Understanding the Advantages and Disadvantages of 'Business Transfer' and 'Company Split'

In the context of M&A between companies and business succession, it is necessary to consider the structure of how to carry out the succession. There are several legal structures, but it is common to choose ‘business transfer’ or ‘company split’ for business succession.

For other structures, please refer to the detailed explanation in the article below.

https://monolith.law/corporate/merger-acquisition[ja]

Both business transfer and company split are mechanisms defined by law, and the necessary procedures are also separately defined. Therefore, in the following, we will explain the differences between business transfer and company split, as well as their respective advantages and disadvantages.

What is Business Transfer?

A business transfer refers to the act of transferring part or all of a company’s business to a third party successor.

Unlike corporate mergers, which involve the wholesale succession of a company’s assets and liabilities, a business transfer involves the individual succession of the selling company’s assets, liabilities, and trading positions through individual contracts. Therefore, a business transfer can be described as a bundle of individual sales contracts and the like.

Furthermore, in the case of a business transfer, it is possible to flexibly respond, such as leaving a part of the assets in the selling company without transferring them.

For detailed explanations about the procedures in actual business transfers, please refer to the following article.

https://monolith.law/corporate/virtual-youtuber-ma[ja]

What is a Company Split?

A company split refers to the comprehensive succession of all or part of the rights and obligations of a joint-stock company or a limited liability company’s business to a purchasing company.

The personalityistic of a company split is this comprehensive succession, and in the case of a company split, there is no need to individually conclude sales contracts etc. between the buyer and the seller for each business or asset.

There are two types of company splits:

• Establishment of a new company (Shinsetsu Bunkatsu)
• Absorption-type company split (Kyushu Bunkatsu)

The establishment of a new company refers to the case where a new purchasing company is established. On the other hand, an absorption-type company split refers to the case where the purchasing company is an existing company.

Difference between Business Transfer and Company Split

Both business transfers and company splits are structures utilized in business succession scenarios such as M&A, and they both have the effect of transferring businesses and assets from one operator to another. However, there are some differences between the two as follows.

Is it a Corporate Reorganization under the Japanese Companies Act?

A business transfer is an individual transaction and is not a “corporate reorganization” under the Japanese Companies Act. On the other hand, a company split falls under the “corporate reorganization” under the Japanese Companies Act.

In the case of a corporate reorganization under the Japanese Companies Act, the businesses and assets owned by the predecessor company are collectively inherited by a single contract. This is called comprehensive succession.

In contrast, in cases that do not fall under corporate reorganization, like business transfers, it is necessary to transfer each business individually through separate contracts.

Need for Creditor Protection Procedures

In the case of a corporate reorganization under the Japanese Companies Act, such as a company split, properties and the like are collectively inherited without obtaining the consent of each creditor. Therefore, it is legally required to notify creditors in advance of the reorganization and to accept objections from creditors.

In contrast, in the case of a business transfer, while there is no need for a procedure to accept objections from creditors, it is necessary to obtain individual consent from creditors for each transfer contract.

Employment Relationship Succession

The need for individual transfer contracts in the case of business transfers is not an exception in employment contracts. If you want to transfer an employment contract to the buyer, the buyer’s operator needs to individually conclude an employment contract with the worker.

In contrast, in the case of a company split, due to the nature of the seller’s company’s assets being collectively inherited, the employment contract is inherited by the buyer without having to re-conclude it.

Advantages and Disadvantages of Business Transfers and Company Splits

As we have seen, there are procedural differences between business transfers and company splits. When considering M&A in practice, it is necessary to understand the advantages and disadvantages of each in order to make an informed decision.

Advantages and Disadvantages of Business Transfers

First, let’s discuss the advantages and disadvantages of business transfers.

Advantages of Business Transfers

The advantage of a business transfer is that you can choose the business to be inherited. This allows small and medium-sized enterprises, which are facing a shortage of successors, to gradually reduce the size of their company by transferring part of their business to other companies.

In this case, one of the advantages of a business transfer is that it allows for detailed adjustments, such as leaving only businesses that pose less operational burden to the company.

Even outside the context of business succession in small and medium-sized enterprises, it is possible to transfer a business that has potential but cannot be fully utilized by the company due to financial reasons, to a company with financial strength and expected synergistic effects.

Disadvantages of Business Transfers

When using a business transfer, careful attention is needed for tax and debt processing. This is because business transfers tend to complicate taxation and debt as they inherit assets, liabilities, and contractual positions individually.

In terms of tax processing, if the amount obtained by subtracting liabilities from the assets to be transferred is positive, it may be subject to corporate tax for the seller. In addition, consumption tax is levied in the same way as regular sales contracts.

Furthermore, in a business transfer, it is possible to transfer only the assets related to the business and leave the liabilities with the seller’s company. However, it is generally necessary to obtain individual consent from creditors. Especially when the debt is a loan from a financial institution, it is a principle that it cannot be inherited without the consent of the financial institution as it becomes a debt assumption.

Thus, while business transfers have the advantage of being able to flexibly select the assets and liabilities to be inherited, they also have the disadvantage of potentially complicating the procedures for inheritance.

Advantages and Disadvantages of Company Splits

Next, let’s discuss the advantages and disadvantages of company splits.

Advantages of Company Splits

In a company split, as mentioned earlier, the rights and obligations held by the seller’s company are comprehensively inherited by the successor. Therefore, complicated procedures such as obtaining the consent of each creditor for each contract are not necessary. The rights and obligations to be inherited include employment contracts with employees, so there is no need to re-contract with each employee.

Also, in the case of a company split, the consideration for the transfer can be made in the form of shares of the buyer’s company. This allows the buyer to inherit the business without having to prepare cash.

Disadvantages of Company Splits

If a profit is made from a company split, corporate tax is levied on that profit. However, there are special exceptions such as not being taxed on the profit from the transfer if certain conditions (qualifying requirements) are met.

Therefore, when performing a company split, it is necessary to meet the qualifying requirements as much as possible, but the process of verifying and confirming these requirements can be time-consuming, which can be considered a disadvantage of company splits.

Summary

Company executives and M&A managers who are considering business succession through M&A and the like need to understand the basic content and differences of each structure.

However, the actual procedures required are extremely complex. In addition, in large-scale business transfers and company splits, legal, accounting, and tax due diligence is essential for risk avoidance.

Therefore, if you are actually going to execute a business transfer or company split, we recommend consulting with a lawyer at an early stage. In addition, it is common to seek the involvement of certified public accountants and tax accountants for tax and accounting matters.