Take 5: Considerations When Negotiating An Asset Purchase Term Sheet
Perhaps you are seeking to grow rapidly and have identified a business whose assets you’d like to acquire. Or you’ve received an offer too good to pass up. Congratulations! But now comes the next step, negotiating the Asset Purchase Term Sheet. A Term Sheet is a document that memorializes the early stages of an agreement between parties and provides the fundamental terms and conditions of a transaction. Below is a brief overview of several factors to consider when negotiating an Asset Purchase Term Sheet:
1. Acquired Assets. One of the primary considerations when negotiating an Asset Purchase Term Sheet is defining the scope of the Acquired Assets. The Term Sheet should explicitly outline what is included in the deal and, equally crucial, what is not. Common elements often included in the definition of Acquired Assets are tangible assets such as inventory, equipment, and real estate as well as intangible assets including assumed liabilities, intellectual property, customer lists, and contracts. On the flip side, excluded assets might involve specific liabilities, contingent liabilities, or assets that the seller wishes to retain.
2. Assumed Liabilities. It is important for the Term Sheet to address which liabilities the buyer is willing to assume. Buyers typically prefer to assume only certain specified and definite liabilities, such as contractual obligations or identified debts, while leaving other liabilities with the seller. While a seller wants to rid itself of as many liabilities as possible, it also may attempt to limit the scope of assumed liabilities to enhance the attractiveness of the deal. To address this, the Term Sheet and final deal documents may include indemnification provisions, escrow arrangements, or specific representations and warranties that allocate responsibility for known and unknown liabilities. Initially addressing these considerations in the Term Sheet allows for a smoother due diligence process and mitigates the risk of unexpected liabilities surfacing post-closing.
3. Purchase Price. Determining and defining the Purchase Price is, obviously, an integral part of any Asset Purchase transaction, and the Term Sheet should provide a framework for understanding and calculating the value of a deal. Common methods for determining the purchase price include 1) a fixed amount; 2) a price based on financial metrics (such as EBITDA or revenue multiples); or 3) a combination of fixed and contingent payments tied to performance metrics post-closing. Earn-out provisions, where a portion of the purchase price is contingent on the target company achieving specific financial or operational milestones, are also frequently used. Other considerations in purchase price negotiations include the form of payment (cash, stock, or a combination), adjustments for working capital, and potential purchase price holdbacks or escrows to secure against post-closing indemnification claims.
4. Closing Conditions. Closing conditions are the prerequisites that must be satisfied before an Asset Purchase can be finalized and it is important to include these conditions in the Term Sheet. These conditions serve as safeguards for both the buyer and the seller, ensuring that critical elements are in place for the successful completion of the transaction. Typical closing conditions include the buyer’s satisfactory completion of its due diligence, obtaining necessary regulatory approvals, securing third-party consents (such as from key customers, suppliers, or a landlord if leased property is involved), and ensuring the accuracy of representations and warranties. Financial conditions, such as the absence of material adverse changes or the delivery of audited financial statements, are also commonly included.
5. Non-Competition Covenant. The inclusion of a non-compete covenant is often a sticking point in Term Sheet and deal negotiations. This provision restricts the seller from engaging in competitive activities within a specified geographic area and time frame. From the buyer's perspective, a non-compete covenant is a valuable and necessary tool to protect the acquired business's goodwill and customer relationships. However, sellers may be hesitant to agree to overly restrictive covenants that limit their future business opportunities. Key considerations include the duration of the non-compete, the geographical scope, and the specific activities prohibited.
This article is meant only as a brief introduction of factors to consider when negotiating an Asset Purchase Term Sheet. If you have specific questions about an asset purchase or other type of acquisition or would like assistance with reviewing or drafting a Term Sheet, we’d love to connect!
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