When a company is being sold, the selling party usually has two options for selling their business. The sale can either be structured as an asset purchase, or it can be structured as a stock purchase.
When two parties decide to choose the asset purchase structure, they have to agree to an asset purchase agreement that contains the key details of the asset purchase. It is in the best interest of both the buyer and seller to use a formal asset purchase agreement because the agreement specifies various aspects of the purchase.
Asset purchase agreements are still not something a business owner has to draft very often. Not to mention there are a lot of negotiations involved in the asset purchase agreement which further complicates the process.
If you are trying to sell your business by structuring it as an asset purchase then you need to know what the asset sale process is all about and how you can negotiate the terms of the agreement. This article will help you in negotiating the asset purchase agreement and explain everything you need to know about the asset purchase process, so read on.
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What exactly is an asset purchase agreement?
An asset purchase agreement comes into play when a company decides to sell its assets to a buyer. An asset purchase is usually an option when a company either can’t issue stock or wants to get rid of some assets by selling them.
Unlike a stock purchase where a company buys another company entirely along with all its assets and liabilities, an asset purchase involves selling specific assets. During an asset purchase, a company can choose what assets it wants to sell and the buyer can also choose what assets they want to purchase.
The agreement used to specify what assets are being sold or bought during the purchase of an asset is the asset purchase agreement. This agreement can be used for any type of business asset sale, however, some common assets that are sold during asset purchase transactions include machinery, plant, goodwill, intellectual property, licenses or contracts, and stocks.
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Key components of an asset purchase agreement
Now that you know what an asset purchase agreement is, it is important to familiarize yourself with the various terms that are commonly used in an asset purchase agreement. So without further ado, here are some key parts of an asset purchase agreement.
Recitals are usually the first portion of an asset purchase agreement, and it contains information about the buyer and seller and the date of signing the agreement. Recitals also contain an acknowledgment by both parties for the asset purchase agreement.
The definitions refer to terms that are going to be repeated several times throughout the agreement. An asset purchase agreement may contain words such as assets and liabilities, or buyer and seller, multiple times. So instead of defining the word every time, the definitions section defines the word and both parties can refer to this section to understand the meaning of different words.
This section of the agreement lists down the items that are being purchased as a result of the deal and any exclusions that aren’t being sold. Next, you will find the structure of the deal, price of assets, liabilities associated with the assets, terms of the payments, and so on. If there are a lot of items being purchased this section may get lengthy.
This section of an asset purchase agreement is pretty self-explanatory. Closing terms refers to any requirements that need to be met to finalize the purchase of the assets between the buying and selling party.
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Warranties are any additional sureties that are usually given by the seller to the buyer during an asset purchase transaction. This section is especially important for the buyers because it can serve as the basis of legal action in case the seller gives baseless warranties.
Covenants are sub-agreements under the broader asset purchase agreement that are used to cover matters related to the actual assets purchase transaction. For example, if the buyer wants to make sure the seller doesn’t directly compete with them for a certain period of time they can specify it in a separate covenant.
This section is meant to protect the interests of both the buyer and the seller. Indemnification contains the penalties that both parties may have to pay should a dispute arise. Even if an asset’s purchase is going smoothly, there is always a risk that some disputes may arise down the road. Having indemnification as a buffer can come in handy in case of any unexpected circumstances.
Asset purchase agreements are recognized by state law. However, each state may have different laws that govern asset purchase agreements. Therefore it is important to mention the state or federal laws that govern the agreement.
In case one of the parties in the agreement is from another country international laws may be involved in the agreement and the governance section will also include the international laws that govern the agreement.
This section is meant to maintain the legality of the agreement and make sure there is no confusion about the legality of the agreement. Not to mention the information contained in the governance section improves the legitimacy of the agreement for both parties involved.
This has to be the most crucial part of the agreement as it requires the dated signatures of both the buyer and seller. Once the signatures are done the agreement is in full effect and the terms of the agreement are applicable.
These are just some major components of an asset purchase agreement and since each asset purchase is going to have different requirements the complexity of the agreement may also change accordingly. Not to mention there are other agreements and contracts that may be interlinked with the asset purchase agreement to keep everything in order.
