What is a Purchase Agreement:
A Definitive Purchase Agreement (DPA), also more commonly referred to as a Purchase Agreement (PA) or Purchase Contract, is the primary legal document that outlines the transfer of ownership of a company or assets from one party to another. There are two main types of purchase agreements: (1) Share Purchase Agreement (SPA), for when a seller transfers the shares of the entity into the name of the buyer, and (2) Asset Purchase Agreement (APA), for when an individual or collection of assets are transferred from the seller to the buyer, rather than the entire company. In this article, we will explore the most common type of Purchase agreement used in car wash M&A, an Asset Purchase Agreement.
An Asset Purchase Agreement is a legal document that outlines the terms and conditions of a transaction in which one party (the buyer) acquires the assets of another party (the seller). This agreement is commonly used in business transactions, allowing for the transfer of specific assets such as equipment, inventory, intellectual property, customer lists, land, buildings and more. The purpose of the APA is to clearly define the rights and obligations of both parties involved in the transaction, providing a framework for the transfer of assets, and minimizing the potential for disputes after closing.
Typical Components of an Asset Purchase Agreement:
1. Introduction and Background
The agreement typically begins with an introduction that identifies the buyer and the seller. It may also include a background section providing context for the transaction, such as the purpose of the sale and any relevant history between the parties.
2. Definitions
To ensure clarity and avoid misunderstandings, an APA commonly includes a section defining key terms used throughout the agreement. This may include terms specific to the industry or transaction, as well as general legal terms.
3. Purchase Price and Payment Terms
The purchase price and payment terms are fundamental elements of an APA in a business transaction. They outline the financial aspects of the deal, specifying the total consideration for the assets being sold and the terms under which the payment will be made. This section is crucial for both parties to understand their financial obligations and expectations.
The purchase price terms are typically outlined as follows:
- Total Purchase Price: The APA specifies the total dollar amount that the buyer will pay to the seller for the assets. This can be a fixed amount, or it may be determined by a formula based on factors like earnings, working capital, or other financial metrics.
- Adjustments and Prorations: The agreement may include provisions for adjusting the purchase price based on certain factors. For example, there could be adjustments for changes in the value of inventory or gift cards outstanding between the signing and closing dates.
- Earnouts: Earnouts are provisions that link a portion of the purchase price to the future performance of the business. The buyer may agree to make additional payments to the seller based on the achievement of specific financial or operational milestones.
- Allocation of Assets: The APA may specify how the purchase price is allocated across the different categories of assets being acquired. This allocation can have significant tax implications for both the buyer and the seller.
- Form of Consideration: The purchase price may be paid in various forms, such as cash, stock, promissory notes, or a combination of these. The form of consideration is negotiated based on the preferences and circumstances of the parties.
The payment terms are typically outlined as follows:
- Payment Structure: The APA outlines the structure of payments, including whether the purchase price will be paid in a lump sum at closing or in installments over time. Installment payments may be tied to specific events or milestones.
- Holdbacks: Holdbacks involve withholding a portion of the purchase price in a third-party escrow account for a specified period, typically to cover potential post-closing adjustments, address certain contingencies, or indemnify the buyer for potential breaches of representations and warranties by the seller.
- Closing Date Payment: The APA defines when and how the initial payment or closing payment will be made. This is typically on the closing date but may be subject to adjustments based on the finalization of certain matters.
- Interest: If there are installment payments or deferred payments, the agreement may specify whether interest will accrue on the unpaid balance and the terms of such interest.
- Currency and Method of Payment: The APA indicates the currency in which the purchase price will be paid and the method of payment, such as wire transfer or check.
- Adjustment Mechanisms: The agreement may include mechanisms for adjusting the purchase price based on factors like working capital, indebtedness, or other financial metrics at the closing.
- Security for Payments: In some cases, the buyer may provide security for payment, such as a personal or corporate guarantee, to assure the seller that the agreed-upon payments will be made.
4. Outline of Assets, Liabilities and Risk Allocation
This section outlines the assets being sold, including a detailed description of each asset. It specifies whether tangible assets (e.g., equipment, real estate) or intangible assets (e.g., patents, trademarks) are included in the transaction. This section also outlines and addresses potential liabilities associated with the assets. The agreement may specify which party is responsible for certain risks or liabilities, and it often includes indemnification provisions to protect the parties in case of unforeseen issues.
