Understanding Asset Purchase Agreements

In this weeks episode, Eric and John break down the fundamentals of Asset Purchase Agreements (APA). The basics: What is it, who signs it, and what are you selling.

• What is an APA, how is different than equity
  • Why APA over equity
  • Exceptions
  • Structure/format of an APA/length
  • How to review, where to start?
• The Parties
  • Individual liability – how does this work
  • Who is the buyer – subsidiary? Who is paying you on deferred payments
• The Assets
  • What are you selling,
    • Online accounts
    • Inventory
    • IP
    • Data/records
    • Domains
    • Social media
    • Causes of action
    • Contracts
    • Goodwill
  • What are you not selling
    • Cash
    • Money in amazon account
    • Certain contracts
    • Corporate records
    • anything specific

Parting Shot of Truth

• Getting settlements done – don’t change the terms mid-stream, it kills momentum and credibility

John:

Hey, everyone. This is John DiGiacomo of Revision Legal, and this is The May it Please the Internet Podcast. And as always I am joined by my partner, Eric Misterovich. Hey, Eric.

Eric:

Good afternoon, John.

John:

And today, we are talking about asset purchase agreements. And this is part one of potentially many parts about walking through these documents and the sale of an eCommerce business. Eric, do you want to get us started and talk about APAs and what they are?

Eric:

Yeah. I mean, when we’re coming up, and trying to come up with content to talk about APAs are just something that we handle so regularly, and there’s so many questions that come up. And you spend so much time working with the parties and talking about these clauses, and just something that we think that people could sit down and listen to. And when it’s time for their exit or acquisition, check this out. It could provide some tips and tricks on how to understand these things, what are they, to help you be prepared for that hopefully really big event in your life to either buy or sell a business.

John:

Yeah. And to give you some context for our firm and kind of what we’ve been doing, we represent a number of these FBA Amazon, FBA roll up entities, other venture capital backed roll up entities. And so we’re doing a number of these deals weekly. So this week, I’ve done two of these deals, substantial, over eight figures. And so through this kind of trench warfare of digging into these documents, we’ve seen a lot of stuff. So hopefully, this context and analysis will be helpful to you if you’re looking to buy or sell a business.

Eric:

Yeah. We’ve been doing this now, I mean, we were kind of well positioned for this because when it started heating up, we had already been handling these kinds of deals for years. Things have kind of standardized a little bit now, in my experience, for handling things like inventory and handling how, I don’t know, the whole process is done from LOI to kind of a closing migration checklist. All of these things have kind of been adopted within the space. Of course, we’re mainly talking about selling online businesses, and a lot of this businesses being Amazon related businesses. In this first kind of section, we’re going to keep it pretty high level and really just cover the basics of what these agreements are, why people use these kinds of agreements, rather than other agreements. But I think we can also hit on some pretty major issues that buyers and sellers need to be aware of.

John:

Well, let’s take it from the beginning. What is an APA? How is it different than selling shares, for example?

Eric:

So asset purchase agreement, the buyer’s only buying the assets and whatever liabilities they’re assuming. But they’re not buying stock. They’re not buying your membership interest. So if you’re selling the business and you have your limited liability company set up, you’re not transferring ownership of that LLC to the buyer. You’re only transferring the assets that LLC owns. And this is the preferred method of these kinds of transactions in most cases. It gives the buyer kind of a clean slate. Right? The buyer’s usually going to start a new entity. It’ll buy all these assets. It’s going to be very picky about any liabilities that are coming with it. It just has this clean slate, doesn’t have any of the historical tax issues, or employment issues, or really any other issues that the seller entity had. And so APA, you’re buying the assets. You’re not buying the stock or the membership interest. So after you sell in an APA, your LLC can still exist. You could use it for something else if you really wanted to, but it’s still there and in existence.

John:

And some of the reasons why you do this is you want to avoid successor liability. So you don’t want to take on all of the risk that occurred prior to the date of closing. You want to cut off that risk. So as soon as you take this business over, it’s no longer your problem, it’s the prior owner’s problem. In some cases, a share purchase agreement for example, might be a better choice, but it’s pretty rare. The cases where it might be a better choice is to avoid some tax. I’m not a tax guy, but from my experience, typically if you’re selling qualified small business stock, that might be a reason to look at it, or if you’re trying to avoid some state level income taxes might be another reason to look at a share purchase agreement. But in most cases, a buyer doesn’t want anything to do with purchasing shares. They only want those assets.

