What is an asset purchase agreement? This insight article from the team at Alston Asquith provides a guide on all the details on how to buy or sell a business and how our solicitors can help.
Contents in Asset Purchase Agreements
- What is an asset purchase agreement?
- What parties would use an asset purchase agreement?
- Do I need an asset purchase agreement or a share purchase agreement?
- What assets can you buy in an asset purchase agreement?
- Due diligence in an asset purchase agreement
- Valuing a business for an asset purchase agreement
- Agreement to sell
- The effective time of the asset purchase agreement
- Restrictive covenants in the asset purchase agreement
- Warranties and protection in an asset purchase agreement
What is an asset purchase agreement?
An asset purchase agreement is the key document that enables the purchase of some or all of the assets of a business. The asset purchase agreement follows the discussion of the proposed terms for the acquisition of assets or an entire business and allows those proposals to be put into contractual form. It is often a lengthy document compared to the proposals which often just an outline of the deal.
A related but separate process of due diligence will be conducted in conjunction with the agreement allowing the buyer to ensure that the terms are fair and to allow for amendments when certain information arises. The agreement allows the buyer to discuss exactly which assets they intend to purchase, what obligations and liabilities it will assume including employees as well as arrangements for the running of the business after the completion of the deal.
What parties would use an asset purchase agreement?
In the simplest form, an asset purchase agreement is between a single buyer and seller but it is possible for the agreement to name multiple parties. This is particularly apparent when either the buyer or the seller is a subsidiary of a parent company. This may occur when the parent company is required to be a guarantor to the agreement and is subject to negotiation.
If there are multiple sellers then they will be named individually on the agreement along with their liabilities including whether these are joint and/or several. This allows the buyer to easily identify who they should take action against if obligations are not met.
Do I need an asset purchase agreement or a share purchase agreement?
When selling a business an asset purchase relates to a specific asset or right owned by a business. In contrast, a share purchase agreement allows an entire company to be bought.
A share purchase agreement would ensure the continuity of the status quo for the company including any contracts that may be in place but likewise would also inherit any outstanding issues, debts and liabilities. A share purchase agreement requires that all the shareholders of a company transfer their shares to the buyer(s) so that they own the whole business. Additionally, the sales must comply with the Companies Act 2006.
For a buyer, an asset purchase may be more attractive as they get to cherry pick the elements of a business they’d like to acquire and restrict what liabilities they take on. In this case, contracts with suppliers and customers do not automatically transfer however under ‘TUPE’ regulations employee contracts still transfer. An asset purchase requires the identification of both what assets are included in the deal and what is excluded. For the seller, it may be beneficial to retain part of their business and they may also be able to command a better price by only selling off an area of the business that the buyer is interested in.
What assets can you buy in an asset purchase agreement?
The asset purchase agreement will define what assets are to be included as part of the deal and equally important, may include assets that are to be excluded. It is important to accurately describe each asset so there is no dispute as to what the agreement refers to especially if the seller has multiple assets that are of similar makeup. An example maybe if the asset purchase agreement only refers to specific employees to be transferred as part of the deal. This underlines the importance of due diligence to understand exactly what is being purchased and outlining the deal to avoid confusion. Examples of what may be included in the agreement are:
An entire business
If a parent company does not wish to sell off all of the businesses they own but rather a specific business or businesses to the buyer.
The is the sale of agreements in place between the seller and third parties such as suppliers and customers. It will also cover any liabilities. The third party will need to consent for this to be included in the asset purchase agreement before completion. This is important because if the profitability of a business depends on certain large contracts then it may devalue the deal without their inclusion. As such it may be wise to make the agreement contingent on their inclusion.
The name of the business/brand
Sometimes a buyer may wish to buy the brand of the business on it’s own in order trade off the brand’s popularity.
This is of the utmost importance as it could be the key to the business. Insider information and confidential details that in the hands of competitors would ruin the business should be included as they are intrinsic to the value of the company.
Up to the point of sale any creditors remain the liability of the seller. As such the buyer will want to ensure obligations are met to maintain goodwill. As such it may be in the buyer’s interests to take on the creditors as part of the deal and adjust the price accordingly.
Debtors may remain the responsibility of the sellers however the buyer may wish to take control of these and enforce collection of owed debts.
This may include the IT infrastructure and any systems that the company may use. It may be necessary to make an arrangement to share the infrastructure after the completion of the asset purchase agreement.
A more complex aspect is employees rights which are governed by TUPE. They will need to be consulted and their existing contracts will be transferred. Employment law is increasingly more complicated but as a general rule, if buying a company, the employees and their rights transfer with the sale. It may also be that redundancy will be required for some employees. If this is required the costs of this will need to be calculated before completion.
What assets will not be sold as part of the asset purchase agreement.
Assets that might be used as part of the business for production and transport such as vehicles, machinery, furniture etc.
This is ‘reputation’ and the expectation that customers will be willing to continue trading based on prior relationships with the business. This is particularly important as the buyer will want to ensure that lucrative relationships can be capitalised on following the completion of the deal.
