Asset purchase refers to the process involved in the buying of a company’s assets. Assets are resources owned by an individual, company, or corporation, both tangible and intangible, for the purpose of yielding profit.
Simply put, assets are things, either physical or not, that provide or are expected to provide benefit for the owner in the future.
There are many reasons while a company or individual may want to purchase assets. During an acquisition or just the startup of business are good reasons for companies to buy assets. The process of buying assets for a startup company or expanding a company is different from when one is acquiring another company as has to pick which assets to buy and which not to buy.
This involves assets like intellectual property, equipment, facilities, inventory, or stock in case of a Limited Liability company and vehicles, amongst others.
An asset purchase agreement (APA) is an agreement between a buyer and a seller that finalizes terms and conditions related to the purchase and sale of a company’s assets. It’s important to note in an APA transaction, it is not necessary for the buyer to purchase all of the assets of the company. In fact, it’s common for a buyer to exclude certain assets in an APA. Provisions of an APA may include payment of purchase price, monthly installments, liens and encumbrances on the assets, condition precedent for the closing, etc. An APA differs from a stock purchase agreement (SPA) under which company shares, title to assets, and title to liabilities are also sold. In an APA, the buyer must select specific assets and avoid redundant assets. These assets are itemized in a schedule to the APA. The buyer in a SPA is purchasing shares of the company. In this case, itemization is not necessary due to transfer of company’s ownership occurs as is. The APA is the legal mechanism for executing a corporate merger or acquisition.
The oil and gas industry does not distinguish between an asset and stock purchase in naming its related purchase agreement. In this industry, whether purchasing assets or stock, the definitive agreement is referred to as the purchase and sale agreement (PSA).
What is an Asset Purchase Agreement?
An APA, (asset purchase agreement) is when a buyer makes an agreement with a seller concerning assets being sold, along with the conditions involved.
It’s like a deal outlining the assets that the buyer in interesting in buying, the worth, and their selling conditions. This agreement is meant to prevent discord, future lawsuits, or claims of ownership and is usually a legal mechanism for processing mergers or acquisitions.
Apart from the exception of the oil and gas industry, all other companies use asset purchase agreement when buying into a new company. In an asset purchase agreement, there is a clear distinction between assets and stock that the Oil and Gas industry lack.
Why do you need an Asset Purchase Agreement?
When purchasing an asset, Asset Purchase Agreement plays a big role in determining what the assets are and controlling the purchase process. It makes sure that the purchaser has all the right authority to buy that particular asset, and the seller has the right to sell it. It answers questions about the worth of the assets and financial standing of both the buyer and seller.
But there are some pros and cons in the context of a merger or acquisition transaction. In an equity acquisition, the buyer buys a company along with all its assets. This also means that it inherits its liabilities as well. With the APA, the buyer gets to sit down with the seller and comb through all the assets and pick the ones that are most likely to generate the most income while forgoing some, if not all, the liabilities.
This whole issue of APA when buying assets may, however, bring about many changes in control problems. Like when an asset is changing hands, there is also a hand-down of control as well. Buyers may need to go out of their way to acquire consents and contracts to ascend the throne.
Defining and controlling behavior is a major objective of the APA. The buyer must represent its authority to purchase the asset. The seller must represent its authority to sell the asset. Additionally, the seller represents that the purchase price of the asset is equal to its value, and that the seller is not in financial or legal trouble.
In the context of a merger or acquisition transaction, asset purchase agreements have a distinct set of advantages and disadvantages compared to using an equity (or stock) purchase agreement or a merger agreement. In an equity or merger acquisition, the purchaser is guaranteed to receive all of the target’s assets without exception, but also automatically assumes all of the target’s liabilities. An asset purchase agreement, alternatively, allows not only for a transaction in which only some of the assets are transferred (which is sometimes desired) but also allows the parties to negotiate which liabilities of the target are expressly assumed by the purchaser, and allows the purchaser to leave behind those liabilities it does not wish to accept (or does not know about). A disadvantage of an asset purchase agreement is that it can often result in a greater number of change of control issues. For example, contracts held by a target, and acquired by a purchaser, will often require the consent of the counterparty in the context of an asset deal, whereas it is less common that such consent will be needed in connection with an equity sale or merger agreement.
Other than having the flexibility to sell only certain assets, rather than the entire company, asset purchase agreements typically also include detailed provisions regarding the transfer of liabilities from the seller.
How to Handle Asset Purchase
When buying assets, the buyer does not have to worry about minority stakeholders in the company. Sometimes the seller still has a stake in the company when the buyer picks the assets, and the seller is left with the liabilities. This purchases usually tends to favor the buyer than it does the seller
There are particular ways to log-in your asset purchase based on how the purchase was financed. This affects your balance sheets and records in various ways. Recording the purchase and its effects on your balance sheet can be done by:
- Creating an assets account and debiting it in your records according to the value of your assets.
- Creating another cash account and crediting it by how much cash you put towards the purchase of the assets. Loans are not part of the cash account.
- Creating a loan account called a note payable account and crediting it by the amount of loan money used to fund the asset purchase.
- Determining if the asset bought is a current or non-current asset and logging or reporting it accordingly in your assets sections. Current assets are those converted to cash within 12 months, and non-current assets are those that take longer than that to convert to cash.
- Finding out your current cash balance by subtracting the cash cost of asset purchase from your initial cash balance. Put the result in the current assets section. The current cash balance is regarded as part of your current assets.
- Recording the loan amount used, which is the note payable in your liabilities section. It can be in the current of the non-current liabilities balance sheet section.