Eric:

That’s what I’ve seen. I mean, oftentimes, if there is a foreign, outside of the US seller, then share purchase agreements are more common. But the buyer’s essentially doing a favor for the seller at that point because it’s the seller that will have negative tax consequences, depending on where they live and where their country’s tax laws are. But when I see share purchase agreements, that’s usually what it’s about is sellers in Australia or something, and he’s going to get absolutely crushed in taxes through an asset purchase agreement.

John:

Yeah. It typically involves a reallocation of the purchase price, sometimes changes to the terms that had been agreed to in the LOI, so almost in every case, an APA is preferred. So let’s talk a little bit about the structure and format of an APA. How long are these things? What do they look like?

Eric:

Well, I always tell people, selling a business, you get it ready to sell. You’ve got a successful business, you’re making money, you decide it’s time to sell. You contact a broker or sell it independently. You vet all these potential purchasers. You get an LOI. You complete due diligence where they’re asking for everything under the sun, and the reward is a 50 page legal document that you probably don’t understand most of what’s in there, and it’s pretty intimidating. And they’re usually 35, 50 pages long. You’ll probably have a set of exhibits that could be 50 to 500 pages long, depending on what’s going on. And a lot of them can be tough to get through.

John:

That’s why you hire lawyer. Every time I look at an APA, I feel like I’m in the Matrix, and I’m Neo, and I’m looking through the matrix and I’m like, “I see what’s behind the door. I see through the APA.”

Eric:

When you read enough of them, you can spot things pretty quickly for sure. Most of them follow the same general format, where there’s going to be essentially articles or sections, and probably runs one through 12 or something like that. And each article or section will cover a different aspect of the legal relationship and buying these assets. Within each section, there’s going to be 10 to 30 subsections in each one. And there’s lots of cross referencing from one section to another. And it’s not an intuitively easy document to get through for someone who’s doing it the first time.

John:

Where do you start when you start looking at an APA? I think that’s a good question because I always start the consideration portion, typically depending on whether it’s buyer or seller, and then I look at things like indemnification. What’s your workflow?

Eric:

I usually check out purchase price. And then I want to see: What are they selling? And how in the hell are they selling a business that makes glass jars and sells them on Amazon for $6 million. It’s just mind boggling sometimes what is being sold and how much they’re going for.

John:

So you go straight for the depression then.

Eric:

Yeah. I go, “Wow, man. This would be great to be selling this kind of business.” But I mean, that is part of the human part of our job, which is sometimes few and far between that you get to help someone who made something out of nothing, and now they’re getting paid for it heavily and it’s awesome. It’s a life changing event for them. But in terms of a legal review, yeah. I mean, I check out the consideration and want to see. How is being paid? How is it split up? I like to look at the timing to see. Are there deferred payments? Are they guaranteed? Are they triggered by performance metrics? And then you start to … All right, well, what are the metrics? And you can kind of dig into that a little bit.

I also really pay attention to timing of closing, timing of the migration. You can’t hand the keys over to these businesses. There’s a process to go through to move all these digital assets over. When does the seller get paid in connection with the moving of these digital assets? And how is that structured? That is a big one. I mean, if you’re a seller, the big things are: When do I get paid? And what’s my risk?

John:

That’s a great point. I also look at: What are the parties getting beyond the assets? So a good example is: Has there been within due diligence, an accurate assessment of the contracts that need to be transferred? And have the parties thought about the IP that needs to be transferred. And is that properly documented? Another one is: Who’s getting liabilities after closing? Who’s getting the cash? So with Amazon particularly, there’s this period where sales that occurred prior to closing my accrue cash that has not been distributed at the time of closing. So who’s getting that cash? Things like that, what you’re looking for is really fundamental fairness. And you want to make sure that the agreement reflects the intention of the parties, so that when it gets to opposing counsel, attorney on the other side, there’s not a big fight, and you’re not hammering out material terms, and it’s just kind of smooth sailing to closing.