How can you negotiate an asset purchase agreement?
As mentioned earlier each asset purchase comes with its own set of requirements and complications so the negotiation process for each agreement is also going to vary. With that being said, there are some general negotiation tips that can be applied to almost every asset purchase agreement to help carve out a favorable agreement. The negotiation tips we are going to share are mostly going to go in the favor of the seller.
Here are some ways you can negotiate an asset purchase agreement as a seller:
Push to transfer liabilities
When a seller is negotiating the asset purchase agreement with a buyer, their goal should be to transfer as much liability as possible. Think of it this way, if you have a plant building that you owe the lease for, your goal should be to transfer the lease for the building if you are selling the equipment.
This will make sure that you don’t end up with a liability that will continue to cost you even after you sell other relevant assets. In fact, one of the most time-consuming aspects of negotiating an asset purchase agreement is the transfer of liabilities.
So as a seller you should be focused on ensuring the transfer of most if not all the liabilities associated with the assets.
Specify the individuals responsible for negotiations
When you are going into the negotiation phase for the asset purchase agreement you should know that the negotiations can last a long time. Therefore it can be difficult to keep track of the negotiations unless the same individual or individuals are handling the negotiations from day one.
This is why it is important to specify who will be responsible for negotiations before entering the negotiations phase.
It is also possible that you may not have negotiation experts in-house and in such a case you can always hire M&A advisors that specialize in asset purchase agreement negotiations. Not only will assigning the role of the negotiator to an individual or a team add accountability into the mix, but having an expert handling the negotiations can produce a more favorable agreement.
Perform your homework
Just like any other business matter, you can’t get into asset purchase agreement negotiations without proper preparation. It is important to have a strategy when going for each negotiation session, and you should keep revising your strategy to give your business an edge.
Having a strategy and knowing what counter offers you may get from the buyer’s negotiation party will help you gain an upper hand. Ideally, your negotiations team should consist of a negotiator and an observer. The observer’s job is to identify patterns or tactics that the other party is using and help come up with strategies for future negotiation sessions.
Push for a stock sale
Keep in mind that asset purchase structure mostly benefits the buyer as the seller may not get special tax treatment as a result of assets purchase. So if you think that going with an asset purchase may put you at a disadvantage tax-wise, then it is best to try and steer the buyer towards a stock purchase instead.
So there you have it, even if each asset purchase agreement is unique these negotiation tips can help the seller exponentially if applied correctly. Negotiations are all about trying to get the most out of the deal and these tips are sure to give you an upper hand.
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Assets purchase or equity purchase which is the better option for sellers?
As mentioned above, while an asset purchase has benefits to offer for buyers, it is not always favorable to sell assets for sellers. The benefits of asset purchase for sellers can come in the form of a higher price on assets. Not to mention sellers can keep the rights to the business even when they are selling business assets. However, that is where the benefits of an asset purchase seem to end for sellers.
The sellers may not be able to make use of the leftover assets after the buyer cherry-picked the assets that they needed to buy. Liquidating the leftover assets can be time-consuming and may not fetch a good return. In addition, sellers may also have to pay higher taxes in case of an asset purchase as opposed to a stock purchase. On the other hand, if the seller goes with a stock purchase, their proceeds from the purchase are taxed at a lower rate thanks to special tax treatment. Not to mention stock sales exempt the seller from any liabilities that may arise in the future. So when you compare the pros and cons of asset purchase and stock purchase, it is clear that sellers should prefer to go with the equity purchase if possible.
In addition to having drawbacks for sellers, asset purchase also comes with some drawbacks for the buyers. This is why asset purchases are usually not preferred by shareholders and they usually prefer stock purchases. The reason why asset purchases may not be the best option for the buyer is that they come with liabilities that are transferred by the seller and the taxation can be complicated for asset purchases.
Asset purchases are not as common as stock purchases. However, they are always an option in case a company doesn’t have issued stock or the buyer is interested in only the assets. By applying the best practices for negotiating an asset purchase agreement, you can maximize the benefits you receive from the purchase as a seller.
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