What is an Asset Purchase Agreement?

An asset purchase agreement is the written agreement by which one company buys another company. Asset purchase agreements define the assets and liabilities to be sold. The buyer is purchasing whatever the two parties define as "the Business," including the rights to conduct this Business.

Because certain assets and liabilities can be excluded from the transaction, asset purchase agreements are widely used contracts. Stock purchase agreements, meanwhile, do not easily allow for the segregation of assets and liabilities between seller and buyer. Moreover, in a stock purchase the seller will typically survive, acting as an extension of the buyer. By contrast, in an asset purchase the seller will usually become a shell after the closing, existing only long enough to disperse the purchase price to the stockholders and to act as a repository of sorts against any financial claims that the buyer may have against the seller following the sale.

Assets can be nearly anything: office supplies, real estate, intellectual property, machinery, professional services. Liabilities often attach themselves to the assets and travel with them.

Often, these agreements have effective dates (when the agreement becomes effective and comes into force) and closing dates, later dates (days or weeks, sometimes longer) at which time the deal closes and the parties sign and exchange documents. During the period in between, with the deal all but assured, the seller will make final its financing arrangements for the purchase.

Much of the asset purchase agreement is concerned with defining and controlling behavior. In the seller's representations and warranties, it represents, among a host of things, that it has the authority to sell its asset; that the assets are of a value equal to the purchase price; and that it is not in financial or legal trouble. In today's world, the representation on the environmental disposition of the assets is often a very important and lengthy provision. Meanwhile, the buyer represents that it has the authority to buy the assets and that has disclosed everything necessary to consummate the deal.

To double-check these representations, the buyer may require pre- and post-closing audits, also known as due diligence. And as protection, both parties draft comprehensive indemnity provisions that look to account for one party's malfeasance or mistakes.

The sections on covenants and conditions precedent talk to the behavior of the parties. For example, the agreement may limit the parties' ability to discuss the deal publicly. Very often, the seller is constrained by a non-compete and a non-disclosure provision, so as not to compete with the buyer and thus make the buyer's purchase moot. Further, in the period between the effective date and the closing date, the seller is also obligated to carry on the Business in normal fashion, so as not to diminish the value of the Business.

Termination clauses allow for termination for a variety of reasons, including material breach, mutual agreement by the parties, a government action stopping the deal, undue delay in closing, or unsatisfactory due diligence.

Sellers have learned to gain an advantage through a bifurcated purchase price. That is, a certain percentage will be paid at the closing, while the balance will come perhaps six months or a year later. In the intervening period, the seller has the chance to outperform expectations. By way of an earn-up provision, the seller may earn more than the stated purchase price, a mutually determined bonus, so to speak.

All in all, the widespread use of the asset purchase agreement means that it has been well tested and well received. For the sale of a business, it is certainly the best and easiest option for both parties.