Eric:

And kind of baked into that, especially with a very brief kind of initial review from me is: Who are we dealing with here? Is this agreement a let’s get it done, fair agreement on the first shot, if I’m representing the seller? Or is it every provision is so overwhelmingly in favor of the buyer that you have to perform surgery on the entire agreement to get it to fair? Not to get it to seller favorite, to get it back to fair and reasonable and market rate for what we see all the time. And that is when you know how much work you have ahead of you.

John:

That’s a really good point. When you get an agreement that does not fundamentally reflect the intention of the parties, and is so one sided that it’s kind of shocking, it really creates a sense of distrust that continues throughout the negotiation process. Every deal, there are terms that change. And they may change as a result of financing issues, or things that had not been contemplated by the parties at the time that the letter of intent was signed. But when you get that kind of master agreement that looks entirely different than what the parties intended, it doesn’t set a great tone. And it really puts you off on a bad footing with opposing counsel, and with the seller, buyer, whoever’s on the other side.

Eric:

It’s a pretty short sighted way of going about it because it’s just going to increase legal fees. It’s going to slow the time to close. And it’s just some of the … Especially if you know you’re going to give on those things anyways if you’re the buyer, just get it over with. Just make the change in the first place, and let’s just get to it and move on to the more important stuff. So you can pick out things kind of right away and finding out how lopsided an agreement is. Agreements are almost always going to favor the buyer. Cash is king and they have it. So that’s the way it goes, but there gets to a point where it can be really unreasonable.

John:

Let’s talk a little bit about parties to an agreement. You’ve got a buyer and a seller. Who else do you think about when you’re looking at the parties to one of these APAs?

Eric:

So the buyer, most of the time, from the seller side, you are selling to a fund, a roll up, aggregator, or whatever they’re called. But you’re not selling to Thrasio. You’re selling to some subsidiary you’ve never heard of before that is owned by Thrasio or whatever parent fund. And that can cause a little concern if you’re the seller because you have these deferred payments that are supposed to be being made. And it could be two or maybe three years down the road. Well, who is this subsidiary? What does this mean? Why isn’t the actual party that I selected a part of this contract? And that’s something to push for as a seller. Who’s guaranteeing these payments? Is the buyer making promises that they’re not going to use some kind of shading accounting tricks to well, this subsidiary doesn’t have any money, so they can’t pay you? Because it’s all being run up the chain or out to other … Whatever it is.

Now I will say most funds that I work with do not try to do shady stuff like that. And a lot of them are open to including guaranteed provisions from a parent entity. That’s certainly the preferred course if you’re a seller, but if you’re the seller, you need to look at who’s the name on the party, on the document that you are selling to because that’s who you have the relationship with.

John:

Even those cases where a seller can’t allow security in the parent company, I’ve found that legitimate sellers are willing to work with the buyer on some level of security. And some of the things that we’ve done in the past are withholding the transfer of some portion of the assets, or holding trademark assignments in escrow, or holding a domain name in escrow, such that once the criteria for the whole back payment is made, those things are released. In a lot of cases, that happens because the party that provides the credit facility for the seller won’t allow security in the parent company because they already have first priority. So it’s important to work with somebody in these deals who understands fully the context of what’s occurring, so that it doesn’t create unnecessary conflict when you discuss things like security, simply because there’s just a misunderstanding about what kind of security can be given.

Eric:

Yeah. That’s a good point. I mean, a lot of those funding documents will restrict the ability of a parent entity to do things like this. But ultimately what you’re looking for, the kind of magic words are some kind of anti circumvention language, where they can intentionally take acts to circumvent their obligations under this agreement. And whether that’s intentionally not funding a subsidiary, or even selling the assets. If they sell the assets, they have to make sure the buyer agrees to these terms. I mean, that one gets difficult, certainly one of the areas that can be negotiated. But it’s as simple as: Who’s on the first page? And that’s where if you’re getting an APA for the first time, make sure you pay attention to that and ask questions. Who is this? Who is this entity? How does it relate to the parent entity that I agreed to sell to? These are very, as basic as it gets, and the buyer should be willing to explain it to you very clearly as what’s going on.

