There are two basic ways to sell a business: a stock deal or an asset deal. In a stock deal, the owners of the selling company sell their equity interests to the buyer, whereas in an asset deal the seller business entity sells all its assets to a buyer entity. After an asset sale, the owner of the seller entity still owns the entity, but the entity is just an empty shell, having sold all its assets to the buyer entity. Primarily for liability and tax reasons most of the business sales and acquisitions that I handle are asset deals, not stock deals. The most important document in an asset deal is the Asset Purchase Agreement (the “APA”). In this article, I will discuss the key provisions of an APA.
PREAMBLE AND RECITALS
The introductory paragraph of the APA is called the “preamble.” The Preamble contains the effective date of the agreement and the names of the parties and creates defined terms for the “Seller” and the “Purchaser.” After the preamble are a series of statements, often beginning with the word “Whereas,” which are called “recitals.” The recitals describe the background of the transaction and provide the context of the deal. For example, the recitals will usually describe the business and its location and the fact that the seller desires to sell and the buyer desires to buy the assets.
DEFINITIONS
In a complicated transaction, the next section is often a glossary containing an alphabetical list of terms that are used throughout the APA and their definitions or a reference to the section of the APA where the term is defined. These defined terms, such as “Acquired Assets,” “Assumed Liabilities,” and “Retained Liabilities” are central to the terms of the transaction and must be reviewed carefully to ensure that they properly describe the deal between the parties.
TERMS OF THE SALE
After the definitions, the APA will usually describe the specific transaction. This section describes the assets that are being sold, often with a reference to an attached exhibit where the tangible assets, such as furniture, office equipment, tools, and vehicles are listed in detail. In addition to the tangible assets, this section will also describe other assets included in the deal, such as intellectual property, websites, social media accounts, phone numbers, customer lists, books and records, and goodwill. Often this section of the APA will also specify certain excluded assets – that is, items that the Seller wishes to exclude from the deal and retain.
This section of the APA usually includes provisions dealing with liabilities as well. In some cases, the Seller will transfer certain liabilities to the Buyer, called “assumed liabilities,” such as contracts with customers or certain vendor agreements necessary to the continued operation of the business.
Most importantly, this section recites the purchase price and any deposit required and any adjustments to the purchase price. Adjustments might be tied to the level of product inventory on the closing date or might be related to the amount of net working capital of the business on the closing date. Provisions for how the purchase price will be paid are also included. Sometimes the purchase price is due all at once at the closing. In other cases the Seller may finance a portion of the purchase price by holding a promissory note from the Buyer. In yet other cases, a portion of the purchase price might be held back for a period of time and paid only upon the company meeting certain financial goals post-closing.
REPRESENTATIONS AND WARRANTIES
The representations and warranties section is usually broken down into two categories: representations and warranties of the Seller and representations and warranties of the Buyer.
Representations and warranties are statements of fact pertaining to the business and to the assets being acquired. The Seller’s warranties and representations provide the Buyer with comfort about certain key facts concerning the business and the Buyer expressly relies on these key facts. If any representations or warranties are false or inaccurate, and the Buyer suffers damages as a result after the closing, the Buyer will have an indemnification claim against the Seller for such a breach of warranty. A number of representations and warranties are standard in every asset deal, such as (1) the organization and good standing of the Seller entity, (2) the authority of the Seller entity to enter into the transaction and the enforceability of the APA against the Seller, and (3) the absence of any contracts or legal requirements that would prohibit the transaction from going forward. Other warranties and representations are specifically tailored to the transaction, such as statements (4) that the accounts receivable reported to the Buyer are valid and collectible, (5) that products in the Seller’s inventory are in a condition to be sold and are not discontinued models or out of date, (6) that the Seller’s trademarks are registered and validly issues and that there are no pending claims, and (7) concerning the Seller’s largest customers or most important vendors.
Closely related to the warranties and representations are the disclosure schedules. The disclosure schedules are attached at the end of the APA and are numbered the same as the warranties and representations to which they relate. For example, a representation might say:
“4.3 Except as identified on Schedule 4.3, all of the Assets shall be delivered to Buyer at closing free and clear of all liens and encumbrances.”
If there is a lien on the assets, the Seller would disclose that lien on Schedule 4.3, by inserting a statement in the schedule such as: “Fourth Bank holds a security interest in the Solstice Print-O-Matic, which is represented by UCC-1 Financing Statement recorded in the Florida Secured Transaction Registry as Document No. 2020419333.”
The Buyer also provides representations and warranties to the Seller to induce the Seller to enter into the transaction. The Buyer’s representations and warranties are usually fewer than those of the Seller and generally pertain to the organization and good standing of the Buyer, the enforceability of the APA provisions against the Buyer and the fact that there are no contracts or laws or court orders that would prohibit the Buyer from completing the transaction.
Buyer and Seller must read the warranties and representations very carefully and seek guidance from their attorneys if any of the warranties and representations are vaguely worded or are not accurate.
PRE-CLOSING COVENANTS AND
POST-CLOSING COVENANTS
In most cases there is a period between signing the APA and closing the transaction. The APA will contain certain pre-closing covenants (a covenant is just a fancy word for an agreement) from Buyer and Seller requiring them to do certain things or prohibiting from doing certain things between signing and closing.