Intellectual property rights
Intangible assets that are registered such as trademarks, patents and registered designs. The value of the business may depend on being able to use these intangible assets and/or having exclusivity.
Leasing & hire agreements
Similar to taking over a business contract, this is normally the rights to equipment. Once again this will be dependent on the third party although they are unlikely to disagree as it will ensure a continuation of their business.
Properties, premises and land
The buyer may wish to acquire property as part of the business. As part of this the buyer will need to ensure they understand any restrictive covenants that may affect the value of the property. Surveyors will be required to complete this and provide an accurate valuation. If the property is held under a lease, the terms of this lease will need to be examined such as any variations and liabilities. For example the building may require repairs or there may be environmental issues.
Having access to records such as lists of customers will allow the creation of plans to develop the future of the business. Additionally, having access to the records will be required for accounting purposes.
Purchasing inventory from a company. The agreement will need to note a date where a stock-take will be required which marks a point for which the seller is liable if it is not transferred without notification and agreement. The value of each item will need to be clearly defined as well as identifying who will do the valuation.
Due diligence in an asset purchase agreement
The agreement should also contain details of liabilities and other financial matters relating to the purchase. Prior to the exchange the buyer will need to conduct due diligence where a professional team will investigate all matters relating to the sale. In addition to the above this will include:
- Accounts – The accounts relating to the particular business(es) being purchased. As the seller may own several businesses the accounts of the parent company may differ from the accounts that are required for the asset purchase agreement. As such the seller will have to prepare a set of accounts relating to the assets set to be purchased.
- Completion accounts – Finalising the price of the purchase may not be possible until completion accounts have been presented which sets outs the financial state of affairs at the point of completion and allows both the buyer and seller to verify whether the accounts are as expected. This leaves a choice in the negotiation, whether to accept an often lower offer that is not subject to completion accounts or a higher offer that will be subject to more scrutiny. Alternatively, a deposit account can be used that will only be released subject to the agreement of both parties. The seller may also wish to retain the title of the assets until the consideration is paid in full or take a charge over the assets or the obligations be guaranteed.
- Completion date – The date at which all obligation in the contract have been met.
- Conditions precedent – The asset purchase agreement may be conditional on certain criteria being met. Some examples include permission of the landlord to transfer the lease, approval of shareholders, the passing of resolutions by the buyer’s board of directors, regulatory clearances or any other third party agreements. Part of the due diligence is to establish if any conditions must be met for the agreement to proceed. There should be a cut-off date where the conditions will need to be met beyond which either the deal will not proceed or the buyer will provide a waiver or some other alternative course of action. They may also be a clause that allows the reimbursement of costs should the conditions not be fulfilled.
- Disclosure letter – A key document in the sale providing the buyer with specific details of the business from the seller to assist with their due diligence. This will provide an extensive list of information that the seller would expect to know in advance of the purchase and limits the liability of the seller as the buyer will not be able to claim they weren’t aware of the details after the sale.
- Effective time/transfer date – The date at which the parties agree the transfer will take effect for accounts that may not be at the same date as completion. (see ‘The effective time of the asset purchase agreement’ below)
- Litigation – The buyer will need to consider if the business being purchased has any outstanding (or potential) litigation which could have potential costs.
- Purchase price – This is the agreed price for the purchase of the assets and will take into account various commercial factors taking into account the benefits and liabilities of the business. The agreement will also take into account the method of payment (e.g. cash, shares, loan stock), whether it is a fixed amount or tied to profits, the date of payment(s) and if there is any retention of consideration. (see ‘Valuing a business for an asset purchase agreement’ below)
- Restrictive covenants – When making the purchase the buyer will likely wish to impose restrictive covenants on the seller preventing them from competing with them in their area of business. Examples include soliciting customers and employees or setting up a new company in their area of business (see ‘ Restrictive covenants’ below)
- Tax – The implications of the asset purchase agreement on tax liabilities
- VAT – Asset sales are subject to VAT unless specifically exempt. When sold as a ‘going concern’ the VAT can be ignored as long as the assets are going to continue being used for the same purpose and both the buyer and seller are VAT registered. More information on transferring as a going concern (TOGC) can be found at this link.
- Warranties – This is a term within the asset purchase agreement that should there be a particular breach then the buyer will be entitled to damages. This ensures the seller provides the important information as required which may affect the buyer’s decision to buy the company as well as comfort to the buyer that they’re covered should any issues arise that were not disclosed.
Valuing a business for an asset purchase agreement
Valuing a business for an asset purchase agreement is a complex task that will often cause debate between the buyer and seller. There is no perfect valuation so there may be a difference in the perception of this value and it is up to the buyer to make an offer that the seller finds acceptable. As such it is strongly recommended that independent advice is sort after in the valuation of assets. There are several features that will be analysed to find this valuation:
- Historical financial results – If the company has a good set of accounts from past years which show a well managed cash flow and good profits this will be a good indicator of whether the business is a good investment.
- Profit trends – Aside from general good financial results it is important to see consistent profitability and even better an upward trend in profits year-on-year.