John:

And if you are a seller too, be prepared that you may be requested to sign the APA individually, not just through your business entity. And the reasons for that is because you’re going to be on the hook for some level of indemnification for things that arose prior to closing, whether it’s IP infringement claims, or it’s a sexual harassment claim because you sexually harassed an employee, or you didn’t pay employee benefits, or something along those lines. That request may be coming, and it’s worth understanding, one, that it exists, and two, what your options are when that request comes. One of the options is to limit the duration of your personal guarantee, quote, unquote, personal guarantee, or to limit the scope or the cost associated with it.

So some people call them cap and baskets, where there’s a cap on the indemnification requirement for the seller, and there’s a basket that basically doesn’t tip until the claim reaches a certain monetary amount. So these are all things to think of, but don’t be surprised, if you’re a seller, and someone says, “Look, you’ve got to sign this in your individual capacity,” because it’s pretty common. I wouldn’t say it’s a reasonable ask, but in a lot of cases, it is a reasonable ask for a buyer.

Eric:

I’m sure we’re going to have some just thrilling indemnification topics on this podcast in the future that are just going to be just a freight train of excitement. But the individual liability is real. It’s highly likely as a seller you’re going to be on the hook for the promises. And part of that gets back to the asset purchase agreement. Right? Your entity is selling all of its assets. Well, if something goes wrong, the buyer doesn’t want to rely on suing an entity that has nothing. It needs someone with something to stand behind these promises. And nine times out of 10, that’s the owners.

Now it could be different depending on the ownership group. Maybe there’s some very small minority owners that don’t have any really active role in the business. Maybe they are appropriate to leave out. But a majority owner is certainly going to be on the hook in most cases for some personal exposure. And you’re right, there’s a million ways to kind of limit that, but your name is probably going to be on the agreement.

John:

Let’s talk about what you’re selling when you sell under an APA. What are the types of assets that we’re talking about here?

Eric:

Yeah. So if we’re talking about the normal structure of an APA, after the intro page, after the six pages of definitions, you get right into article two is usually the most custom part of an APA. Maybe it’s named article one in a certain one, but it’s going to be one or two. This is the article that covers: What are you selling? What are you not selling? Usually, purchase price, timing, and inventory, a lot of the nuts and bolts. And so one of the first sections of an APA will be titled purchased assets or acquired assets. And it’ll have this very long definition of what is being sold. Nine times out of 10, the definition is something to the effect of all assets used in operation of the business, or in connection with the operation of the business.

Then it usually provides a kind of laundry list of more specific things that would be considered a purchase asset, for example, your Amazon account. Right? Your Seller Central account, that’s going to be asset number one. Now if you’re not selling the whole account, but you’re only selling listings, then that would be included. There’ll be general descriptions of inventory, of intellectual property, trademarks, copyrights, patents. You’re selling all the data that you have. Again, if you’re selling an Amazon business, this stuff is probably just all within your account. Now if you’re selling other kinds of online businesses, you may have data and records that are kind of spread out.

But it’s going to include everything, domains, social media, if you had the right to sue someone, but you never did. That cause of action is most likely to the buyer. We’re going to talk about the specific contracts that you would be selling to a buyer, or signing to a buyer in connection with the sale. And then ultimately, you’re selling all of the goodwill that’s associated with the business. Why do people buy from you? The goodwill can be expressed in a lot of ways, and Amazon’s probably … Customer reviews play a big role in that. But this section of the APA, it’s important to understand. It’s usually very broadly drafted. It’s almost easier if you need to be specific as to what you’re not selling.

John:

Yeah. That’s a great point. That’s typically the edit that occurs. It’s a list of things that aren’t being sold, the exclusions, things like owner’s Tesla, or the fax machine in the office. But there are things that you’re not selling, and those things are also listed as well. We think about things like cash, so any cash on hand that you may have. We had mentioned this before, but money in your Amazon account. You might be entitled to money that currently exists there, and there might be a true up after closing for money that accrued for goods sold prior to closing, but not yet had been distributed to the seller.

You’ve got contracts that you don’t want to sell. Could be things like an SEO analytics account, Ahrefs or something along those lines account that you use for another business, records for your corporation. So if you’ve got employee records, you’re going to have to keep those for a while, or you have accounting records. You can’t get rid of those because you could get audited, or you could be subject to a lawsuit, so you’ve got to hang onto those. And anything else that you come up with that you think you should retain, like I said, owner’s property, a computer that the owner regularly uses, things like that.

