Asset Purchase Agreement/More Info


Asset Purchase Agreement 
Additional Information 
  
Asset Purchase vs. Stock Purchase  

An ongoing business can be purchased in two basic ways:  a "stock purchase" or an "asset purchase."  In a stock purchase, the buyer acquires all (or at least the controlling interest) of a corporation's outstanding shares of stock from its shareholders.  In a stock purchase, the corporation continues in business with new owners (i.e., the new shareholders).   

Alternatively, a buyer may instead purchase only the assets used in the business.  In this case, the corporate seller gets out of the business, and the buyer then uses the purchased assets to operate the business.  This Asset Purchase Agreement form is used only when a buyer is acquiring business assets. 
 

Benefits of an Asset Purchase 

Normally, a buyer will prefer to buy a business by purchasing assets only, while a seller usually prefers to sell the corporation's shares of stock.  An asset purchase transaction traditionally provides certain benefits to the buyer:   

- The buyer need only purchase and pay for assets important to the business.  

- The buyer establishes a new cost basis in the depreciable items such as equipment and fixtures.  

- This provides the buyer tax benefits by maximizing allowable deductions for depreciation expense.   

- The buyer generally acquires the business free of liabilities created by the seller and claims against the business that arise before the transfer of the assets. 
 
While buyers usually prefer an asset purchase, many businesses are bought and sold through the acquisition of stock.  Whether a business is transferred through a stock purchase or an asset purchase depends a great deal on the relative bargaining positions of the two parties, their individual tax situations, and the ease of transferring the business through one method or another.  The seller is often primarily motivated by tax considerations.  That is, the seller wants to get the proceeds of the sale with the payment of the least amount of tax.   


Assets Purchased 

The Asset Purchase Agreement form contemplates that the buyer will purchase all of the assets used in the seller's business, but will not acquire things like cash and accounts receivable.  The form provides that the buyer will acquire the seller's trade names and telephone numbers.  The assets to be sold are identified in the agreement and the rules are established for their transfer to the buyer. 


Purchase Price  

Along with determining the way that the business will be transferred, the most important matter the parties must decide is a purchase price and how that amount will be paid.  Valuing a business is a sometimes tricky, always subjective, process.  There are many different formulas and methods for determining value.  Value may be determined by one of the following methods, either by itself or by combining it with the principles of another method: 

> Using a multiple of sales, net profits or cash flow.  Often, there is a standard valuation range for a type of business.  In many cases this is expressed as some multiple of the earnings of the business.  For example, the price of a share of stock in a publicly traded company is often expressed in terms of a "price earnings (PE) ratio."  Accountants, lawyers, business brokers, trade associations and business owners often know the range of multiples or other formulas to estimate the value of a business.   

- Comparing sales of similar businesses.  This information is not often publicly available.  However, accountants, business brokers and business owners may provide this information.   

- Fair market value of the business assets.  Do not rely on market value information from the seller.  It may be necessary to have a professional appraisal to ascertain this value.   
 
Both buyers and sellers are encouraged to seek professional advice from accountants and business appraisers to arrive at a reasonable, fair valuation.  Most advisors recommend that buyers not over pay by calculating a price component for both the earnings and the assets.  In other words, if you are paying for the business based upon the market value of the assets, you are buying the "engine" to produce the earnings.  Do not also pay for the earnings as a separate component. 

Buyers must also be conscious about relying too heavily on the business financial statements.  Valuation is often effected by many variables not clear from these statements, such as: 

- the time remaining on existing contracts with suppliers or customers  

- trade secrets, formulas and technical know-how 

- the qualities of management and employees 

- the business location 

- time remaining on a patent, license or copyright 

- the right to transfer a license or authorization.   
 
 
Due Diligence 

After the contract is signed, it is important for the buyer to begin the process of "due diligence."  This involves a detailed review of the seller's financial records, physical assets, properties and other matters.  Without thorough due diligence, the buyer may end up with a business that involves risks or issues that are not understood or appreciated until it is too late. 
Due diligence can involve evaluation of virtually any part of a business, but almost always involves things like these: 

- Professional examination of financial records and tax returns 

- Inspection of inventory for quality and salability 

- Review title to land, equipment and intellectual property for ownership and liens 

- Examine equipment and fixtures for operability and value. 
 

Financing the Purchase 

The Asset Purchase Agreement form provides for the payment of the purchase price entirely in cash, or a combination of cash and seller financing.  Seller financing of the sale of a small business is common, particularly where the buyer does not have, or cannot borrow from a bank or other institution, all of the money needed to pay the purchase price.  Before agreeing to finance a buyer, the seller must consider several factors:   

- Can the buyer put up sufficient collateral for the loan?   