- One-off events – Certain year’s financial results may be skewed by a one-off event that is unlikely to repeat. The accounts should be studied carefully to ensure results are a fair representation of the usual trends. Such examples of one-off events could be a sporting/cultural event, supply issues or as recently experienced a worldwide pandemic.
- Supply and demand – As with the purchase of any product if the market is saturated with assets available to purchase then this will make it less valuable. Should there be a shortage of the particular asset then the seller will be able to demand a higher price.
- Staff matters – Any issues relating to the employees such as whether salary changes will be required after acquiring the business, pensions, staff relocation costs, redundancy and any potential savings as a result of this.
- Resale of assets – Profits from selling on any assets that were required to be purchased as part of the asset purchase agreement
- Rebranding – If integrating the acquired assets into an existing business how much will this cost?
It would be sensible to have more than one valuation of the business to find a good midpoint to begin negotiation. Each valuer will have its own methods and as such, it is important to not place too much weight on any particular valuation. They will likely use the following criteria/techniques when making their valuation:
- Return on investment
- Discounted cash flow analysis techniques
- Earnings multiple valuations
- Net asset valuation
Agreement to sell
Whilst it may seem obvious that the agreement implies that the seller is happy to sell and the buyer is happy to buy, the ‘agreement to sell’ is a key clause in the asset purchase agreement. Further to this, making the agreement implies that the seller has either a full or limited title guarantee.
Full and limited title guarantee implies that the seller has the right to make the sale and that the seller will do all it reasonably can to give the title it purports to give at its own cost. A full title guarantee implies that the sale is entirely free from all charges or adverse rights that the seller knows about or could reasonably be expected to know about whereas the limited title guarantee only provides this since the last sale and is not aware of anybody else doing so.
By these definitions, it would be in the buyer’s interests to attempt to secure a full title guarantee for the asset purchase while the seller would prefer a limited title guarantee to reduce their liabilities.
The effective time of the asset purchase agreement
Depending on the circumstances relating to the asset purchase agreement it may be beneficial for both parties to backdate the effective time of the deal which will be prior to exchange or the completion date. Usually the reason for this is to simplify accounts meaning that any profits after a particular date will be attributed to the accounts of the buyer.
Notwithstanding this, the seller is still liable for any taxes until completion and therefore may wish to have an indemnity from the buyer for tax due for the period between the effective date and actual completion or alternatively, that profits accounted for in this period will be net of tax when completing the asset purchase. As there is a time difference between the effective date and completion it may also be necessary to adjust the final price to account for any changes in assets such as the sale of stock, new debts etc.
Restrictive covenants in the asset purchase agreement
A useful clause in an asset purchase agreement is a restrictive covenant that would prevent the seller from competing against the buyer for a period after the completion of the sale. This will need to be tightly drafted to ensure there are no loopholes but just as important are not so restrictive that the seller cannot conduct business which is unlikely to impact the buyer which may be unenforceable. In any disputes, it is up to the buyer to justify the necessity of the restrictive covenants. Areas in which they can restrict are:
- Soliciting existing customers or suppliers
- Soliciting employees
- Geographical restrictions
Warranties and protection in an asset purchase agreement
To complete the purchase in an asset purchase agreement, the buyer will usually have to put a certain degree of trust into facts provided by the seller. To provide additional security the buyer can seek warranties to recover losses if the statements provided by the seller turn out to be false. This, therefore, provides a strong incentive for the seller to be full and frank with their disclosures. Such warranties will vary considerably depending on the nature of each asset purchase.
A court may see fit to award damages or rescind the contract if the warranty is breached. Rescission of the contract is normally possible if the buyer has not taken action to affirm the contract (e.g. sold on some assets) OR it is not possible to restore the buyer and seller to the position prior to completion OR an innocent third party will be prejudiced. For rescission, the buyer would have to show that the breaches are so fundamental that damages would be insufficient.
If the buyer has been induced into the asset purchase agreement via a misrepresentation by the seller then the following remedies may apply relating to the Misrepresentation Act 1967:
- Potential to rescind the contract
- Damages awarded by the court for innocent misrepresentation in lieu of the contract rescission
- Damages for negligent misrepresentation
- Fraudulent misrepresentation (deceit) can lead to damages extending to losses as a direct result of the asset purchase (as long as attempts have been made to mitigate loss)
- If a misrepresentation is repeated in the contract (e.g. a warranty) the contract may be rescinded
If a specific potential issue has been identified in the due diligence the buyer may wish to indemnify themselves from any losses that may arise from this issue. The indemnity would entitle the buyer to a payment should the identified issue come to fruition within the scope of the clause and so must be clearly worded. There will normally some provision that will prevent a double recovery should the issue be covered by both an indemnity and a warranty.
Limitation of seller’s liability
From a seller’s perspective, they will not want the liabilities in the asset purchase agreement to be indefinite so will limit this using the following limitations:
- Restriction to matters within the seller’s knowledge
- Prohibiting small claims
- Restricting the aggregate liability
- Time limitations
- Limiting the share of liability when there are multiple sellers
- Preventing double recovery
- Disclosing matters prior to the sale which may constitute a breach of warranty
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