Asset Purchase Agreements 101
The purchase agreement, accompanied with an operating agreement and the related equity documentation, is a crucial component to a restaurant transaction. An asset purchase agreement outlines in detail the terms and conditions under which the buyer may purchase the assets of a business. An asset purchase agreement must balance the interests of both the buyer and the seller by addressing how the purchase price is allocated among the various assets, how liabilities are transferred to the buyer, and how the buyer will compensate the seller for closely held equity ownership. Parties may also wish to address non-competition and indemnification provisions directly in the asset purchase agreement itself.
An asset purchase agreement will usually be accompanied by a related exhibit documenting the various assets that have been agreed upon to be included in any purchase. This list is typically exhaustive and will include a description of all buildings, furniture, fixtures, equipment and property being purchased, as well as those assets excluded from the deal. It is important to include this list so as to avoid an argument as to whether a particular item is included within the scope of the agreement . That said, for the seller there are sometimes instances where items you want to exclude from the agreement will not be on a purchase agreement exhibit. For instance, take a bar that has an extensive liquor inventory. Often they may not include an inventory of their liquor stock in the initial asset purchase agreement and want to exclude it because they may not wish to transfer it until the restaurant is sold, knowing the buyer would need to start with a full liquor inventory. In these types of scenarios, they may want to use the purchase agreement itself to allow for the sale to be subject to the buyer being able to stock their liquor shelves. Any other omitted items can be addressed in separate provisions and exhibits to the asset purchase agreement.
A stock purchase agreement (i.e., the other common agreement used in connection with a restaurant transaction) involves the buyer purchasing the stock of a company directly from a seller so as to purchase the individual assets of the company rather than the company as a whole. While stock purchases are typically considered less risky than asset purchases, they are also less common in acquisitions of closely held companies due to the assumption of liabilities associated with the company, including payment of capital gains tax.
Elements of a Restaurant Asset Purchase Agreement
An asset purchase agreement is a legally binding contract used when a buyer purchases some or all of the assets of a business from a seller. Assets may include furniture, equipment, real estate, intellectual property, inventory, and goodwill. An asset purchase agreement typically contains many components and provisions specific to the sale.
The most important part of the contract is the list of assets that the Buyer is acquiring because it details exactly what is being purchased. Typical assets include: A strong asset purchase agreement should contain a complete list of all the assets being transferred from Seller to Buyer so that the parties know exactly what is included in the sale. It is important to be as specific as possible to avoid any disagreements after the closing.
The Seller will usually only be responsible for certain, specified liabilities and not all liabilities. The deal is often structured as an asset sale so that the Buyer can pick and choose which liabilities to assume and limit exposure. A lot of liability issues can often be negotiated because both the Buyer and Seller have a high degree of flexibility in determining how to allocate risk in the purchase agreement.
The purchase price is usually one of the first terms to be agreed upon between buyer and seller. There are many ways to structure the sale price, including an all cash transaction, financing the price with seller financing, and/or financing the purchase price through a third-party lender. The majority of sellers will prefer to receive cash or other assets rather than stock in the buyer’s company. In addition to the form of payment, Buyer and Seller will also need to agree on the timing of the payments for the purchase price and that is generally based on cash flow and other sponsor needs. Payments to Seller typically become due at closing and then a deferred payment schedule is outlined in the purchase agreement. If seller will be providing financing to Buyer, then the purchase agreement will need to address the payment terms including principal, interest, prepayment, and applicable remedies for default in payment.
Restaurant Due Diligence
Due diligence is the process by which a potential buyer examines the business operations and legal aspects of a potential purchase to verify the seller’s representations and to identify any potential issue or liability. While the scope of due diligence can be quite broad, in a restaurant asset purchase context, you are looking for an accurate picture of the assets to be acquired and the extent to which those assets are subject to encumbrances, along with an analysis of the current and future liabilities of the business.
Financial Due Diligence
As discussed in prior posts, financial records consist of balance sheets, operating statements, general ledgers and tax filings. The content of these documents can vary from business to business, but generally speaking, the principal goal in reviewing contracts is at least fourfold: As the owner of the business, you have the right to obtain the seller’s books and records for your own due diligence purposes. Make sure you get everything you need, or perceive that you need, before you open escrow.