- Will the business support the payment of the debt and other obligations, and still allow the buyer to make a decent living?   

- Is the buyer capable of managing the business properly?   

- Will the seller be willing to remain involved in the business after the sale to help train the buyer?   
 
- Assuming the buyer is incorporated, should the principal shareholder(s) guarantee the loan?   
 
The collateral for the loan is usually the assets that have been purchased by the buyer.  This kind of transaction is often called a "leveraged buyout."  This means that the buyer has paid in cash only a portion of the purchase price and uses the assets of the business as security for the financing, or leverage.   

The buyer will want to make sure that the assets of the business to be acquired are not already collateral for some other loan, or that any outstanding liens will be removed before the transaction is closed.  To insure that there are no liens on the assets, it is important for the buyer to check with state offices in the seller's state for any financing statements.  Buyers should check with the office of the Secretary of State or other state office for filings made centrally, and also in the office of recorder of deeds or other county office where the seller's headquarters office is located or where any assets to be acquired are located.  A search should be made under the Seller's proper legal name, as well as any other business or trade names that the seller uses.  This is usually done by filing a UCC Form 11, Request for Information.  These forms are available from local business stationery stores and other outlets. Buyers should make their search at or about the time the agreement is signed and then again immediately before closing.  

Buyers who do not have sufficient cash or seller financing to complete the asset purchase should not sign the agreement unless there is a financing contingency provision.  Such a clause gives a buyer some period of time to obtain financing and, failing to secure it, the buyer is not required to complete the purchase.  A similar provision is common in a contract to buy a house or other real estate.  Business sellers are not usually willing to agree to financing contingency, but some buyers may be able to negotiate such an arrangement. 


Bulk Sales Law 

Both the buyer and seller should also be aware of the rules on bulk transfers.  Each state has some laws, usually as a part of the Uniform Commercial Code (UCC), that relate to the creditors of the business to be sold.  Without some legal protection, a creditor may find that the debt has been "wiped out" by seller that pockets the proceeds of the sale without paying off the debt.  Article 6 of the UCC provides a system for notifying the creditors of the seller, who then have an opportunity to be paid out of the seller's receipts of the sale.  Many states have some version of the UCC's Article 6 in their statutes, but others have tried it and rejected it.  

For additional information on this special law regarding a sale of a business, see the Business Law Topics section "Bulk Sales Law."  The application Asset Purchase Agreement form provides options for compliance with the bulk sale law, or alternatively to waive compliance with that law.  


Allocating the Purchase Price 

Allocating the purchase price among the assets acquired is also a tricky matter.  Normally, the buyer and seller agree on a "gross" purchase price.  When completing their Asset Purchase Agreement, the parties must allocate a portion of that gross price to each of the various assets.  The general rule is that the allocation must be based upon the fair market value of the purchased assets.  However, the tax and other laws do provide some room for the parties to agree on some other method of allocating the purchase price.   

Tax considerations often drive the negotiations of allocation.  Normally, the buyer wants to allocate as much of the purchase price as possible to assets that can be depreciated or amortized.  This helps reduce the buyer's taxes on business profits.  Sellers usually desire to allocate the purchase price to assets that, upon sale, are taxed at capital gains rates instead of the higher ordinary income rates.   


Income Tax Considerations 

Tax considerations are always important to both the buyer and the seller.  Tax laws are particularly complex, and neither a buyer or seller should proceed with the acquisition of a business without fully understanding all of the applicable federal and state tax rules.  The best way to understand them is to talk with a professional tax adviser.  The following is a discussion of basic tax issues.   

Briefly, the seller's goal will be to receive the proceeds of the sale subject to the least amount of tax.  If the selling business is incorporated, this becomes complicated.  The selling corporation may be taxed on the proceeds of the sale, and there may be additional tax imposed when the remaining proceeds are distributed from the corporation to the shareholders.  The amount of the tax owed, if any, will depend on the seller's basis in the assets sold, the amount of the purchase price allocated to individual assets, the way in which the money is distributed to the shareholders, and many other matters.   

The purchaser of business assets usually desires to insure that the maximum amount of the purchase price of the assets is allocated to assets that may be depreciated or amortized for tax purposes.  The amount of depreciation or amortization is a deduction that produces a lower tax bill.  Businesses are not allowed to take a deduction for depreciation or amortization on all assets.  The law permits a deduction of a reasonable amount related to the exhaustion, wear and tear on tangible property used in a trade or business, or on property held for the production of income.  Depreciation is not allowed for inventories, stock in trade, land or other natural resources.   

