What Do the Legal Terms Mean in an Asset Purchase Agreement (APA)?

Negotiating terms for your acquisition is one thing. But once negotiations wrap, how do you translate the deal into a legally binding asset purchase agreement (APA)? 

You could hire an attorney to write or review the document for you – but you’ll face mountains of legal fees while they decipher it. And if you don’t use legal counsel, you’re stuck wading through pages of dense legal jargon, slowing your acquisition process while you interpret each written demand. Navigating the APA with little knowledge of legalese also increases the risk you agree to something you don’t want to. 

So, how do you build an APA without losing time or money or wrecking the deal? By gaining a basic understanding of APA legal terminology and knowing exactly what you agree to. 

Not sure what representations, warranties, or indemnification are? No worries. We’ve defined all the terms you need to know and how they apply to your sale, whether you’re buying or selling. Familiarize yourself with these concepts, and you’ll have no trouble drafting or reviewing an APA.

What Is an Asset Purchase Agreement?

An asset purchase agreement is a legally binding contract between a buyer and seller that finalizes the terms and conditions of an acquisition. It describes the acquired assets, the purchase price, representations and warranties, escrow terms, and more. 

What’s Included in an Asset Purchase Agreement?

You don’t want to risk the sale falling apart because of a misunderstanding about a term or provision. Avoid delaying or destroying the acquisition by enhancing your knowledge of APAs and what they include. To help you do that, we’ve broken down a sample document below.

Party Information, Recitals, and Definitions 

The first paragraph of an APA explains who’s participating in the deal and what you’re buying or selling. It includes the full legal names of the buyer and seller, plus the business type if either party is a company (LLC, corporation, sole proprietor, etcetera). In the example below, Leonard Jackson is the buyer while Lenny’s Little Library LLC is the seller. 

You’ll also find definitions of repeatedly used words, like the following: 

• Closing date: The date the buyer approves the assets, and the escrow service releases funds into the seller’s account. On Acquire.com, the buyer and seller mutually agree on the time and place of closing virtually. 
• Effective date: The date the buyer and seller sign the APA. They enter the agreement and make it effective from that date forward, even if the deal closes later. 
• Party: Either the buyer or seller.
• Parties: Both the buyer and seller. 
• Consideration: What the buyer pays the seller for the purchase and delivery of the assets.

After naming the parties and defining terms, we now hit the recitals section, which explains why the parties signed this APA. In M&A transactions, it typically describes how the seller sells the “Purchased Assets” to the buyer under the conditions laid out in the APA. You can define those assets (and other terms or abbreviations) in the recitals paragraph or specify that they’re “defined below” throughout the APA. 

Purchased Assets

Under purchased assets, first declare that the seller agrees to “sell, assign, transfer, and convey” each of the listed assets to the buyer. You can list all the assets immediately afterward or attach them in an appendix, like this Schedule 1.

In either the appendix or the purchased assets section (Section 1, in this case), you can add definitions to avoid any confusion or legal loopholes. For instance, the example below defines IP rights and includes summaries of the acquired patents, copyrights, trademarks, and domain names. 

Assumption of Liabilities

Before signing an APA, the buyer and seller bargain to see if the buyer takes on any existing liabilities from the seller. Liabilities include debts, loans, accounts payable, taxes owed, and more. If they don’t take liabilities, this section of the APA (Section 2) can be short and simple, declaring that the “Buyer shall not assume any liabilities of the Seller.” 

Generally, in asset sales, the buyer assumes no liabilities of the seller unless they specifically agree to one. For example, the seller could negotiate for liabilities related to employees’ termination. If the buyer only acquires technology and doesn’t transfer any employees, the seller can negotiate for the buyer to cover any outstanding wages or benefits coverage. 

But ultimately, the buyer aims to assume as few liabilities as possible. If they succeed, the seller should note which liabilities they’re still responsible for to ensure they don’t breach any previous contracts. 

Purchase Price

In Section 3, the parties name the purchase price and how the buyer will pay – all cash at closing vs. seller financing, for example. Seller financing is when the buyer pays for the acquisition in multiple payments over time.

Below, Leonard Jackson chose to pay the full price at closing, calling it “Cash Consideration.” If both parties agreed to include earnouts or seller holdbacks, those terms would also appear in this section. 

Earnouts are additional compensation the seller receives based on the acquired business’s future performance post-closing. 

Seller holdbacks are when a buyer “holds back” a portion of the purchase price until a certain period passes post-closing and an agreed-upon event either occurs or doesn’t. It’s insurance against the seller, who receives the funds from escrow after meeting the specified conditions. 

Representations and Warranties

Most acquisitions include representations and warranties on behalf of both parties. Representations are an assertion of a fact, while warranties are promises that the fact is true (and a promise of consequences if the fact is not true). For example, a seller might represent that they’ll transfer the Purchased Assets “free and clear” of any mortgages, liens, or charges. But if that proves false, the seller will pay for it per the warranty. 

The buyer and seller will represent and warrant different parts of the acquisition, which we’ll discuss below.

How Representations and Warranties Apply to Sellers

First, sellers confirm their authority to be able to sell the business or assets. The document could state something like, “Seller has all requisite corporate power and authority to enter into this Agreement and all related agreements and instruments to be executed and delivered by such Seller, to perform its obligations hereunder and thereunder and to consummate the transactions contemplated hereby and thereby.” 