Eric:

Things that I see come up that kind of cause problems in the excluded assets, which is usually how it’s defined, are if you have something within your Amazon account that you’re not selling. So I’ve had situations where people had a Kindle publishing business that technically was not going to be a part of the sale, but was within the Amazon account, or like I said, certain listings. Sometimes email addresses can be a touchy subject because people maybe use that email for personal reasons, and they don’t really want the buyer to see all of their email history. Sometimes that comes up, but usually these things are not very controversial. Some discussions back and forth can usually resolve all of these issues. This is usually not an area that requires a lot of redlining. But it’s certainly an area that’s very important to understand as a buyer and seller as to what you’re getting, what you’re selling, and what is being retained by the seller.

John:

I’ve got a fun one. When I was an associate attorney, I might’ve been two years into practice, my partner at the time, he had this client. And this client owned a bunch of, let’s just call them construction businesses. It was a little bit more detailed than that, but he had several construction businesses across the country. And the client wanted to buy a 1-800 number that was extremely cheesy, one of those kind of 1-800 call Sam esque numbers. And it’s illegal, apparently, it’s illegal to buy an 800 number. So the partner comes to me and he says, “Client wants to buy this 800 number.” I do the research on it, I realize it’s completely illegal to sell an 800 number. He’s like, “I don’t care. Figure it out. Get creative. That’s what being an attorney’s all about.” And so I had to call up a couple friends who had served in the FCC and come up with a game plan. But you’ve got to watch for those things. I mean, despite this sounding relatively basic, there are pitfalls with it in this process.

Eric:

Oh, yeah, all kinds of things can come up, especially when you have businesses that have taken out loans. Everything is connected or encumbered by a lien and secured interest. A lot of times, sellers don’t really understand the impact of those things. But there could be license agreements. There could’ve been a patent dispute, and you’re under some license agreement. Now we’ve got to figure out what to do there. You could have unique contracts that the other party gets to say whether or not it’s going to be assigned. And your whole deal could be dependent upon this third party and whether or not they’re going to sign this contract, so all kinds of stuff can come up with this, even though it usually isn’t an area for problems.

Knowing what you’re selling and what kind of comes with those assets, you have to know all of it. You have to know all the details, otherwise you can get to closing and run onto some problem that really can prevent the entire sale.

John:

And particularly in the COVID area, notifying your lenders for EIDL loans, or PPP, or any SBA loan really, is key because the SBA has to approve the transfer of any assets that may be encumbered by their loans. So yeah, things like that are extremely important. They must be addressed. Eric, you said you have a parting shot of truth today. What do you got?

Eric:

Yeah. I do. We give a lot of kind of technical legal advice, and really diving into some details. But sometimes there’s just things about working in the legal world that clients do, that I really wish they didn’t do. And I want to try to dedicate some time to this in our episodes. But the one I thought of today had to do with settlements. A lot of our time is spent figuring out a way to resolve problems, not just going to the wall and suing everyone, and asking questions later. It’s trying to get to a resolution. And a real problem in that is when clients change their settlement demands mid negotiation. They need a new term. They don’t like this term anymore. They want to increase that. They want to decease that. They actually also need this.

You have to get everything you want upfront because if you don’t, it just kind of kills your whole momentum. We are really trying to think about how we’re presenting it. We’re trying to add leverage where we have it. We may include things that we don’t really need on the first one to kind of have some give. But then when you come in later and change the terms, it just drives everyone nuts, and it doesn’t help resolve the situation.

John:

That’s the worst in mediation too because if you come out of mediation with a set of terms, and then you want to add, or subtract, or change terms later, oh man, talk about judges losing their mind on you. It’s always a terrible decision. So I think that’s great advice.

Eric:

Yeah. I mean, it may take a little bit longer and really think about it and really, before you say, “This is the offer I want to make,” take some time and talk about it with your attorney, and talk about all the things that you’re concerned with. Think about the future. What would life be like under these terms? Of course, things happen and sometimes you have to add things you maybe didn’t realize. But you really can do a lot of damage, and sometimes it’s clients trying to be tough negotiators, which is fine, but you have to know that could also blow up the whole deal.

John:

Yeah. That’s great advice. Well, thank you, Eric. This has been another episode of May it Please the Internet. This is Revision Legal’s podcast, and we appreciate you listening.