5. Representations and Warranties
Both the buyer and the seller provide assurances to the other party regarding various aspects of the transaction and the assets being sold, including the accuracy of information and the condition of the assets. Representations are statements of fact made by each party, while warranties are promises regarding certain aspects of the transaction. These assurances help build trust between the parties and serve as a basis for legal recourse in case any statements are later found to be untrue. It is common for the seller to make significantly more representations and warranties than a buyer. Below are common Reps and Warranties that are typically outlined in an APA:
Buyer and Seller Representations and Warranties
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Financial Statements
The seller often represents the accuracy of its financial statements, stating that they present a true and fair view of the financial condition of the business. | Authority
The buyer represents that it has the legal authority and capacity to enter into the agreement and to fulfill its obligations under the APA. |
Ownership and Title
The seller represents that it owns the assets being sold, and these assets are free and clear of any liens or encumbrances unless otherwise disclosed. | Funds Availability
The buyer may represent that it has the necessary funds or financing in place to complete the purchase as outlined in the agreement. |
Contracts and Liabilities
The seller may represent that it is not in breach of any material contracts and that there are no undisclosed liabilities that could significantly affect the business. | Due Diligence
The buyer may make representations about the extent and results of its due diligence investigation, stating that it has had the opportunity to examine the seller's books, records, and operations. This time for examination is referred to as the diligence period. |
Compliance with Laws
The seller represents that it is in compliance with all applicable laws and regulations related to its business operations. | No Litigation
The buyer may represent that, to its knowledge, there is no pending or threatened litigation that could significantly impact the transaction. |
Materiality and Material Adverse Changes
The representations and warranties often include qualifiers related to materiality. Certain breaches or inaccuracies may only be relevant if they are considered material to the overall transaction. The agreement may also address the concept of a material adverse change (MAC) and specify the conditions under which a change in the business between signing and closing could allow the buyer to reconsider or renegotiate the deal.
Survival Period
The representations and warranties are not open-ended. They have a specific duration, known as the survival period, after which they are no longer applicable. The survival period is the timeframe during which a party can make a claim for a breach of representations and warranties.
Disclosure Schedules
The seller often provides disclosure schedules that qualify or except certain matters from the representations and warranties. These schedules identify any known exceptions or disclosures related to the accuracy of the statements made.
6. Covenants
Covenants are promises or commitments made by the parties to take specific actions or refrain from certain activities (restrictive covenants) before, during, or after the completion of the transaction. This section may include:
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Covenants are contractual promises or commitments made by one party to another. These promises can cover a wide range of actions or behaviors and are intended to ensure that the parties fulfill their obligations under the agreement. | Restrictive covenants, also known as negative covenants, impose limitations on the actions or activities of one or both parties. These limitations are intended to protect the interests of the other party or prevent certain actions that could be detrimental to the agreed-upon transaction. |
Affirmative Covenants
These are promises by a party to take certain actions or meet specific obligations. For example, a buyer may covenant to maintain certain financial records after acquiring a business. | Non-Compete Agreements
These covenants prohibit one party, typically the seller, from engaging in business activities that directly compete with the business being sold for a specified time and within a defined geographic area. |
Negative Covenants
These are promises by a party to refrain from certain actions or behaviors. For instance, a seller may covenant not to compete with the business being sold for a specified period after the sale. | Non-Solicitation Agreements
These covenants prevent one party, often the seller, from soliciting employees, customers, or suppliers of the business being sold for a specified period. |
7. Conditions Precedent / Contingencies
These are the conditions that must be met before the sale can be finalized. Common conditions include regulatory approvals, environmental review, third-party consents, and the accuracy of representations and warranties.
8. Tax Matters
Tax matters play a significant role in a Purchase Agreement (PA), and parties involved in a transaction should carefully address these issues to ensure compliance with tax laws and optimize the tax implications of the asset sale. Below are common tax matters that are typically outlined in an APA:
- Allocation of Purchase Price: The allocation of the purchase price among the different assets being acquired is a critical tax consideration. Both the buyer and the seller have a vested interest in how the purchase price is allocated, as it affects the tax treatment of the transaction. The parties often agree on a specific allocation to tangible and intangible assets, which can impact depreciation, amortization, and capital gains tax.
- Tax Representations and Warranties: The seller usually provides representations and warranties related to the company's tax matters. This may include representations regarding the accuracy of financial statements, the payment of taxes, and compliance with tax laws. The buyer seeks assurances that there are no undisclosed tax liabilities that could affect the value of the assets being acquired.
- Tax Indemnities: To address potential tax liabilities that may arise after the transaction, the APA often includes indemnification provisions related to taxes. These provisions specify which party is responsible for any taxes that arise from events or transactions that occurred before the closing date.
- Transfer Taxes: The APA may address the payment of transfer taxes associated with the sale of certain assets. Transfer taxes can include state or local taxes imposed on the transfer of real property or other specified assets. The agreement may specify which party is responsible for these taxes.
- Employee Benefits and Taxes: If the transaction involves the acquisition of employees along with the assets, the APA may address employee benefits and associated tax matters. This could include issues related to employee retirement plans, stock options, or other employee-related tax considerations.
- Tax Compliance: The seller typically provides assurances in the APA that the company being sold is in compliance with all applicable tax laws. The buyer may require the seller to disclose any ongoing or potential tax audits, disputes, or assessments that could impact the business's financial health.
