Mark Pestronk
Mark Pestronk

Q: I am going to acquire another agency's entire book of business for an earnout equal to a percentage of revenue for three years, which we will pay to the retiring owner. To me, this sounds so simple that I wonder why we need an "asset purchase agreement" with all the boilerplate clauses that lawyers add. Why can't we have a handshake deal or a simple one-page agreement or even our standard independent contractor agreement?

A: In my May 21 column, I explained why seemingly simple earnout formulas can lead to disputes unless the agreement covers all elements of an earnout, including the definition or kinds of revenue or sales to which the percentages apply, the client base, the method or timing of recognition of revenue or sales, the measurement period of months or years and the frequency of payment. All that alone will certainly require more than a one-page agreement.

In addition, there are very important legal considerations when you buy a company's assets, and the agreement must take these into account. Even if you aren't taking any furniture or equipment, a purchase of the intangible assets (book of business, client list, work in progress and the like) makes this a true asset acquisition in the legal sense.

Here's a short list of some legal issues that every such agreement must deal with:

First, you need to know who the seller's owners are and whether they need to consent to the asset sale. If there are multiple owners, the number of owners who must consent depends on the law of the state under which the agency was set up and on any owners' agreement, such as a stockholders' agreement, partnership agreement or LLC operating agreement.

If you don't know who the owners are and what percentage of them must agree to an asset sale, you may end up owning nothing if just one owner signs your agreement.

So the purchase agreement needs a statement by the selling entity about such ownership. In addition, your agreement may require the signatures of most or even all of the owners, and in some cases, you will also need copies of minutes of stockholders' and board of directors' meetings authorizing the sale.

Second, you need to find out whether the selling company owns the assets "free and clear," which means that there are no creditors' or taxing authorities' liens on the assets you are buying. Otherwise, the creditor could repossess the assets or the taxing authority could impose a levy on them, and you may wind up with nothing. So the agreement must state that there are no claims on the assets.

Third, the seller needs to state that the financial information that has been provided is accurate. Otherwise, if the seller exaggerates sales or revenue or understates expenses, there is almost nothing you can do about it.

Fourth, you need the seller to state that there are no pending or threatened lawsuits by creditors like the landlord or claims by government entities like the IRS for withholding taxes or Labor Department claims for overtime or unpaid wages. Otherwise, your agency may be liable to the claimants and may get joined in a suit to stop the sale.

Some buyers tend to think that, if the buyer does a "due diligence" investigation of all these issues, it is not really necessary for the agreement to cover all these points, but that is not correct. Unless the agreement covers the seller's statements about these issues, the buyer will be in a weak position if an unpleasant surprise pops up after closing.
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