A First Time Business Buyers’ Guide on What Features to Look For
When you’re buying a new business (or license, asset, liability, property, piece of intellectual property…the list goes on!) you will be asked to make an Asset Purchase Agreement.
Depending on what you’re buying, some asset purchase agreements will be simpler than others. However, for alternative assets, they can also get very complicated.
So, we’ve put together this guide to help you understand asset purchase agreements. We’ll take you through what they are, how they work, why you need one, and the features you should look for as a first time business buyer.
What is an asset purchase agreement?
An asset purchase agreement, also known as a purchase deal or purchase contract, sets out the terms under which one party will take control of an asset (or assets) from another party.
That isn’t as complicated as it sounds.
Let’s say, for example, that you want to purchase the IP (Intellectual Property) rights to something. A character, a phrase, some artwork – whatever it is, you want to buy the right to use that IP in order to sell products.
Because selling IP rights is not as straightforward as a direct purchase (in which a customer buys an item directly from a vendor, with no strings or conditions attached), an asset purchase agreement is required. The asset purchase agreement will set out exactly what you must, what you can, and what you cannot do with the new product.
For example, if you are buying the IP rights to a certain design, the asset purchase agreement may state that you can use this design on your merchandise, but you cannot use it in controversial ways or on controversial products. It will outline who owns what, and the limits of the rights extended.
What’s the difference between an asset purchase, an acquisition, and a merger?
Asset purchase agreements may form part of acquisition or merger agreements, but they’re not exactly the same thing.
With a merger or acquisition, one company takes full or almost full control of another – including all of the latter’s assets. With an asset purchase agreement, one company is taking on only one (or some) of a company’s assets.
Acquisitions and merger agreements may be ‘bigger’, but they’re often more straightforward. There are fewer details to iron out. It can go from a very simple proposal drawn up by Proposify competitors to a signed deal very quickly.
An asset purchase agreement is less significant in terms of volumes traded, but it can be more complicated to figure out who retains what rights. For this reason, asset purchase agreements may take longer to negotiate.
Why do I need an asset purchase agreement?
Because complicated transactions, such as selling your online business, tend to involve a lot of moving parts, you need an asset purchase agreement to ensure that everything (and everyone!) is fully covered.
Asset purchase agreements also give both parties the flexibility to negotiate terms and work out the best deal all round.
Before we go any further, we should strongly advise you to get help from a trained legal professional when drawing up your asset purchase agreement. With any purchase or investment it is important to have a due diligence checklist – but this is especially vital for an asset purchase.
A legal professional will know how to make the agreement airtight, and can also advise you on ways to protect yourself and get the best deal possible out of your negotiations.
What should I look for in an asset purchase agreement?
Exactly what you need in an asset purchase agreement will differ depending on your circumstances. But, in general, an asset purchase agreement should have the following parts:
This section sets out the parties involved in the asset purchase – i.e. the buyer and the seller. It should provide names and details of both the individuals and the businesses involved. For clarity’s sake, it’s often a good idea to add contact information to this section.
This section makes sure that everybody knows exactly what’s being talked about. It defines any terms that might be unclear. So, if an asset has a unique name, this section will state that name and clarify that it refers to that asset.
For example, if one party is selling a blog called ‘Best International Recipes’, or BIR for short, the Definitions section will state that ‘Best International Recipes’ and ‘BIR’ refer to the same asset (the blog).
If multiple assets are being traded, you may want to make things simpler throughout the agreement by referring to them as ‘Asset 1’, ‘Asset 2’ etc. In this section, you will define exactly what ‘Asset 1’, ‘Asset 2’ etc are.
This describes the asset or assets being traded. Sometimes, additional information about each asset might be attached to this section in an appendix.
This section may also detail whether the assets are:
- Tangible: physical items
- Intangible: non-physical items like logos, trademarks, designs, or other IP
- Current: items that can be turned into cash within one year, such as inventory and prepaid expenses
- Fixed: items that continually generate income but may not easily be converted into cash. Examples of fixed assets include land, buildings, and vehicles.
This section states the price for each asset, and the total purchase price. It is best to be completely clear and unambiguous about this.
This is where things can get complicated. The additional covenants section sets out other terms and conditions you and the seller have negotiated.
Let’s say that you are buying the rights to a web design proposal template. The ‘additional covenants’ section might detail where you can use this template, which trademarks or watermarks it must bear, who can use it, how it can be used, and so on.
Other examples of additional covenants include:
- The timeframe of asset transfer
- Non-competition agreements
- Confidentiality agreements
- Use of trademarks/copyrights/patents
- Financing agreements
It can help to add a Letter of Intent as an appendix to this section. What is a Letter of Intent? Basically, it sets out the official start of negotiations, and the conditions under which they are occurring. It can be useful to clarify each party’s initial position as negotiations go on.
The ‘Additional Covenants’ section can go on for several pages, and may look intimidating when first set down. But it’s worth going into as much detail as possible.
Here, each party sets out how much responsibility they will bear for the assets traded. Even if you trust your negotiation partner implicitly, it’s still worth clarifying this.
For example, the seller may give the buyer a warranty that the asset is in good working order, and that they will refund or replace it if it stops working.
Similarly, the seller may disclaim any future responsibility for the asset, and the buyer will confirm that it (and anything generated by it) is solely their responsibility from the date of purchase.
Again, it is worth spending some time getting this section perfect. It could be critical if things go wrong down the line.
The indemnification section is designed to add protections for selling a business, so that both you and the other party have legal recourse in case things go wrong. Following on from the responsibilities and disclaimers set out in the previous section, it outlines legal protections and ramifications if any of these agreements are breached.
Usually, this section will state that the party breaching the covenant must ‘indemnify’ (compensate) the other party.
Breach of covenant provisions
This section sets out exactly what a breach of covenant might look like, as well as its potential effects. This is another section that can get pretty lengthy, but it really is worth ironing out all the details.
This section may also lay out how progress and quality is tracked. This is increasingly common where the asset is data-based. For example, the breach of covenant provision section may stipulate that data performance is to be tracked, and the performance parameters which constitute a breach of covenant.
Having identified ways in which covenants might be breached, this section may also detail how the breaching party must indemnify the other party. Often, however, this will have been covered in the indemnification section.
Requirements before closing
This section details the things that need to happen before the sale can complete. For example:
- Repairs or upgrades to assets
- Third party approval
- Financial agreements
- NDA signatures
The signatures are what make the agreement legally binding, and enforceable.
Every party should sign and date the signatures section. It’s also a good idea to print each party’s name, for the sake of legibility and clarity.
Start on the right foot with an asset purchase agreement
Asset purchase agreements may not always be right for you. Depending on your circumstances, you may find them too complicated and/or time-consuming to draw up.
However, for more complicated asset purchases – NFTs and IP, for example – an asset purchase agreement is worth doing. It ensures that both you and the seller are on the same page throughout the process, and protects you in case things go wrong.