
review examines four distinct sets of facts:

those that affect the value of the assets of the business (i.e. are important assets of the business
owned, leased or licensed?);
those that affect the liabilities of the business (i.e. what are the actual and contingent liabilities of
the business? Has the business provided any guarantees? Have any lawsuits been initiated or are
any pending or threatened? Has the business signed any contracts that contain a liquidated
damages clause?);
those that affect the corporate status (i.e. does the corporation legally exist? Were all previous
transactions the business entered into duly authorized? Does the business have the power and
authority to enter into this particular agreement?); and,
those that become relevant if there is a change of control (i.e. do the business contracts permit a
change of control? If so, what are the consequences of a change of control?).

This article only superficially deals with the multitude of considerations that may arise during the
acquisition process. Specific deal considerations are entirely dependent upon the particular facts of your
situation. Prior to making any decisions regarding a potential acquisition or sale, it is important that you
first assemble a professional team of advisors, including a lawyer, accountant and banker, in order to
discuss the relevant issues raised in this article. If we can be of assistance in this regard, please contact
our firm at 416.920.2300.

Asset vs. Share Purchase Summary

Asset Purchase

Share Purchase

Ability to pick and choose liabilities

Tax favourable from the Purchasers perspective
Tax favourable from the Vendors perspective
Consent from third party required
Assets need to be re-titled
Quicker and simpler process (generally)
Compliance with Bulk Sales Act (Ontario) required (unless
waived by the purchaser)
No change in status with respect to employees
Establishment of new pension
and benefits plan required
Due diligence required
CONTACT INFORMATION
Brooks Barristers & Solicitors
261 Davenport Road, Suite 300
Phone: 416.920.2300
Facsimile: 416.487.3002

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articles, checklists and Web sites that we have compiled to help answer your legal and business questions.
This article provides information of a general nature only
and should not be relied upon as professional advice
in any particular context.