Sounds pretty dense, right? All it means is the seller is qualified to agree to the provisions in the APA and carry them out. 

Other situations that the seller represents and warrants in an APA include owning the title to the property (purchased assets) and promising non-infringement (confirming the business’s IP doesn’t infringe on anyone else’s intellectual property rights). 

Essentially, sellers use this section to confirm that the business is what the seller represents it to be. If any part of the representation falls through (termed inaccurate), warranties allow the buyer to take legal action against the seller in the event of a loss. Warranties promise consequences for inaccuracy, and typically, those consequences result in an indemnification claim, which we’ll address in the next section. 

But remember, representations and warranties come in all shapes and sizes. Many APAs will contain more than what we include in our APA Builder. More complex deals require numerous representations and warranties, sometimes as many as 30 or 40. 

How Representations and Warranties Apply to Buyers

The representations and warranties section provides insurance for buyers against the seller. Buyers trust the seller to fulfill their promises about the business, and representations and warranties provide a backup plan if things go wrong. 

But buyers also provide insurance for sellers, usually by confirming their authority to buy the business and pay for it. Buyer representations include a similar section to sellers about their ability to complete the sale and follow the terms of the agreement. 

Some APAs also include a section that represents and warrants the buyer’s financial ability to complete the purchase. A section can also state that the buyer’s financial documents are “complete and accurate” for the seller’s due diligence process. 

Indemnification

What happens if a buyer or seller does misrepresent something (lies) or breaks part of the contract? Indemnification specifies the consequences of that break, namely that the offending party will compensate the other for financial damages, including losses and lawyer or court fees.

If we get into the nitty gritty, to indemnify is to compensate the other party for current or future losses. Per the APA, the “Indemnifying Party” will hold the other party “harmless” (they won’t pursue legal action against the non-indemnifying party) for any resulting claims, demands, damages, losses, costs, liabilities, and expenses (including attorney and consultant fees). 

However, the suffering party can’t squeeze every penny out of the indemnifying party. Some APAs, like the one below, specify that the max amount of losses the indemnifying party will pay can’t exceed the purchase price paid – provided the losses don’t arise from fraud or intentional breach/misrepresentation.

Some APAs also include a survival period on indemnification. Meaning, the parties can only indemnify for a set period and not afterward. Six months after the closing date, for example, the representations and warranties or binding covenants could expire. 

Since sellers often represent and warrant more, buyers sometimes demand an indemnity holdback to ensure the seller can cover any post-acquisition claims. Like a typical seller holdback, indemnity holdbacks are portions of the purchase price held in escrow until an event occurs – in this case until the survival period ends. Holdbacks make it more efficient for the parties to resolve indemnification claims since the money’s readily available to return to the buyer. 

Governance and Dispute Resolution

To be able to enforce the terms of your APA, declare which state, country, or international laws govern your agreement. If a dispute arises, the parties adhere to the governing law of that location. 

Speaking of disputes, this section also explains how the parties will deal with a claim about the APA. Before jumping straight into legal action, many buyers and sellers specify that they’ll try to resolve it between themselves first. If that doesn’t work, one party can send a written notice to the other. They agree to meet later to try and resolve it through “good faith negotiations.” If the negotiations fall through, either party can resolve the dispute through legal action. 

In the example below, the parties specified that Delaware will be the governing law, which is a popular choice for many founders. Why? Because Delaware doesn’t tax corporations at the state level. Per Investopedia, the state also eschews sales tax, personal property tax, value-added taxes, inheritance tax, and capital shares or stock transfer taxes. Delaware also has the most developed legal philosophy for corporate law out of any other state in the U.S.  

Closing Conditions (or Covenants) 

Parties use the closing conditions section to clarify what each must do to complete the transaction before closing. It includes key elements like contingencies and legally binding agreements. 

Some APAs, for instance, include a contingency that within a certain number of days, the buyer and seller will each complete due diligence. Or, the conditions confirm that the seller will provide the buyer access to all business information from the effective date until the closing date.

As for the legally binding agreements, some APAs include a non-competition clause and a non-solicitation clause in the closing conditions. Non-competition clauses ensure the seller and certain key employees won’t compete with the buyer for a set period post-acquisition. Meanwhile, non-solicitation clauses prevent the seller and certain key employees from stealing clients or employees from the acquired business for a set period. 

In the example below, the parties agreed to a non-compete and non-solicit agreement, with the terms laid out in an attached APA document. The legally binding agreement promises that for the specified “Duration,” the seller will not engage in activity that competes with the acquired business or solicit employees, consultants, customers, clients, and more. 

If the seller breaks those agreements, the buyer can take legal action against them. Often, for non-compete breaches, they’ll move for a preliminary injunction, which prohibits the seller from engaging in conduct that violates the agreement. The seller might have to quit their job if they work at a competing business, for example. 

To avoid a legal headache, wait out the full duration of your non-competition or non-solicitation clauses before doing anything that looks remotely like competition or solicitation. 

Still Have Questions? 

We’ve thrown a lot of information at you about APAs, binding agreements, conditions, and more. To fill in any knowledge gaps about your asset purchase, feel free to consult one of our M&A advisors to help you navigate your acquisition process. They’ll connect you with the right buyer and expertly market your startup. Don’t wait to list your startup on Acquire.com today. 

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