Amortization is similar to depreciation, in that it allows for the recovery of certain capital expenditures that are not ordinarily deductible in a way that is similar to straight line depreciation.  Some intangible assets may be amortized.  For example, Section 197 of the Internal Revenue Code permits the amortization of the cost of certain intangible items acquired after August 10, 1993, and used in a trade or business.  Some of the items that may be amortized include:   

- Goodwill 

- A covenant not to compete entered into in the connection with the acquisition of a trade or business  

- Any license, permit or other right granted by a government   

- Any franchise, trademark or trade name.   
 
Be sure you consult with a tax advisor to determine when these items can be amortized.  Section 197 also defines many items of intangible property that cannot be amortized.  Under Section 197, the regular amortization period is 15 years.   

Because a covenant not to compete must now be amortized over 15 years, there may be less incentive (at least for tax reasons) to negotiate for these promises.  Now, buyers may be more interested in completing consulting agreements with the seller.  These fees may be written off as they are incurred.   


Sales Tax Considerations 

Also important is the matter of state sales tax obligations.  Unfortunately, buying assets does not insulate a buyer from liability for sales and uses taxes that should have been paid by the seller before the transfer of the assets.  Not all states have a sales tax and not all of them tax the same transactions.  For example, some states impose a sales tax on the provision of labor, but most do not.  Nearly every state has a statute that creates "successor liability" for the buyer if the seller has not paid sales or use taxes due. 

If the business sells goods or services at retail subject to sales and use taxes, the buyer will want to make sure all taxes due have been timely paid.  Most states have a process that allows the tax authorities to release this payment information to business buyers.  It is also advisable to check with county and state offices to see if there are any outstanding tax liens.  Buyers must promptly establish state sales tax accounts and collect and pay all taxes after buying the business.  Sales tax is not normally owed on the purchase of the business and the assets.  Promptly upon completing the purchase (or just before, in some states), the buyer must notify the state sales tax authority and register for a tax ID number. 

Buyers should call the office in each state where the seller makes retail sales for information on the seller's standing with the state's taxing authority. 


Employee Matters 

Often, dealing with employees represents one of the more difficult matters in the sale of the business.  As a general rule, the buyer is not ordinarily required to retain the employees of the business or to pay any severance or other obligations.  The buyer may elect to hire or not hire individual employees.  Union contracts, states laws or agreements may change these rules.   

Care should be taken so that the buyer is not liable to the federal or state government for any employment related taxes of the former owners.  The buyer should obtain a new taxpayer identification number from the IRS, and establish new accounts for the payment of employment taxes.   

Buyers and sellers must also take care in dealing with any employment related benefit plans.  In most cases, buyers will not want to assume any responsibility for these plans.  Sellers must take care in terminating or modifying these plans when the business is sold.  A federal law known as COBRA, as well as many state laws, require employers to make health insurance benefits available to terminated employees.  It is important to remember these obligations imposed by law, and to address them appropriately in the Asset Purchase Agreement.   

Dealing with employees is a sensitive matter.  The change of ownership can be a stressful time for employees who are unsure about their status with a new owner.  While philosophies on handling this issue vary, it is usually best for the owner/seller to make the formal announcement about the sale of the business.  That announcement should be made only when it is reasonably certain the sale will occur, but before rumors and gossip cause problems in the workplace.   
 

Franchises 

Special caution must be taken if the business to be transferred is a franchise.  In most cases, the franchise agreement provides that the franchisee (i.e., the seller) cannot sell the business without the franchisor's consent.  To get that consent, the buyer must often pay a new franchise fee or make other agreements with the franchisor.  Sellers and buyers should read the franchise agreement carefully to understand their respective rights and obligations.  In most cases, the seller should introduce the buyer to the franchisor early in the negotiations to ensure that consent to the transfer will be given.  Lastly, buyers should make sure the agreement clearly states that the purchase is contingent upon the franchisor's consent to the transfer to the franchise upon terms acceptable to the buyer. 


Helpful Resources 

Many helpful resources exist for the person planning to buy or sell a business.  In addition to your accountant and lawyer, also talk to your banker.  The Small Business Administration provides many good services, such as the SCORE (Service Corps of Retired Executives) program and well-stocked libraries.  Most are free of charge.  Your public library will have many useful books and periodicals.   

You may also want to talk to a business broker.  These individuals bring together business sellers and buyers in return for a commission normally paid by the seller.  If you choose to contact a business broker, make sure you understand the fee arrangement the broker uses and check out the broker's references.  Many brokers use the Business Reference Guide, a book published annually by the Business Brokerage Press in Concord, MA.  This handy book contains information on businesses bought and sold nation-wide, valuations, laws and other aids.