The Asset Purchase Agreement, Section by Section
A walk through each part of an asset purchase agreement, what it says, where sellers get caught, and which sections are worth negotiating before you sign.
Words by
Matan Michael
When the first draft of the asset purchase agreement arrives, it is usually long, and it reads as though it was written by someone who expects to be disappointed. That is the buyer's attorney doing the job. The document is a template with your business poured into it, and most of its sections are routine. A handful decide how much money you keep and how much risk you carry after closing. Knowing which is which lets you spend your attention and your attorney's hours where they count.
What follows goes through the agreement in the order it is normally laid out. Your attorney will have the final say on wording and on anything that depends on your state.
The opening pages: parties, definitions, and what is being sold
The first page names the buyer, the seller, and sometimes you personally as a party to certain promises. Look at who the buyer is. A buyer often forms a new company for the purchase, and a new company has no history and no assets beyond what it is paid in. If the buyer is a new entity, ask how the obligations after closing, such as the seller note or the earnout, will be backed up.
Then come the definitions, which people skip. Terms like "Business," "Excluded Assets," "Indebtedness," "Working Capital," and "Material Adverse Effect" are defined here and used throughout. A change to one definition changes every section that uses it, so a short word in the definitions can be worth more than a long argument in the body.
The purchased assets section lists what transfers. Equipment, inventory, customer lists, the phone number, the website and domain, the trade name, contracts, permits to the extent they transfer, and goodwill, which is the value of the business beyond its physical things. A well-drafted list names categories and attaches a schedule of specifics. The excluded assets are usually cash, personal vehicles, your insurance policies, tax refunds, and anything else you agree to keep. If you want to keep something, such as a piece of equipment you are fond of or a domain name tied to your family, write it into this section. An item that is not listed as excluded is probably going.
What the buyer takes on, and what stays with you
An asset sale is popular with buyers because they can choose which obligations to assume. Assumed liabilities are normally the ongoing contracts and leases going forward, and sometimes ordinary trade payables up to the closing. Everything else stays with the seller. That means old taxes, lawsuits that arose before closing, and debts to lenders. Our post on asset sales versus stock sales explains why the structure matters to both sides.
For a seller the excluded liabilities are the cost of the structure. You remain responsible for them after the sale, and the buyer will often ask you to promise in writing to pay them. Make a list of what you still owe on closing day and decide where the money will come from. Most of the time it comes out of the proceeds at the table through payoff letters, which your attorney or the closing agent arranges.
The price and how it is divided
The purchase price section covers the amount, how much is paid at closing, how much is escrowed, any note, any earnout, and any adjustment for working capital or inventory. Read it with a calculator beside you. Owners sometimes find that the headline number in the letter of intent has changed in form, with more of it deferred or conditional than they remembered.
This section also contains the allocation. The buyer and seller must agree how the price is divided among categories of assets such as equipment, inventory, goodwill, and the non-compete, and both report that split to the IRS on Form 8594. The split matters because different categories are taxed differently for the seller. Goodwill is usually taxed more favorably than equipment that has been depreciated, and a payment for a non-compete is generally taxed as ordinary income. Buyers prefer more of the price on equipment, where they can write it off sooner. Your tax adviser should look at the allocation before the agreement is signed, since changing it afterward is difficult and both sides have to report the same numbers.
Closing mechanics and what each side hands over
Short but useful. This section sets the date, the place, and the list of things each side delivers: the bill of sale, assignments of contracts and the lease, payoff letters, the escrow agreement, and officer certificates. If any item on the list needs a third party, such as a landlord who must consent to an assignment, put a name next to it in your own notes and begin early. See the lease is part of the deal for how that tends to go.
Pay attention to any sentence that requires you to deliver a result. "Seller shall deliver landlord's consent" is a promise you can break by factors beyond your control. "Seller shall use reasonable efforts to obtain landlord's consent" is one you can keep. A small change in a verb can move a closing risk from you to the buyer.
What you are promising: the seller's representations
These are the statements about the business that we discuss at length in our post on indemnification. This section tends to be the longest. It covers organization and authority, financial statements, taxes, title to assets, condition of equipment, contracts, employees, litigation, compliance with laws, insurance, and the absence of undisclosed liabilities. A closing section near the end often adds a catch-all that says nothing the seller said contains a false statement or leaves out something needed to make it not misleading. Resist that last one if you can. It turns every careful, qualified statement into a flat promise.
Read each statement as a question you must answer truthfully. If you cannot, the answer belongs on a disclosure schedule. Time spent here is time you will not spend in a dispute later.
What the buyer is promising
The buyer's statements are much shorter. They are an entity in good standing, they have the authority to sign, and they have the money. Sellers glance at these and move on, and that is a mistake when part of the price will be paid later. Ask for evidence of funds, or of the lender's commitment, and ask what happens to your deal if financing does not arrive. An SBA lender's timetable can run longer than the closing date in the contract. Our post on SBA loans in acquisitions covers that.
Promises about the time before and after closing
The covenants are promises to do or not do things. Before closing, you will run the business in the ordinary way, keep your key employees and customers, keep the insurance, and avoid big changes without the buyer's consent. These clauses are reasonable in principle. They become a problem when they are written so tightly that you need permission to hire a part-time employee or buy a replacement part.
After closing there are usually three. A non-compete and non-solicit, covered in our post on non-compete agreements, which varies by state and by the reasonableness of its scope. A transition services promise, where you stay for some period to help, described in how long you stay after selling. And a promise to keep the buyer's information confidential, including the terms of the sale. These are valuable to the buyer because the goodwill they are paying for would not hold if you opened across the street.
Employee matters also sit here. The buyer usually offers jobs to some or all of your staff, and the agreement says who pays accrued vacation and what happens to a retirement plan. Check what you have promised your employees against what the contract says.
The conditions before anyone has to close
Conditions are the tests for closing. Each side's statements must still be true, each side's promises must be kept, the consents must be in hand, no lawsuit may be pending to stop the deal, and nothing disastrous may have happened to the business. The buyer will often add a condition that financing be received, a condition that a satisfactory lease be signed, or a condition that key employees accept offers.
Every extra buyer condition is an exit door. A condition that depends on the buyer's satisfaction, with no standard attached, comes close to an option to walk away. Push to have those conditions tied to specific facts, and push for any financing condition to expire on a date. A seller who has pulled the business off the market for ninety days should not be left waiting on a loan that was never underwritten.
Indemnification, termination, and the boilerplate
Indemnification is the part that settles who pays after closing and is worth its own read. We cover it in our post on indemnification in plain language. Termination clauses say when either side can cancel, and whether the buyer's deposit comes back. The boilerplate, meaning which state's law applies, where disputes are heard, notices, assignment and amendments, looks dull. Which state's courts hear a dispute can change the cost of bringing a claim, and a clause that lets the buyer transfer the agreement to someone else may leave you owing promises to a stranger.
Where to spend your time
Of everything above, the sections that tend to move money are the definitions, the excluded assets, the price mechanics and allocation, the seller's statements and schedules, the closing conditions, and indemnification. Ask your attorney to mark those up first and tell you in plain words what each one costs you in the worst case.
You can also help before the first draft shows up. Gather the lease, the equipment list, the contract files, the payoff figures for every loan, and the tax returns. An agreement is easier to finish when every schedule in it can be filled in from a folder that already exists.