9. Closing Statement
The closing is the final step in the transaction, where the buyer pays the agreed-upon purchase price, and the seller transfers the assets. This section outlines the logistics of the closing, including:
- Transaction Summary: A summary of the transaction, highlighting the key terms and conditions agreed upon by the parties.
- Date and Location of Closing: Clearly specifies the date on which the closing is taking place, as well as the location where the parties are meeting to complete the transaction.
- Transfer of Assets: Details the specific assets being transferred from the seller to the buyer. This section may reference schedules or exhibits attached to the agreement that provide a comprehensive list of the assets.
- Purchase Price: Outlines the total purchase price for the assets and the agreed-upon payment structure. This includes any adjustments or prorations that may have been agreed upon during the negotiation.
- Payment Mechanism: Specifies the method of payment for the purchase price. This could include wire transfers, checks, or any other agreed-upon form of payment.
- Deliverables: Lists the documents and items that must be delivered by each party at the closing. This may include certificates of title, assignments of contracts, and any other necessary documents to effectuate the transfer of assets.
- Closing Conditions: Verifies that all conditions precedent specified in the APA have been satisfied or waived by the parties. This includes regulatory approvals, third-party consents, and the accuracy of representations and warranties.
- Prorations and Adjustments: Addresses any prorations or adjustments to the purchase price that were agreed upon during negotiations. This may include adjustments for inventory levels, prepaid expenses, or other items with values that change over time. This section will also outline any legal or broker fees to be paid.
- Seller's Deliverables: Outlines the specific documents and items that the seller must deliver to the buyer at the closing. This may include bills of sale, assignment agreements, and any other documents necessary to transfer ownership.
- Buyer's Deliverables: Specifies the documents and items that the buyer is required to deliver to the seller at the closing. This could include the payment of the purchase price, assumption of liabilities, and any other actions necessary to complete the transaction.
- Post-Closing Obligations: Addresses any post-closing obligations or responsibilities of the parties. This may include cooperation in the transition process, the resolution of outstanding matters, or other actions to be taken after the closing.
- Governing Law and Dispute Resolution: Confirms the governing law of the agreement and outlines the dispute resolution mechanisms if any conflicts arise post-closing.
- Signatures: Provides spaces for the authorized representatives of both the buyer and the seller to sign and officially execute the closing statement, acknowledging that the transaction is complete.
10. Indemnification
In the event one party breaches the agreement or if there are unforeseen liabilities associated with the assets, the indemnification section outlines the process by which the responsible party compensates the other.
11. Miscellaneous Provisions
This section covers various legal and procedural matters, such as dispute resolution mechanisms, governing law, and the allocation of expenses related to the transaction.
12. Exhibits and Schedules
Exhibits and schedules are attachments to the agreement that provide additional details or documentation, such as a list of the specific assets being transferred, financial statements, or other supporting documents.
Car Wash Industry Standard Precedents for an APA
The following chart summarizes key agreement terms outlined in a Purchase Agreement that an owner should be comfortable with and willing to accept upon selling your car wash to a new owner. This table was compiled using over 100 closed purchase agreements CWA has represented in the last 3 years and represents the average results achieved for each type of owner who has sold their car wash with Car Wash Advisory.
| Earnest Money Deposit (EMD) | An earnest money deposit (EMD) is a sum of money that a buyer provides to the seller as a demonstration of their serious intent to purchase a property or enter a business transaction. | ≥ 5% | ≥ 2% | ≥ 0% |
| Holdback Amount | A portion of the purchase price in a business or asset transaction that is retained by the buyer or a neutral third party for a specified period after the closing. | 0 – 3% | 1 – 5% | 1 – 5% |
| Non-Solicit | A contractual provision that prohibits one party from actively seeking or soliciting certain individuals or entities identified in the agreement. | ≥ 3 years | ≤ 5 years | ≤ 5 years |
| Non-Compete | A non-compete clause, or non-competition agreement, is a contractual provision in which one party agrees not to engage in certain competitive activities, typically within a specified period and geographic area. | ≤ 3 years
≤ 5 miles | ≤ 5 years
≤ 10 miles | ≤ 5 years
≤ 10 miles |
| Due Diligence Period | It involves reviewing financial, legal, operational, and other relevant information to ensure that the parties involved have a complete understanding of the situation and can make informed decisions based on accurate and reliable data. | ≤ 45 days | ≤ 60 days | ≤ 75 days |
| Closing Period | The time between the signing of a definitive agreement (such as a purchase agreement or merger agreement) and the actual closing of the transaction. | ≤ 15 days | ≤ 30 days | ≤ 30 days |
Conclusion
In summary, an Asset Purchase Agreement is a comprehensive legal document that governs the sale and transfer of assets between parries. It serves as a roadmap for the transaction, addressing crucial aspects by clearly defining the rights and responsibilities of the buyer and the seller. The main goal of an APA is to minimize the potential for disputes and provides a foundation for a successful and legally sound business transaction.
