What is an asset purchase?
An asset purchase is the purchase of stuff. The "stuff" could be tangible and intangible property. A buyer is not buying ownership of another company. That is, the buyer is not buying shares of stock in a corporation or membership interests in an limited liability company. Most small business acquisitions are asset purchase transactions. There are some key steps in any asset purchase deal.
The Letter of Intent
An asset purchase begins by the buyer and seller signing a letter of intent (LOI). The LOI is usually non-binding. It sets forth general terms of the transaction, including a general description of the assets, the price, the payment terms, and a general description of how the transaction will happen.
The Asset Purchase Agreement
After the LOI is signed, the parties usually start working with their attorneys on the asset purchase agreement. The asset purchase agreement is the binding agreement between the buyer and seller. It lays out the specific terms of the purchase. It has representations and warranties of the buyer and seller. The asset purchase agreement will address employment of key employees after the sale is complete and noncompete agreements. It will also have a number of disclosure schedules or exhibits.
The closing of an asset purchase usually happens by the delivery of original documents and the payment of money. The buyer gets the all the documents that transfer title to tangible and intangible property. The seller gets cash. The seller may not get all the cash.
There will be representations and warranties that "survive closing." A buyer will usually require a holdback of the purchase price. This holdback will be used to pay damages if seller breaches any representation or warranty. The amount of the holdback is often a major point of negotiation.
Representations and Warranties Insurance
Both the buyer and the seller should consider purchasing representations and warranties insurance. The policy provides a clean exit for the seller by reducing holdbacks. This can be especially valuable for passive sellers. The policy provides more protection for a buyer. The policy will extend the time to discover and recover for a breach of a representation and warranty. It also removes the risk of non-recovery. Sellers may spend or transfer the money. Insurance companies can pay (usually).
Probably the biggest benefit of such insurance is it speeds up the transaction. In our experience, the most time spent in negotiation is over representations and warranties. Insurance may eliminate or shorten the time spent.