The main legal document when buying and selling a business is the Asset Purchase Agreement (or an APA, for short). In the vast majority of business sales, the assets of the existing business are sold to a new business. Rather than the entire business changing hands, all its assets change hands. The assets include everything the seller-business owns, including its contracts with customers, real estate, property and fixtures, and intellectual property. The buyer-business creates a new business entity (typically, an LLC or a corporation) to acquire all these assets.
The Asset Purchase Agreement is the contract that transfers everything from the seller to the buyer. It is the most important agreement in the transaction, governing all the rights, duties, and obligations of the parties, as well as the legal remedies available in case there is a dispute.
Clients often wonder what it is about this agreement that is so important: why is there a significant amount of time spent making sure the details are all just right? This post explains some of the main provisions in any Asset Purchase Agreement to give a better understanding of what types of provisions are involved.
Preamble and Recitals
The Preamble and Recitals of an APA are the sections that frequently begin with a series of statements beginning with the word “Whereas.” It gives a detailed background for the context of the transaction, and often looks something like this:
“Whereas, Acme Widget, Inc. is in the business of selling widgets throughout North Carolina;
Whereas, Beta Widget, LLC has made an offer to Acme Widget, Inc. to purchase substantially all of its assets;
Whereas, Acme Widget, Inc. and Beta Widget, LLC have agreed to a purchase price for the sale of all assets;
Now therefore, the parties hereby enter into this Asset Purchase Agreement. ....”
The actual Preamble and Recitals is likely to contain many more “Whereas” statements with additional details about the nature of the transaction. While these statements are not considered legally binding – they are not the actual terms of the contract – but in the event of a dispute, they will help a judge or arbitrator to understand what the parties’ intentions were going into the sale.
Definitions
Most APAs will have a Definitions section, giving precise definitions of the key terms used. For example, you may want to define the name of the seller-corporation to include the owner or shareholders of the seller in order to hold them personally liable. There may also be financial terms relevant to the purchase price that are defined, such as EBITDA, or “material adverse change” (see our post covering material adverse change clauses).
The Purchase and Sale
As this section contains the payment terms, the buyer and seller will usually look at it first. It may also contain an exhibit identifying a list of all the assets that are being included in the sale. If there is an earnout provision where the buyer pays part of the purchase price over time, based on certain agreed factors, those factors may be elaborated on in this section.
Representations and Warranties
In the Representations and Warranties the parties affirm that any promises they made are true and will continue to be true up through the closing. For instance, the seller may have provided financial information in due diligence that must not change prior to the closing. These shift the risk of damage or expense resulting from the facts not being or remaining true onto the party making it.
Buyers want due diligence and earlier representations to remain true. The buyer may also want representations about what sorts of situations the seller does or does not have knowledge of – like issues with customers, potential lawsuits, or other adverse issues. The parties may also state how long those representations will survive for, i.e., whether the facts will remain true for a certain period of time after the closing.
Covenants and Conditions to Closing
Covenants impose a duty on the parties. Positive and negative covenants form a sort of firewall to make sure that certain events will (or will not) happen before the business is sold.
These may be affirmative covenants like allowing access for due diligence, providing copies of documents, making certain legal or regulatory filings, or procuring consents or authorization from third parties.
The covenants may also be negative, like prohibiting operating the business outside the ordinary course, not using certain confidential information, or non-compete agreements.
Indemnification
Indemnification is the parties’ agreement to indemnify (pay for) damages caused to each other. The seller will likely want to be indemnified by the buyer if the buyer breaches, fails to assume certain liabilities that should go along with the business, or fails to undertake any of its post-closing obligations.
The buyer, on the other hand, will want to be indemnified by the seller if the seller breaches, causes additional liabilities that the buyer unexpectedly owes, or violates any of the seller’s pre-closing obligations.
A good indemnification clause includes the type of damages that are payable (compensatory damages, incidental damages, punitive damages, each of which are applicable to different types of circumstances), the circumstances giving rise to the damages, and a process for handling indemnification claims.
Termination
When the parties agree to buy and sell a company using an APA, a significant investment is on the line on both sides. There are investments of time, money, risk, other resources, as well as opportunity cost. For this reason, the parties do not want it to be too easy for either side to back out.
For example, after a certain period the parties may not be able to terminate unless there is a certain material fact that turns out to be true. Or, if the transaction is being financed, the buyer may want to ensure that it has the right to back out of the agreement if financing cannot be arranged. There may also be industry-specific reasons for being able to terminate, such as fluctuations in the market.
Miscellaneous
The title of the “Miscellaneous” section is misleading – some of the most important provisions in the APA are contained here. These are provisions about the governing law for the agreement, how disputes are resolved, where disputes are resolved (e.g., in arbitration or in court). In the event of a problem, this is where the parties’ attorneys will look first.
In conclusion, all of the above are just a few of the major sections of an Asset Purchase Agreement for the purchase and sale of a business. Each agreement is different – they are all fact-specific, industry-specific, and client-specific, so no two Asset Purchase Agreements are the same. It is important for your attorney to be educated about the business you are buying or selling in order to ensure that each contingency is adequately addressed. Our firm values the relationships we have with our clients, getting to know the ins and outs of every transaction to make sure every possible contingency is addressed.
Dye Culik PC is a Charlotte, North Carolina business law firm representing companies of all types throughout North Carolina. We represent both buyers and sellers in the negotiation, drafting, and closing of M&A transactions. Connect with us for help with your business.