Agreements are a key component of any corporate transaction, and mergers and acquisitions are no exception. However, since the majority of acquisitions take place based on a stock purchase basis, buyers and sellers are often unaware that they have the option to buy and sell specific assets.
Asset sales take place using an asset purchase agreement or APA, and this agreement is beneficial for both parties involved in an asset purchase. Businesses can sell or buy tangible as well as intangible assets using an APA while protecting the interests of both parties involved.
There is a lot of confusion about APA and asset purchases in general because they are not as widely used.
Not to mention, each asset purchase or sale will require both parties to negotiate its terms, which makes an APA even more difficult to understand. However, the benefits an APA has to offer make the effort required for understanding the agreement worth it. So if you are someone who wants to learn more about an APA and everything associated with this agreement, then keep reading.
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What is an APA, and who is it meant for?
Before we learn how an APA works, we have to understand what this agreement is all about and who can use it. As the name suggests, the purpose of an asset purchase agreement is to govern the transfer of assets and their ownership between the buyer and seller. The asset purchase agreement contains terms that both parties have to agree on in order to legally transfer the assets.
The buyer and seller roles are clearly specified in an APA to avoid any confusion about who owns the assets once the transfer of assets is completed. So the more thorough an APA is, the lower the chances of any loopholes in the asset purchase process.
An APA also contains terms that govern the post-purchase phases and who will be responsible for the liabilities associated with the assets being sold. Both buyers and sellers need the legal protection that comes with an APA, as this agreement prevents either party from backing off from the terms specified in the contract.
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What assets can be sold using an APA?
An APA can be used to sell both tangible and intangible assets that a company owns. Keep in mind that as long as the seller has verifiable ownership of an asset, it can be sold to a buyer along with any possible liabilities associated with the asset.
With that said, here are some examples of tangible and intangible assets that can be sold with the help of an APA.
Tangible assets: Some companies either own most or all of their assets in the tangible form. Any tools or equipment used in the manufacturing process are tangible assets and can be sold using an APA. Manufacturing tools including machines, computers, are all examples of tangible assets.
Intangible assets: Intangible assets are the complete opposite of tangible assets because they don’t exist physically. However, they still hold significant value and may be sold using an APA. Some examples of intangible assets that you can buy or sell using APA include trademarks, brand names, logos, and copyright. In the case of an intangible asset sale, the rights to the intangible asset are transferred.
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What are some technical terms of an APA?
An APA is not a standardized document and while you can find templates for an APA, these templates need to be filled with information that is unique to an asset purchase. It goes without saying that asset purchase agreements are essentially a collection of some terms and conditions that need to be met in order for the asset purchase to be complete.
If you have previously been a part of a merger or acquisition, you should be familiar with some terms of asset purchase agreements, such as due diligence. However, there are some APA related terms that are unique to this agreement, here is a list of all of these key technical terms:
Letter of intent
Also known as LOI, the letter of intent is the section in an APA that is concerned with listing down the objectives of the buyer.
The letter of intent is the most important negotiation tool of the asset purchase process because unless the buyer’s intent letter is agreed upon by both parties, the asset sale can not commence.
Due diligence is an important part of any merger or acquisition, and asset purchases are no exception. The seller’s warranties on the assets and liabilities being sold will be included in the asset acquisition agreement. And the buyers should spend a decent amount of time performing due diligence about the seller and the assets that they want to buy.
An APA will also help determine what happens to the employees of the company that is selling its assets. Whether the employees who were in charge of the assets that the seller is selling will be employed by the buyer, or whether the seller will remain liable to pay salaries and other benefits to the employees.
Indemnifications are any penalties that both the buyer and seller agree upon in case either party doesn’t fulfill the terms of an APA.
The indemnification is there as a deterrent to prevent any misconduct or breaches of the agreement. So when you are drafting an APA, it is essential to pay close attention when putting together indemnifications for the agreement.
Another term you will almost always find being used in an APA is a non-competition agreement. This agreement is a subcontract within the broader asset purchase agreement that prevents the seller from competing against the buyer directly after the asset purchase.
