Getting the legal side of a business purchase right can mean the difference between peace of mind or potentially a lot of worry post sale, especially if things run into difficulty.
We’ve written before about the basics of the asset purchase agreement (APA) but here we dig in to some of the more advanced thinking on hiring the right counsel and agreeing the best contract for the deal. To help ease your fears over contracts, we have put together this article with the help of Cliff Ennico. Cliff has been practicing law for 25 years in New York and Connecticut and specializes in small business acquisitions. He also has significant first-hand experience in advising on online business M&A.
Hiring The Right Counsel
Hiring good counsel for a business transaction is essential and no more so than in the internet space where the intricacies of acquiring digital assets often requires web experience and creative thinking.
When hiring an attorney, be sure to carefully vet their knowledge of online. Have they ever worked in the space? What precedent transactions?
It’s important they understand the components of the internet business you’re looking to purchase and the considerations (for example intellectual property rights, contract assignability, domains).
It’s important to note that the contract writing and agreement phase typically comes towards the end of the deal process and by then a significant amount of time and effort has been invested on both sides.
Too much hassle in contract review and negotiation can be fatal to a deal and over the years we have seen a number of deals derailed by unreasonable attorney demands.
Some important red flags to look out for:
- Drafting an APA from scratch – if the attorney wishes to write an APA from the ground up this is usually a bad sign, one that they want to rack up billable hours. Most established attorneys will have template contracts which are modified to the specific terms of the deal. This is more than sufficient.
- Represent everything – there are typically a standard set of representations that a purchaser requests of a seller in any given APA. These are, for example, warrants that the seller owners the assets, they are free of any lawsuits or liens and there are no outstanding claims for taxes on the assets. These are customary terms and buyers should be wary if they are removed by the seller’s counsel. That said, if the buyer’s counsel is suggesting the seller guarantees the business’ performance post sale, this should be a red flag which no seller should agree to.
- Refusing to collaborate – inevitably there are terms which will harbour some disagreement between parties. If the seller’s counsel is willing to find a solution collaboratively but the buyer’s attorney is a binary yes/no, then that’s going to create a friction that will turn most sellers to consider going back to find another buyer. Finding a pragmatic lawyer is absolutely essential to getting a deal done.
With the right legal counsel on board, it’s time to get the APA together.
The Asset Purchase Agreement
Drafting the best possible APA for a transaction comes down to two broad themes, 1) ascertaining all the assets to be included and 2) seeking the right assurances from the seller.
Mapping Out The Assets
One of the primary goals of the buyer is to ensure they receive all the assets required to run the business in the same fashion as the seller, from day one. Therefore, mapping out all the elements of the business (assets, accounts, contracts, etc.) and scheduling them into the APA is key.
The strategy for each asset should be threefold, 1) identify 2) ensure ownership and 3) ensure transferability. This should permeate all aspects of the business (from the domain right through to the employee agreements). Some examples of what to consider for the major areas:
Domains – Buyers should look to ensure all the domains are registered in the name of the seller. Any and all relevant extensions (e.g. .net, .org) that the seller might own must be included in the sale. Secondly, buyers should ensure there is adequate time for renewal on any of the domains for transfer. Finally and essentially, conduct a trademark search on the domain names. Any live trademark that another party has that conflicts with the domains for purchase will mean they are liable for dispute at any moment.
Hosting – Buyers should examine the hosting agreement that the seller is signed up to. This includes reviewing the terms of use and checking for the assignability of the hosting contract post sale. This is essential to ensure there is no breach in contract terms and plan for continuity in the transition period.
Content – Buyers should look to examine the top performing content on the website and ensure the owner has the rights to the copy. If it was ghost written by other writers, make sure there are assignments or agreements in place that grant the intellectual property solely to the seller and by extension the purchaser once the assets are sold.
Licences / Plugins / Subscriptions – Most online businesses run on at least 4-5 open source platforms or paid-for subscriptions, some as many as 30+. It’s vital that buyers are aware of the most important of these and ascertain their assignability / transferability in the event of a sale as well as any specific obligations they might be inheriting from the terms of service. For example, taking on a particular discounted subscription might mean inadvertently accepting a major cost increase in 12 months from now.
3rd Party Associations – This is one of the most important aspects to the legal side of acquiring an online business. It is essential that buyers map out every 3rd party relationship and examine the agreement (written or otherwise) underlying it. Usually if the relationship accounts for >5% of revenue or expenses, this is a good barometer for whether to review it. Ensure that there are no debts outstanding against the agreement, the seller has not breached it in any way (and you by extension when taking over) and that the terms will survive a transfer of ownership.
With all the assets and agreements mapped out, buyers should make sure to include as much of the detail in the form of schedules or exhibits in the APA. A good attorney will request they are all documented and form part of the agreement.
Now it’s time to consider the assurances from the seller.
Seeking Assurances From The Seller
As mentioned above, there are a standard set of representations and warranties that buyers should expect from the seller. These typically include:
- The seller having full power, authority, and ownership to enter into the agreement;
- The seller has obtained all necessary approvals and permits required to the sell the assets;
- The assets are in good condition and repair and are fit for purpose;
- The assets do not:
- contain material that infringes any third party intellectual property rights and in particular copyright, patent and trademark rights;
- do not violate any applicable laws or regulations; and
- are not subject to any lawsuits, threats of litigation, claims, arbitration, investigation or other proceedings at law or in equity, before any court, arbitration tribunal, licensing authority or governmental agency;
- The APA contains no untrue statement of a material fact or omits to state a material fact;
- There are no liens, mortgages, pledges, assessments, security interests, leases, adverse claims, levies, or encumbrances of any kind on the assets; and
- There is no basis for the assertion of any claim for taxes prior to signing which, if adversely determined, would, or is reasonably likely to, result in the imposition of any lien on the assets.
In addition to securing these representations, the buyer should seek indemnification from the seller for any issues arising from the operation of the business prior to closing. Typically the seller agrees to indemnify, defend and hold the purchaser harmless from all liability prior to closing.
The non-compete also forms a very important component of the APA and buyers should be careful to find a ‘restricted business’ definition that both accurately reflects the nature of the business and encapsulates any growth plans they have for the future.
It is important to note that many internet business owners are serial online entrepreneurs and will be very wary of signing any non-compete that is too broad and prohibits them from moving on to new and unrelated ventures.
The restricted business definition can sometimes be the cause of disagreement so it’s important both buyer and seller approach this collaboratively. One thing to keep in mind is always practicality.
In the event of a future breach, it typically costs $10-20K to get a ruling in court so if the breach is not causing material damage to the business, it may not be economically sensible to pursue legal action in any case.
Finally, training and support should be clearly documented in the APA. Leave no room for ambiguity on the expectations the buyer has of the seller. Include language that stipulates the number of hours per week, the time to respond and the nature of services to be provided.
Transition support is one of the largest post sale obligations the seller is likely to have, so having a clearly documented agreement on this is vital.
With all of these in place you should have a solid legal foundation for a successful business purchase and be well protected against any unforeseen events ahead.
Remember that a good APA is a result of collaboration and good legal advice so be sure to approach the legals phase with a flexible mind and good counsel behind you.
Disclaimer: The information contained in this article is not intended to be and does not constitute financial advice, investment advice, tax advice, legal advice or any other advice. You should not make any decision, financial, investments, trading or otherwise, based on any of the information presented in this article without undertaking independent due diligence and consultation with a competent financial advisor. You understand that you are using any and all information available in this article at your own risk.