Explaining asset purchase agreements

Unlike a share purchase, where the buyer acquires the company as a whole (including all assets and liabilities), an asset purchase allows the buyer to select which assets to acquire and which liabilities, if any, to assume. This flexibility makes asset purchases a popular route where buyers want to avoid historic risks, acquire only part of a business, or achieve particular tax or commercial outcomes.

An asset purchase agreement is the key document governing the transaction. It sets out precisely what is being bought and sold, how the purchase price will be paid, and how risks are allocated between the parties. Typical provisions address the effective time of transfer, apportionments and prepayments, title to assets, restrictive covenants, warranties and indemnities, and the treatment of employees under TUPE (which stands for the Transfer of Undertakings (Protection of Employment) Regulations 2006). The agreement also deals with the mechanics of completion, including conditions precedent, payment arrangements, and protections for both buyer and seller.

A closer look at the fundamental elements of an asset purchase agreement highlights how they can operate to balance the interests of buyer and seller while ensuring clarity and enforceability in the transfer of a business.

The agreement will, fundamentally, set out that the seller agrees to sell, and the buyer to buy, the business and that the buyer is to receive clear title to the assets of the business, free from third-party claims.

There will also be a list of the assets being transferred. Only those expressly identified are included; all others remain with the seller. To avoid uncertainty, asset purchase agreements often include a sweeper clause confirming that any unlisted assets are excluded, to avoid the buyer acquiring anything they don’t want inadvertently. Common exclusions include pre-existing liabilities, cash, certain book debts, insurance policies, and unwanted property.

Typical assets acquired include plant, machinery, vehicles, stock, property, intellectual property, IT systems, contracts, know-how, goodwill, and employees (who usually transfer under TUPE). Each category raises specific considerations, such as insurance for physical assets, valuation methods for stock, consent requirements for contracts and IT, and restrictive covenants to protect goodwill.

By clearly defining what is being acquired, the asset purchase agreement reduces the risk of disputes and ensures continuity of the business after completion.

The purchase price will also be divided between the various assets being bought — such as goodwill, stock, property, intellectual property, and equipment — because each has different tax and accounting treatments. This allocation is usually agreed between the parties’ accountants, with goodwill often attracting the largest share.

To ensure fairness, asset purchase agreements commonly include provisions on apportionments and prepayments:

• Advance receipts. Where the seller has received payment for services to be provided after completion, the benefit passes to the buyer.
• Prepayments. Where the seller has prepaid for goods or services to be used after completion, the buyer will reimburse the seller.
• Periodic income and expenses (e.g., rent, utilities). These are apportioned between seller and buyer on a time basis.

Apportionments are usually agreed post-completion within a short timeframe (often two weeks is a sensible amount of time). One-off payments (such as statutory redundancy entitlements) are excluded. 

The TUPE Regulations protect employees when the business they work for (or sometimes part of it) is transferred from one employer to another by ensuring that their employment also transfers. The agreement will generally contain provisions ensuring that employment costs after completion are for the buyer and those relating to the period prior to completion are for the seller.

Holiday entitlement can create particular complexities because accrued but untaken leave transfers with the employees, and if there is significant holiday accrued this can be a significant cost to the buyer post-completion. To address this, the asset purchase agreement may include apportionment provisions requiring the seller to compensate the buyer for leave accrued prior to completion, although sellers frequently resist on the basis that holiday does not crystallise as a liability until it is taken or employment terminates. In practice, the treatment of holiday entitlement is often negotiated, with buyers seeking protection against unusually high accruals (including carried-forward leave), and sellers limiting their exposure to avoid open-ended liability.

A transfer as a going concern (TOGC) arises where a business is sold as a continuing operation rather than a simple sale of assets. Provided certain conditions are met, such transfers are treated as outside the scope of VAT. Key requirements include (a) that the buyer continues the same type of business without significant interruption; (b) that the business is trading up to the point of transfer; and c) that the buyer is VAT-registered (or becomes so at completion). Where property is involved and the seller has opted to tax, the buyer must also opt and notify HMRC for the relief to apply. Structuring a deal as a TOGC avoids VAT being chargeable on the purchase price, which can have a significant impact on cash flow. Note that there is a window of time after completion for the buyer company to register for VAT if it’s not already done so.

Restrictive covenants are clauses in an asset purchase agreement that stop the seller from immediately competing with the business they have just sold. They usually prevent the seller from setting up a rival business, poaching customers or suppliers, or hiring staff for a set time and possibly within a certain area (though the latter depends on the type of business – with an online/international business a geographic restriction may be irrelevant).

These restrictions must be limited to what is necessary to protect the goodwill the buyer has paid for. If they are too broad in scope, geography or duration, they may not be enforceable.

When buying a business through an asset purchase agreement, the buyer usually asks the seller to give warranties – promises about the state of the business and its assets (for example, ownership, contracts, employees, or tax). If these turn out to be untrue, the buyer may be able to claim compensation. Warranties also encourage the seller to disclose any problems upfront, so the buyer can decide whether to renegotiate or walk away.

In some cases, the buyer will also ask for indemnities, which are stronger protections. These require the seller to cover specific risks on a pound-for-pound basis, such as tax or employee claims.

Yes, sellers will usually try to limit their liability, for example by capping the total amount they could be asked to pay, excluding very small claims, or setting time limits for making claims. Increasingly, buyers and sellers also use warranty and indemnity insurance, which lets the buyer claim from an insurer rather than the seller, helping to reduce disputes and give the seller a cleaner exit.