Employee Contracts
Employee contracts are a big part of any restaurant deal. If there are support staff such as accounting or human resources, find out what contracts are in place and how they will impact your margins, future personnel policies and practices; are there existing conflicts between them and yours? Are they well-drafted? Will they impose unnecessary contract or statutory obligations on you going forward?
Permits
Above and beyond building permits for improvements, every restaurant must meet several other types of health permits, including: liquid waste hauler, grease hauler, grease trap cleaning; grease removal; dry cleaner; bakery goods; poultry and egg products; meat products; seafood and seafood processing; canned goods; bottled water; egg handlers; shredders of recyclable materials; any hazardous materials; etc. There are municipal and county regulations as well. If you plan to change the business or offer new products, your due diligence needs to ensure that the transition will not create any issues with what approvals you need to operate successfully.
Supplier Agreements
If you are assuming supplier and vendor contracts, be aware of how the terms could affect your business going forward. Also, if the supplier or vendor agreements require assigned guarantees, understand how much of an obligation you are assuming and whether you will need to consider factoring these into your purchase financing.
Common Restaurant Asset Purchase Deal Pitfalls
Purchasing the assets of a restaurant can seem like a straight-forward process. However, as there are so many moving parts that are unique to the industry, pitfalls can be easily overlooked. Some of the most common pitfalls that I see involve:
Identifying and Quantifying Assets
The physical assets of a restaurant include furniture, fixtures, equipment, decorations, leasehold improvements, etc. Many times the seller and the buyer have differing values on the assets. For example, the seller may think they could sell their tables for $150 each, while the buyer is thinking $75 each. We recommend that you conduct a formal inventory with a detailed schedule of assets with values attached. You should also include a valuation schedule for future improvements if applicable. If either party is financing, the private lender will likely want a personal guarantee, and will certainly want to see the value of the company’s assets.
Understanding All of the Agreements
We already discussed most of the agreements contained within an asset purchase, but suffice it to say that a thorough review of all material contracts is important so that you do not inherit any unpleasant surprise obligations. What happens if the seller has a franchise agreement? Will the new owner have to be approved by the franchisor? What about any deeds or mortgages on the business premises? Are there any problems with the title? All of these issues can be sorted out within the contract. In some cases, you can enlist the help of an attorney to sort through these potentially complicated and lengthy agreements.
Assignability of Contracts
Contractual agreements will not be assigned to the buyer unless they are expressly allowed to do so. For example, a lease agreement is generally not assignable without the consent of the commercial landlord. If the lessee is not approved by the landlord, the lease could be terminated by the landlord. The majority of leases have express language relating to assignments. If the lease is assignable, there may be a tenant acquisition fee of several thousand dollars.
Fulfilling Tax Obligations
Any outstanding taxes must be satisfied prior to closing the transaction. Generally, the closing agent will obtain a closing invoice, which will detail all of the taxes, licenses, and fees which will be paid on behalf of the seller. A non-payment of required taxes typically results in a lien against the property. Again, the closing agent should be able to provide evidence of any outstanding debt.
Dispute Resolution
Many times disputes arise after closing. We generally recommend to include a dispute resolution provision in your Asset Purchase Agreement. After closing, any disputes between the buyer and seller should be mediated. Our clients have had great success with including mediation clauses in their agreements.
Legal and Regulatory Issues
When drafting a restaurant asset purchase agreement, it is essential to keep in mind that your subject property is likely located in some city or county jurisdiction, which means that the corresponding laws and ordinances will apply. The terms of an asset purchase agreement must comply with all relevant laws and regulations. For example, if your subject property is a brick-and-mortar restaurant, there are probably local zoning requirements , construction guidelines, health and safety regulations, and even liquor license laws to consider. Disregarding local laws may create liability for the purchaser or seller, or both. For this reason, working with legal counsel experienced in negotiating and drafting asset purchase agreements can be a valuable resource for both buyers and sellers of restaurants so they do not run afoul of any compliance issues.