As it is with the current assets, current liabilities are those that can be recovered with 12 months and non-current are those that are expected to take longer than that. In a situation where all assets were paid for from the cash account, there is no need for a note payable report.
Example of Assets Purchase
Let’s assume you own a cosmetics company that’s generated an income of 100,000 from its sales saved in the bank. You have about 70,000 and owe a Shea butter and honey company about 20,000.
You have set your sights on purchasing a boutique down the street that is about to fold. You want to acquire this and merge businesses. Instead of just buying the whole place, you decide just to purchase its assets. After taking a look at the company’s inventory and assets and liabilities, you purchase the sewing kits and design for 60,000.
This means that although you lost 60,000 in cash, you gained sewing kits, which are meant to generate more cash for you. Although you have less cash in your cash account, you have increased the value of your assets without incurring any loss from liabilities.
Parts of an Asset Purchase Agreement
Whether you wish to buy or sell an existing business or its assets, you will want to govern the transaction with an asset purchase agreement. Depending upon the details of the transaction, the length of your document will vary. However, the basic structure of an asset purchase agreement is similar regardless of the specifics.
Here are parts of an asset purchase agreement that you may want to include in your document.
The opening paragraph of an asset purchase agreement includes the buyer and seller’s name and address as well as the date of signing. You should also add an acknowledgment of the agreement on behalf of both parties.
Identify keywords that your document will use several times and define them. For example, rather than having to describe the terms of the sale repeatedly, you can collectively refer to it as the “Sale” uniformly throughout the APA. Definitions of specific words will help avoid confusion in the future.
3. Purchase Price and Allocation
In this provision, you should describe what the seller is selling to the buyer as well as any exclusions that apply. Detail the structure of the deal, including price, payment terms, and liabilities the buyer assumes. Since this section may be lengthy, it is not uncommon to shift long lists to an attachment.
4. Closing Terms
Closing is when the transaction is formalized. The closing terms should define what is required to complete the business or business asset’s purchase or sell, including any terms and contingencies.
There are promises that both parties will likely make to each other. Warranties are the representations associated with the purchase. If the seller makes unfounded guarantees, this section is critical for the buyer to pursue legal redress.
Covenants are sub-agreements under the asset purchase agreement. For instance, the seller may promise to not compete with the buyer for a specific period in a geographic location. Depending upon the transaction, the covenants will vary widely.
Indemnification protects buyers and sellers in the event of a legal dispute. It describes the financial damages that one party pays to the prevailing party and under what circumstances, including attorneys’ fees, court costs, and more.
There are numerous bodies of law that may apply to contracts . Your asset purchase agreement should indicate which state, country, or international laws govern your contract for legality purposes or in case a dispute arises.
9. Dated Signatures
No contract is complete without dated signatures from both parties. Ensure that you leave a dateline for each signature since the asset purchase agreement could be signed on different dates. You do not need to get the document notarized.
Your asset purchase agreement will be unique to your situation. Since these transactions tend to be complicated and work in conjunction with other existing contracts, such as partnership agreements , hire transactional lawyers to assist you in this process.
Advantages and Disadvantages of an Asset Purchase Agreement
If you are considering an asset purchase agreement to formalize the sale of a business or asset, you should consider the pros and cons before deciding to use this type of document. Review the advantages and disadvantages below.
While there are downsides to an asset purchase agreement, there are several distinct advantages, including:
- You can define how you want the transaction to be structured
- Ownership over specified assets are only transferred, which can mitigate legal issues
- You avoid problems with minority shareholders
- Assets can be sold at fair market value (FMV)
- Both parties avoid running into opportunities and instead attract serious buyers and sellers
The advantages of an asset purchase agreement are critical for some businesses. Ultimately, the most significant advantage is that it provides reassurance and an understanding among the parties involved while protecting their legal rights.
Although the positive aspects of an asset purchase agreement are numerous, there are a few disadvantages associated with asset purchase agreements, including:
- You will need to engage in the retitling process, which can be costly
- Employment contracts may need review and renewal
- Specific permits and licenses may not transfer to the buyer without reapplication
- Assets sold well below FMV may result in insufficient capital for the buyer
The decision to use an asset purchase agreement vs. other legal instruments, such as a stock purchase agreement, should be made in conjunction with a legal professional with experience in this area. Otherwise, you could make legal mistakes that affect you later on.
Assets purchase is an unavoidable process when acquiring or merging a company or expanding yours as assets are a crucial part of any company. When purchasing assets, buyers have to make a clear distinction between what the assets and liabilities as so as not to incur most of their cost but focus on getting the best from the assets.
When dealing with assets purchase, it does not only refer to mergers and acquisitions, a startup business or an expanding one may need to acquire assets as well. A computer school buying desktops for their classrooms are also purchasing assets.
Frequently Asked Questions
What is an asset purchase agreement?
An asset purchase agreement is a legal document that outlines the terms and conditions of an asset purchase. This document will typically include a description of the assets being purchased, as well as the price and any other pertinent information related to the sale.
Who is the asset purchase agreement for?
The asset purchase agreement is typically between the buyer and the seller of the assets. However, in some cases it may also include other parties involved in the transaction, such as a lender or funding source.
What assets are being purchased?
The assets being purchased should be specifically identified in the agreement. This could include a list of specific items, or could be more general in nature.
Who drafts an asset purchase agreement?
The asset purchase agreement is typically drafted by the buyer and seller of the assets. However, in some cases it may be handled by an attorney.
What needs to happen before an asset purchase closing?
In order for the asset purchase to close, the buyer and seller will need to sign the agreement, as well as any other necessary parties. The buyer will also need to provide any funding required for the purchase, and the seller will need to transfer ownership of the assets.