6 Key Pieces of Long Form Asset Purchase Agreements (Part 4 - Buying and Selling Businesses)
(For those just joining us, this is the third in a seven-part series on how to buy or sell your business. Please see the prior blog posts for more context.)
Asset purchase agreements (APAs) are the long-form documents that can be anywhere from ten pages to over one hundred pages depending on the complexity of the transaction.
While most small business purchases are achieved through APAs, there are some cases where a transaction may call for a buyer to purchase the corporate shares or LLC membership units of the seller instead. Buyers typically insist on asset purchase agreements instead of selling shares in the company due to the liability that is tied to acquiring shares in the company.
Some situations where it is preferable for the Buyer to acquire all of the corporate shares of the company instead of the assets of the company are:
- If Buyer acquiring debt of the Seller company is part of the underlying agreement,
- If the Landlord or some other third party will not agree to the assignment of the lease to a new entity but has no right to agree or not agree to the transfer of ownership of the tenant company.
- If Buyer wants to avoid the administrative headache of transferring utilities and paying utility deposits, Buyer may choose to purchase shares or units instead of the assets.
Back to APAs. If you have previously negotiated a signed letter of intent that contains the material terms the parties have agreed upon, an APA negotiation can be an easy and positive experience, with no real further issues to debate. However, if the LOI does not contain much detail, APA negotiations can drag out because the underlying deal must be finalized.
Below are the six top issues to consider when preparing to buy or sell a small business through an asset purchase agreement:
1. Material Terms from the LOI In Full Detailed Language. When I draft an APA or review one from the other side, the first thing I do is check the APA against the LOI to confirm that the language in the LOI is the same as the APA and all of the LOI sections are included. The high profile items should all be determined by this point (price, payment schedule, assets, contingencies). The granular details that are tangent to the material terms that are settled in APAs.
For example, a LOI may say “Buyer agrees to a 2 year non-compete agreement for hot dogs.” The APA needs to spell out: 1) in what geographic area, 2) what is the definition of “hot dogs” (does it include brats?), 3) what happens if there is a non-compete breach, 4) how long does the Seller have to find out about the breach? And the list goes on. That’s an example of just one LOI term.
In addition to LOI terms, there are additional parts of the APA discussed below.
2. Representations and Warranties. Each party will make representations and warranties to the other party. That means the parties will affirmatively represent as true a list of things, such as having the authority to sign the document (this is important if it is an entity), all of the financial representations being true, etc. The most important representation and warranty in my experience is that the financial information that Seller shared with Buyer is true. If the Seller shared false or misleading financial information with Buyer, any future payment obligations Buyer may have to Seller under the agreement could be void. Sometimes equipment has a warranty, but if you are the Seller you want to argue that the equipment is sold as-is.
3. Due Dilligence. Due diligence is just a fancy way to say “doing a deep dive through Seller’s documents and financials to verify representations of the Seller as true.” This typically includes bank records, business records, expense information, tax returns, inventory records, payroll records, review of equipment and property and other inspections.
Due diligence language is always included in APAs that are complex or are for large companies. For smaller deals, or deals where the Buyer has already conducted due diligence before the APA is negotiated, there may not be a due diligence period.
Just to zoom out, the most typical timeline is: LOI APA Due Diligence Period Closing. However, a contract is whatever the parties want it to be. I have seen deals go straight to an APA and close immediately. It depends on the circumstances of each individual deal.
4. Conditions Precedent For Closing. The conditions precedent for closing are the contingencies that were listed in the LOI, minus the contingency about reaching a mutually agreeable long-form agreement. Assuming the LOI has been signed and those terms have been integrated into the APA, the contingencies in the LOI may still not have happened, but may still have more time to occur prior to Closing.
All APAs need to have a bill of sale document from the Seller acknowledging that the transaction has closed. Some APAs close on the day of the signing if all of the conditions precedent have already occurred and there is no need for a due diligence review period.
5. Anything Else. “The APA is your oyster!” someone probably never said. But, they should have. If the parties can agree to it, then the term can go in the APA. Random items I have seen that become material parts of deals include retaining a certain employee for a period of time, the sale of or options to purchase unrelated property or equipment, and non-disparagement clauses.
6. Boilerplate. The boilerplate terms are the sections of the APA that control the litigation of the agreement. These terms are typically not negotiated and are standard. The most contentious boilerplate terms are typically choice of law and venue in situations where the parties are in different states. It is preferable to litigate in your own backyard.