The most important of these covenants pertains to the Buyer’s ability to perform investigations of the Seller’s business and the assets that Buyer is acquiring. These investigations are usually referred to as “due diligence investigations” or sometimes simply as “due diligence.” In the “due diligence” clause the Seller promises to afford the Buyer with access to the business, its books and records, and its assets for a certain period prior to the closing. Commonly, the due diligence clause permits the Buyer to terminate the transaction without penalty if the Buyer discovers facts about the business during its investigations that affect the value of the business or that result in the Buyer no longer wanting to proceed with the deal.
Another important covenant requires the Seller to continue to operate the business prior to closing in the ordinary course, consistent with past practices. For example, the Seller must continue to order supplies and maintain appropriate levels of inventory and cannot make major changes in compensation paid to employees pending the closing.
This section may also include certain covenants that will be performed after the Closing. Such post-closing covenants include confidentiality agreements, non-competition covenants, public announcements of the transaction, and customer communications.
CLOSING CONDITIONS
This section of the APA is usually labeled “Conditions to Closing” or “Conditions Precedent to Seller’s Obligation to Close,” or “Closing Contingencies.” These are conditions that must be satisfied, either by the Buyer or the Seller, before the other party is required to consummate the deal. For example, may deals are contingent upon the Buyer obtaining financing for all or a portion of the purchase price. If the Buyer does not obtain the necessary financing, it is not required to proceed to closing. Another common condition is that the representations and warranties made by the parties in the APA must be true as of the closing date and that both parties have complied with their pre-closing covenants. If the business has certain licenses or permits, such as liquor licenses, then a provision would state that the closing is contingent upon the necessary licenses having been transferred to Buyer or Buyer having obtained such licenses prior to closing. Finally, it is common to have as a condition that the Buyer will obtain a lease for the business premises or that the landlord will consent to the assignment of Seller’ existing lease to the Buyer.
INDEMNIFICATION
The indemnification provisions of an APA are vitally important and are not always well understood by the parties. These provisions entitle each party to be compensated by the other for losses incurred as a result of the other’s breach of warranty and other specified causes. For example, suppose the Seller gave a warranty that its contract with its largest customer was in full force and effect and could not be terminated except in the event of Seller’s breach. After the closing, the new owner contacts the customer and the customer discloses that the customer had given the Seller notice of termination 30 days ago. The Seller would be responsible for indemnifying – that is compensating – the Buyer for losses that result from this breach of warranty.
The indemnification provisions can be quite complicated. In addition to outlining each party’s rights to indemnification, there are usually provisions that establish a procedure to be followed to notify the party of the claim and for the indemnifying party to object to such claims. Most indemnification provisions contain a survival period after which no claims may be brought and a limitation or cap on the amount that a party may recover on indemnification claims. Sometimes there are thresholds that must be met before a party may make an indemnity claim and deductibles, similar to those in an insurance policy. Finally, in some cases a portion of the purchase price is deposited in escrow for a period of time to pay any indemnification claims that arise.
TERMINATION
The APA will contain a section addressing how the agreement may be terminated. This section will provide a mechanism for terminating the APA if Buyer discovers adverse information during its due diligence investigation or if any of the closing conditions have not been met or if a party violates any of its pre-closing covenants. If the Buyer has paid a deposit, the termination section will explain under which conditions the Buyer gets its deposit back and under which conditions the Seller is entitled to retain the deposit. This section will also any provisions of the APA that will survive and continue to be in effect even after termination, such as confidentiality provisions.
GENERAL PROVISIONS
The final section of the APA contains several general provisions, sometimes referred to as “boilerplate,” that are common to almost all contracts. The fact that they are common provisions does not make them less important, however. These general provisions cover issues such as attorney’s fees and expenses, dispute resolution, amendments, assignability of the APA, and other matters. A common provision that the parties ignore at their peril is the “integration clause.” For example:
“10.5 This Agreement contains the entire agreement between the parties and supersedes all prior and contemporaneous agreements and understanding related to the subject matter hereof.”
This means that if there were any promises made by the Seller to the Buyer, and those promises are not included in the text of the APA, those promises cannot be enforced – they are not “part of the deal.” If the assets being acquired include a delivery van and the van is currently inoperable, but the Seller assures the Buyer that he will pay to have the delivery van fixed after the closing, that promise must be incorporated into the APA or it will not be enforceable by the Buyer against the Seller.
CONCLUSION
There is no “one-size-fits-all” when it comes to an APA. The agreement must be drafted specifically for the type of business being acquired and must accurately reflect the deal between the parties. Purchase price, how the purchase price is paid, which assets are included and which are not, which liabilities will the Buyer be responsible for, and what will the Buyer’s recourse be if the Seller breaches its warranties or covenants are all matters that must be tailored to the specific deal. Nevertheless, each APA has a similar structure and similar types of provisions, even if the details are different. After reading this article, I hope that a business buyer or seller will at least understand this common structure and have a better idea of what the various provisions are and the purposes they serve.
To contact corporate law attorney Matthew Lapointe, please call 941.748.0100 or email mlapointe@blalockwalters.com.
