Twelve things to consider when drafting an asset purchase agreement

2016 has been a year in which many business purchase and sale transactions have occurred. There appear to be a few reasons for this. Generally, business has improved significantly since the end of the Great Recession. This has caused the values of companies of all types to increase. Those that may have desired to sell their businesses during the recession have waited for values to return to or surpass pre-recession levels. And, there is significant funding available in the marketplace. Financial institutions locally and around the country are anxious to loan money for transactions that make financial sense.

There are many structures and tax considerations involved in the purchase and sale of a business. Some are more complex than others. In this column, we cover one of the more basic of transactions – the purchase and sale of assets of a business.

Whether you’re a seller or a buyer, the following sets forth many of the issues involved in negotiating and drafting an asset purchase agreement (APA) for the purchase and sale of a business. Addressing at a minimum the issues listed below will help each party obtain what they expect from the transaction with less likelihood of issues arising post-closing.

Purchase price. What is the purchase price and what does it include? Is the purchaser assuming certain debts of the seller and is the value of those debts included in the purchase price?

Payment. Is the price being paid in cash or an ownership interest in the purchasing company? Is the purchaser paying all cash at closing with some combination of equity and borrowed funds being used to fund the purchase price? Is the seller willing to “carry back” a certain amount of the purchase price to be paid by the purchaser over time? If stock is received for all or part of the purchase price, is it registered under state and/or federal securities laws or is this stock subject to an exemption from securities registration making it freely tradable?

Closing price adjustments. The purchase price may need to be adjusted at closing based on the performance of the business as set forth in closing date financial information. It is often the case that a purchase price will be adjusted for working capital, value of net assets, balance sheet adjustments, trailing revenues and EBITDA (earnings before interest, taxes, depreciation and amortization).

Earn-out. It is not uncommon for the seller to be paid a portion of the purchase price post-closing, based on the performance of the business after closing. The basis for these post-closing contingent payments must be carefully considered. Covenants should be included in the APA that clearly define the basis on which these payments are to be calculated. Earn-outs are a source of frequent litigation after closing.

Taxation. The parties should be concerned with characterization of the transaction for tax purposes. Is there a way to characterize the transaction in a tax-deferred manner? Are there tax planning opportunities around asset basis and existing net operating losses? The allocation of the purchase price, among the various components of the business, will determine the portion of the purchase price that the seller can treat as capital gains with a more favorable tax rate applied.

It Is important to note that in Washington, personal property tax is due on the closing of an asset purchase transaction in which the sale closes the following calendar year. These taxes are due to the county in which the transaction occurs within 30 days of closing.

Purchase price holdback. Will the purchaser require a certain amount of the purchase price to be held in a post-closing escrow to protect the purchaser from inaccurate financial information provided by the seller and violation of representations and warranties relied on by seller? As with earn-out provisions, this is an area that is ripe for a later disagreement. The terms of the holdback must be carefully negotiated, clearly understood and properly included in the APA.

Indemnification provisions. These are typically included for the parties to protect each other from post-closing breaches of representations and warranties made in the APA and from other breaches that arise. Consideration should be given to limitations placed on these indemnification provisions as to time and dollar amount.

Non-competition agreements. The purchaser may wish to consider obtaining non-competition agreements from the seller and the seller’s key employees to protect the enterprise value of the assets purchased.

Employee issues. Early in the negotiation process the seller and purchaser should determine whether or not seller’s employees will be employed by the purchaser post-closing. If not, the seller will need to address the payment of salary benefits and severance to existing employees. And, for businesses with 100 employees or more (and in some cases as few as 50 employees), compliance with the Worker Adjustment and Retraining Notification Act (WARN Act) must be reached. This requires, among other things, as much as 60 days of notice to employees about an upcoming mass layoff.

If the buyer is to retain all or a portion of the seller’s employees post-closing, negotiation of responsibility for vacation, paid time off, medical and dental insurance, retirement plans and any other seller-provided fringe benefits, must occur and be included in the APA.

Third-party approvals. There are often contracts, leases and other agreements utilized by the selling company that may require approval to assign to the purchaser. These approvals generally have a long lead time and should be addressed early in the process of putting the transaction together.

Due diligence. A sophisticated buyer will engage in a high-level of due diligence on all aspects of the seller. Timeframes for this activity should be incorporated into the APA and corresponding representations and warranties from both parties should be included in the APA.

Fees. Generally, each party to a transaction bears the cost of their own legal and accounting representation. There may be fees for consultants, appraisers, brokers and others as well. Sharing of these fees should be agreed to in advance and documented in the APA.

This article addresses the basic issues involved in an asset purchase and sale transaction. Each transaction is different and may require the negotiation and inclusion of other provisions. The parties’ legal counsel and accounting advisors should be consulted very early in the process.

Steve Horenstein is a managing member of Horenstein Law Group PLLC. He practices law in areas that include business, real estate, land-use and government relations.