Most buyers and sellers of a small business will encounter an asset purchase agreement as part of the transfer of the business from the seller to the purchaser. While we do not recommend drafting and negotiating an asset purchase agreement without the help of an attorney, you, as the seller or purchaser of the business, may want to understand the basic workings of an asset purchase agreement.
What is an Asset Purchase Agreement?
An asset purchase agreement (APA) is a legal document between the purchaser and a seller of a business that sets forth terms and conditions under which the seller will transfer all the business assets to the purchaser. Yes, you are buying a business, but the business is really a collection of assets that, together, constitute the business. For example, a business may be comprised of all the furniture and equipment needed to run the business, contracts with its customers, the lease for the business location, and its trade names and trademarks, phone numbers, websites, and business listings.
The APA is often structured in a way where the parties first execute the APA and then some time goes by until the transaction is actually consummated and the business changes hands, which is called the Closing. You may have encountered this when you purchased a home. You first sign the agreement of sale. Then you get all your ducks in a row with respect to a mortgage and maybe approval by the home owner’s association. When all of that is lined up, the actual closing of the home purchase occurs and you became a homeowner.
Who drafts the Asset Purchase Agreement?
Usually the attorney for the purchaser. The parties may have already entered into a term sheet setting forth the basic terms of the purchase, which will be used by the attorney to draft the APA.
Who are the parties to an Asset Purchase Agreement?
The purchaser and the seller of the business. Often, the seller and purchaser are business entities, such as a corporation or a limited liability company. In that case, once the seller sells and transfers all of its assets, there is really nothing left. The entity remains an empty shell. If there is a breach of the APA, there is nothing to be had from that entity. For that reason, you may want to include the owner of the selling entity, or the shareholders, as parties to the APA.
What are the crucial elements of the Asset Purchase Agreement?
An asset purchase agreement usually has major headings dealing with the following:
- The specific assets being sold and how they will be transferred
- The purchase price and how it has to be paid
- Obligations of the seller and purchaser prior to or after the closing of the transaction
- Risk allocation provisions, such as representation and warranties, indemnification, and termination
- Provisions dealing with the mechanics of the Closing
Description of Assets being Sold
You want to be fairly specific in describing the assets being sold. In my experience, a broad general description along the line of “substantially all the assets of the business” is often not specific enough because very often certain assets are excluded. For example, most small business acquisitions exclude cash on hand by the seller or bank and security accounts of the seller. If you state “all the assets”, technically that would be included. So I recommend that the description makes it very clear which assets are included, and which are excluded. Then it should also be made clear what liabilities, if any, are taken over by the purchaser. If the purchaser purchases certain contracts that are part of the business (for example, supplier agreements), it has to be clear whether the purchaser takes over all liabilities under that contract and from what point in time.
Purchase Price and Payment
This section deals with the purchase price for the assets and how it has to be paid. A common scenario is that the purchaser makes a payment at closing and pays the rest in installments. If there are installments, the purchaser would usually give a promissory note for that amount and may give a security interest in the purchased assets, in case the purchaser defaults under the promissory note. The promissory note and the security agreement are usually separate documents to be signed at closing. The APA will simply reference to them and provide that the Closing requires that the purchaser delivers a duly executed promissory note and security agreement.
Pre Closing and Post Closing Covenants
The seller and purchaser will typically have some obligations prior to closing and after. Both parties should be obligated to do everything necessary to make the closing happen. The seller is obligated to run the business just as normal and not do anything that would cause a “materially adverse event” prior to closing. Seller and purchaser may be obligated prior to closing to conduct a valuation of inventory in order to finally determine the purchase price.
The seller may be obligated to keep consulting the purchaser after the closing to facilitate the transfer of the customers and the business as a whole.
Representation and Warranties and Indemnification
There will be a set of representations and warranties by the seller and the purchaser. These reps and warranties can be heavily negotiated because they can create liabilities for the seller or the buyer. You will usually see reps and warranties relating to:
You may wonder why you need these reps and warranties when you are buying the assets of the business. Even though, as a general principle, the purchase of assets does not cause a transfer of the liabilities of the business to the purchaser, there are some exceptions, especially if the business will be run essentially as before, i.e. same location, same equipment, same employees. In that case, there may be successor liability for the purchaser of the assets and you would want the seller to represent as to any potential liabilities.
An indemnification provision will provide that the seller has to indemnify you from all losses and damages resulting from a breach of the APA or any of the reps and warranties the seller made. Here again the parties usually heavily negotiate the extent of such indemnification provisions. There may be discussions about limitations of the upper limit of any indemnification payments or exclusion of certain damage categories. The parties may haggle whether the indemnification provisions are the “exclusive” remedies in case of a breach, which would exclude any other remedies, such as damages for breach of contract.
There will be provisions dealing with what has to happen prior to the closing, so-called “conditions to closing.” In a typical small business sale, there is usually the condition that the landlord of the business premises has consented to the transfer of the lease to the new owner. If there is more than one shareholder of the selling corporation, you will want to have confirmation that the shareholders properly consented to the sale.
The actual closing mechanics will be laid out. What does the seller have to provide at closing? Often the seller has to deliver executed versions of all ancillary documents, the landlord’s consent to the transfer, and maybe keys to the premises or passwords to domain names or business listings. The purchaser will typically have to deliver the purchase price in the form of immediately available cash, such as a wire transfer or a certified check. If part of the purchase price is financed by the seller via a promissory note, the purchaser has to deliver the executed promissory note.
There may also be provisions about what is supposed to happen if the closing conditions cannot be fulfilled. For example, the landlord refuses to consent. Usually, that gives the seller a right to walk away from the deal. The APA may state so in sections called termination rights.
Why do you need a lawyer to handle the Asset Purchase Agreement?
I hope I made the basic workings of an asset purchase agreement somewhat clear. However, even if you find a template on the internet, or maybe your business broker provides you with an agreement, I highly recommend that you do not go this alone. APAs can be complex and if you change one thing in the middle, it may have consequences for all kinds of other provisions which you may not be able to foresee and correct. APA’s are also complex in that someone needs to determine how each asset that is part of the asset package can be transferred to the purchaser. Tangible assets are usually transferred with a bill of sale, but contracts have to be assigned and require their own assignment instrument. Each contract has to be reviewed in order to detemine whether an assignment requires consent. Some permits and titles may require registration or may not be transferable at all, which would require a work around. The negotation of the reps and warranties requires specialized knowledge about what is customary and what would cause undue risk for either buyer or seller. So, bottom line, I think it would be penny wise and pound foolish to not engage a lawyer for this kind of transaction.