The taxation section is going to be part of all asset purchase agreements, and it will specify how the seller will report the gains from the asset sale.
Third-party permissions are used to make sure that any third party that has a stake in the assets being sold doesn’t object to the transfer of the asset’s owner.
Third parties that the seller may need permission from before selling an asset include any lessor or any party that has an agreement related to the assets in question. It can take a long time to get the necessary third-party permissions for all of the assets being sold, so sellers must start this process early in the asset sale process to prevent delays.
An APA is a legally recognized and enforceable agreement. However, it is important to specify what laws govern the agreement in order to make it enforceable.
There is a governance section in every APA that lists down any state, federal or foreign laws that may relate to enforcement of the agreement in question.
These are some basic terms that are part of most asset purchase agreements. However, drafting an APA from scratch requires legal and corporate expertise. So if either party (buyer or seller) lacks the experience and ability to draft an APA, it is best to seek professional help from an advisor to make sure you have a functional agreement.
What happens if any party breaches the asset purchase agreement?
As mentioned earlier, an APA is going to list down all the regulations that govern the agreement, as well as any penalties that arise in case of a breach. So should a breach of any of the terms of the agreement occur, the party that made the breach will have to face the consequences.
However, the exact implications of breaking the terms of an APA may vary from case to case. That is where the indemnification section of an asset purchase agreement comes in. The penalties that the breaching party may have to face are going to be specified in the APA itself, so the course of action in case of a breach is clear.
Some legal actions that are taken in case of a breach of the APA include:
In case one party is found to be going against the terms of the APA, the other party may approach a court to stop the breach from happening. However, this step can only be taken if there is a risk of a breach or in case of an ongoing breach.
The court will interfere and force the party that is in breach of the agreement to follow through with the terms of the agreement.
Most APA specifies a monetary penalty that needs to be paid by the party that breaches the agreement.
With that being said, in most cases, a breach may not be detected until it has occurred or may arise after the sale has been closed. That is why it is important for buyers to get warranties for the assets being acquired for a set period of time. The warranties will help in holding the seller accountable if any aspect of the sale was misrepresented. Similarly, sellers should make sure to add provisions in the asset purchase agreement that prevents the buyer from missing any payments for the asset.
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What are the advantages and disadvantages of an APA?
An APA is an essential contract, which means an asset purchase shouldn’t be commenced without drafting an APA first. So it goes without saying that an APA has a lot of benefits to offer, as explained in the previous sections. However, this doesn’t mean that an APA doesn’t come with its fair share of cons. Let’s take a look at some of the advantages and disadvantages of asset purchase agreements:
Benefits of asset purchase agreements:
Just like any other business contract, an APA can keep everything in order during an asset sale. With that said, there are additional benefits associated with an APA, including:
Ability to specify assets and liabilities
Consider a situation where a buyer wants to acquire specific assets from the target firm, or the seller wants to sell some assets while retaining others. It can be difficult to specify which assets and liabilities are a part of the sale unless they are listed in a formal agreement.
That is where an APA comes in, as it prevents buyers from acquiring assets the seller is not willing to sell, and it prevents sellers from transferring any liability that the buyer doesn’t want. The ability to specify specific assets to be sold or bought is the major reason why APA should be a key part of an asset purchase process.
Ability to specify the market value of the assets
Buyers can use an APA to specify a purchase price for the assets that represent the market value of each asset. This means that the buyer can get higher tax savings thanks to higher depreciation on the assets they acquired in future
Disadvantages of asset purchase agreements:
An APA may become more than just a time-consuming contract in some cases due to the disadvantages associated with it. Some disadvantages of an APA include:
Each asset needs to be transferred with detailed rules
An APA requires the sellers to take permission from all of the third parties that are associated with the assets being sold, which is a time-consuming task.
Since buyers can choose to avoid acquiring some liabilities using an APA, it may leave the seller with insufficient capital to pay off those liabilities after the sale.
Asset purchase agreements may seem complex at first glance. However, now that you know the basics of an APA you are in a much better position to enter an asset purchase process.
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