3 of the Most Important Provisions in Asset Purchase Agreements
An asset purchase agreement (often called an “APA”) is typically used when buying or selling a business. Three of the most important provisions in an asset purchase agreement are: a material adverse change clause, a non-compete agreement, and indemnity and liability provisions.
The most common way to buy or sell a business is to use an asset purchase agreement. An APA is a contract where the seller of a business sells the assets of an existing business to a buyer. Rather than sell the entire business, including the corporation or LLC, however, the buyer is able to choose what portions of the ongoing concern he or she wants.
Asset purchase agreements are an excellent vehicle for buying a business because the seller knows exactly what is being bought – and what is not. For example, the buyer may only want to purchase assets like the company name, a lease, and intellectual property, but does not want to include the business’s debts or liabilities as deliverables in the APA.
In drafting or negotiating an APA, it is important to pick your battles. The buyer and seller will not agree on all the terms, and you may not be able to get concessions on every single contractual preference you have. By strategically prioritizing the most essential provisions, however, you – whether you are the buyer or the seller – can walk away with provisions in your asset purchase agreement that are most important to you.
An asset purchase agreement is typically negotiated by the buyer or seller’s attorney. The attorney should know the client and the client’s goals, what will satisfy the client, and whether there are particular needs the client has in the APA transaction. An attorney negotiating an asset purchase agreement can find areas of overlap between buyer and seller, and can find where the opposing side is willing to make compromises.
There are three vitally important terms to be negotiated in any APA: (1) a material adverse change clause, (2) a non-compete agreement, and (3) indemnity provisions. Though every provision is important, these three should be carefully considered by any buyer or seller.
1. Material Adverse Change Clauses in Asset Purchase Agreements.
A material adverse change clause (sometimes called a MAC clause, or a material adverse event or MAE clause) allows the buyer to cancel the asset purchase agreement if detrimental events occur to the business before to the closing. There is often a period of time between when the APA is agreed upon and when the actual closing is, so a material adverse change clause gives the buyer the right to back out if something happens to the business.
An example of a definition of a “material adverse change” is as follows:
"Material Adverse Change" shall mean any event, change or effect that has a material adverse effect on (a) the Business, taken as a whole, or the properties, results of operations, or condition (financial or otherwise) of Seller, taken as a whole (except for any such event, change or effect resulting from (i) the negotiation, execution, delivery or performance of this Agreement or the transactions contemplated hereby or (ii) changes in generally accepted accounting principles in the United States (“GAAP”)) or (b) the ability of Parent or Seller to consummate the transactions contemplated hereby.
This says that if a business experiences negative changes to its overall financial condition, or other disadvantageous conditions, the buyer is permitted to back out. A buyer will want a strict MAC clause, whereas a seller wants a MAC clause that requires the buyer to purchase the business no matter what happens.
By carefully defining what counts as a material adverse change, the buyer and/or seller may be protected and will have either the right to back out, or the right to force the closing to occur.
2. Non-Compete Agreements in Asset Purchase Agreements.
Buyers typically ask sellers to sign non-compete agreements as part of the APA. A non-compete will prevent the seller from working in the same industry as the business being sold for a set amount of time, and within a specific geographic area.
Non-compete agreements are important because the seller does not want to be indefinitely prohibited from working in an industry with which he or she has become familiar over the course of running the business. Thus, buyers want non-compete clauses that are extensive, while sellers want non-compete clauses that are limited.
These are important to negotiate in a manner that is forward-looking. Most non-competes state that if a party violates the agreement, he or she may be ordered by a judge to cease involvement in a new business, and can even be ordered to pay the other side’s attorney’s fees and court costs. Litigation over a non-compete may have a domino effect – if a buyer is involved with new partners, the violation of the non-compete can have legal and financial effects on these new partnerships, too. On the other hand, buyers do not want to purchase a business only to have the former owner compete by setting up shop down the street.
Consequently, carefully drafting non-compete agreements is fundamental when negotiating an asset purchase agreement.
3. Indemnity Provisions in Asset Purchase Agreements.
Indemnity clauses in asset purchase agreements state when each side is liable to the other for financial obligations. Indemnity clauses require one side to indemnify (pay for) the other side if certain agreed-upon events occur.
For example, a common indemnity clause might state that if there are undisclosed liabilities like loans or an account payable that the buyer becomes obligated for when he or she purchase the business, the seller must indemnify the buyer for those amounts.
When the business is sold, the buyer and seller do not expect to be required to have further financial obligations to each other. Thus, indemnity clauses are important because they say when one party must pay the other party – even after the closing.
Indemnity clauses are essentially risk allocation clauses. The purposes of all contracts is to allocate risk, and indemnity clauses allow the parties to do so intentionally. The most common issues that come up with indemnity clauses are those related to financial risk, operational risk, and legal risk.
There are many aspects of asset purchase agreements that must be considered by both buyer and seller. The above three provisions are some of the most important. An asset purchase agreement defines the risks, liabilities, rights, and remedies that each party will have, both during and after the sale. If you are a buyer or a seller, your APA should be reviewed by an attorney experienced in business purchases and sales.
Dye Culik PC is a Charlotte, North Carolina business law firm that represents business owners, entrepreneurs, and franchisees throughout North Carolina in business matters from incorporation to sale, and anything in between. If you have a question about your business, contact us to see how we can help.