Completing the Purchase Agreement
Negotiating and then finalizing the purchase agreement is a crucial step in the restaurant transaction process. The etymological roots of the term "wrap-up" imply that it is something that can be done in a few moments of time. However, as we discussed in the previous post, there is nothing "wrap-up" about closing on a restaurant deal. It’s a lengthy and involved process that requires careful attention to detail and an understanding of how to get the deal done. Let’s explore the process of actually finalizing the subject purchase agreement.
Negotiating and Finalizing the Purchase Agreement. The seller and buyer’s legal counsel and financial personnel spend substantial time negotiating and revising the purchase agreement leading up to a final version that is suitable for execution. However, even after everything seems good, there is likely one final draft before closing which is a clean version of the agreement documenting the parties’ mutual assent to this iteration of the purchase agreement.
Closing. The closing is the consummation of the restaurant/bars asset sale. It is the point at which the purchase price is paid (either in whole or in part), and the seller and the buyer exchange an executed copy of the purchase agreement and other required documents. The parties may have already worked out the logistics of closing the transaction, so that the closing can be simply a "paper" transaction in which the parties exchange documents—executed copies of the purchase agreement and closing statements, etc.—through their respective attorneys. However, at times the closing is a physical exchange of the purchase price, the keys and other tangible assets of the restaurant, and/or the stock certificate(s)/security instruments with the respective parties (for example, the seller may want to personally escort the buyer through the restaurant premises doing a "hand off" of the establishment just prior to closing).
If the seller is an individual, the closing will be relatively straightforward. However, if one of the parties is an entity (corporation, LLC, etc.), that party will need an individual who is authorized to sign the documents on its behalf. It is advisable to have that person designated in the purchase agreement so that there are no questions about authority when it comes time to close the deal. In the event that a party not designated in the purchase agreement needs to sign, that party will have to designate the signing party as its agent or representative.
At this time, the parties will also review any financing documentation and security documents to determine if any collateral documents such are needed (of course, attorneys will need to review the financing documents for relevance to the transaction and make sure everything is in order). If the buyer is financing a portion of the purchase, it will need to have the financing transaction documents arranged. This process may involve negotiation with the lender and other third parties. Finally, if the transaction includes an inventory transfer, the closing will include an inventory count and transfer.
Post-Closing Matters and Reminders. The parties will be required to file certain forms with state and/or federal agencies to reflect the change in ownership. For example, the state department of revenue will usually require a copy of the closing purchase agreement and notice of the transfer of a liquor license or of the record ownership of a corporation or LLC. Other laws may also require certain notices and filings.
Finally, once the transaction is closed, the buyer should audit the closing materials ("blue folder") to ensure that it has received all of the documents it was supposed to get as part of the acquisition.
Restaurant Asset Purchase Success Story
Maria Noriegas had owned and operated better than average restaurant businesses all over the southeast. Much of her success is due to her insistence that she would only purchase restaurant businesses with A+ demographics. For years she has wanted to buy a restaurant in Greenville, South Carolina, but there hasn’t been much available. That changed one day when she got a call from her favorite restaurant broker. Maria and the broker spent several months and many hours analyzing (and analyzing and analyzing) the potential demographics, location, and potential sales of a particular restaurant in the upstate. The restaurant had been in business for several years but was not profitable. The owner couldn’t make the rent and was ready to leave. He didn’t want to deal with a sale so he hired the broker to do the work and get out. Before Maria knew what hit her, she had discussed so much of the stuff in the first half of this article that she had become a "restaurant professional." So at that point she became nervous about the potential purchase . But Maria and the broker had built a bond of trust and admiration during their long discussions (many hundreds of dollars spent) so they pushed on. They put together a detailed analysis of the demographic studies, plus gave their own descriptions of the location, and drew some conclusions that are probably clear by now. Maria made an offer to purchase the assets of the business, not the stock, for the value of the equipment and furniture – which was less than the owner had in the business. Maria offered to pay 20% down and all cash. And she would pay the broker’s commissions. She wanted a clean break from the old owner. The idea made sense for everyone. The owner would not get the money he and the bank thought the business was worth but he didn’t have to be involved. Maria would be able to acquire the assets and build a new business that didn’t have all the baggage and legacy of the prior owner. The broker got the listing but sold it so he earned his fee and still got to ‘keep’ the restaurant seller relation. It was a match made in strategic planning heaven.