This glossary is intended to help explain some of the terms used throughout the guide, and it’s also meant to help business owners familiarize themselves with the kind of legal language they’ll be exposed to during the acquisition process. To accomplish both goals, each defined term in this glossary that is likely to appear as a defined term in an Asset Purchase Agreement includes a “legal definition” that shows how the term may be defined within the Agreement and a “plain English” definition that explains the legal definition in non-legalese terms. Those terms that only have a “plain English” definition are important to know for purposes of this guide, but may not be defined terms within the Agreement. Readers should note that the legal definitions used in a particular deal may be different than the legal definitions provided here, especially if the defined term is a negotiated one.
Legal Definition: “Affiliate” means, with respect to a specified Person, (a) any other Person directly or indirectly controlling, controlled by or under common control with such Person; or (b) if such specified Person is an Entity, any director, executive officer, partner, trustee or other fiduciary of such Entity. For purposes of this definition, “control” (including “controlling”, “controlled by” and “under common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, by contract or otherwise.
Plain English Definition: An Affiliate of an entity may include a parent, sibling, or subsidiary company, as well as any person associated with the entity who has the power and authority to cause the entity to act or refrain from acting.
Plain English Definition: An Asset Acquisition is one of the two ways a transaction can be structured, with the other being a stock sale. Asset Acquisitions involve the transfer of the Business’s assets to a separate entity, which effectively creates a new business that is, in most situations, separate and distinct from the Seller’s company.
Purchased Assets: The Purchased Assets shall include, without limitation, the following assets of Seller…all of Seller’s rights under the Contracts identified in Section x.x of the Disclosure Schedules.
Disclosure Schedules: [Contract title] between Seller and [other contract party] dated [date of contract] (each contract is specifically identified in this manner in the Disclosure Schedules).
Plain English Definition: This term is used as shorthand to refer to the group of contracts the Buyer has agreed to assume as part of the acquisition. The Assigned Contracts are typically defined in the Purchased Assets section of the Agreement and in the related Disclosure Schedules. In some purchase agreements this concept is captured using the term “Assumed Contracts.”
Plain English Definition: An assignment occurs when one party to a contract transfers all of its rights and responsibilities under the contract to some third party. Some contracts may limit the ability of one or more contract parties to make an assignment, in which case the party that wants to assign the contract must obtain permission from the other contract party or parties for the assignment to be effective.
Legal Definition: As of the Closing Date, Purchaser will assume only the following Liabilities, commitments and obligations of Seller and will not be responsible or liable for any other Liabilities or obligations of Seller or the Business (collectively, the “Assumed Liabilities”): (i) any Liabilities under the Assumed Contracts arising or to be paid or performed after the Closing Date (other than to the extent that any such Liability results from any breach of or default under an Assumed Contract by Seller occurring prior to the Closing Date, whether claimed or alleged before or after the Closing Date); (ii) the Indebtedness, but only to the extent and in the amount that is reflected in the Closing Working Capital (as finally determined and set forth in the Final Closing Statement); and (iii) those additional current Liabilities expressly included in the Closing Working Capital (as finally determined and set forth in the Final Closing Statement) but only to the extent of the amount of such Liability set forth therein. Notwithstanding the foregoing, Purchaser shall not assume any Liability (or portion thereof) to the extent arising from any violation of Law, or from a Proceeding or Order occurring prior to the Closing Date.
Plain English Definition: Asset acquisitions aren’t strictly limited to assets; certain liabilities will also be transferred to (i.e. “assumed by”) the Buyer as part of the sale. Typically, the list of Assumed Liabilities is short and does not include any Liabilities not specifically mentioned in the list.
Plain English Definition: This term is used in the representations made by both Buyer and Seller to communicate that each has the legal ability to enter into the Agreement and take the steps necessary to complete the transaction. These are often considered “fundamental representations” because if either party does not have the necessary authority the entire deal will be invalidated.
Balance Sheet Date
Legal Definition: The balance sheet of Seller as of December 31, 20XX, is referred to herein as the “Balance Sheet” and the date thereof as the “Balance Sheet Date.”
Plain English Definition: This is the date of the most recent audited or reviewed balance sheet for the Business. The date is used as a benchmark for certain representations and covenants because it is the most recent date for which the Business’s financials have been evaluated by an independent third party.
Legal Definition: Indemnifying Party shall not be liable to the Indemnified Party under Section x.x(i) until the aggregate amount of all Damages in respect of indemnification under Section x.x(i) exceeds Fifty Thousand Dollars ($50,000) (the “Basket”), in which event Indemnifying Party shall be liable for Damages in excess of the Basket.
Plain English Definition: The Basket sets the minimum amount of damages that must be reached by one party in order for it to bring an indemnification claim.
Legal Definition: The aggregate amount of all Damages for which the Indemnifying Party shall be liable to the Indemnified Party under (i) Section x.x(i) shall not exceed Two Million Dollars ($2,000,000) (the “General Cap”); and (ii) Section x.x, in the aggregate, shall not exceed Ten Million Dollars ($10,000,000) (the “Aggregate Cap”).
Plain English Definition: The Cap sets the maximum amount of damages that will be owed by either party for all indemnification claims. As shown in the Legal Definition, there can be separate caps for different categories of claims. For example, a representation that could result in major liability if it turned out to be false could be excluded from the General Cap but remain limited by the Aggregate Cap.
Plain English Definition: CERCLA is an acronym that stands for Comprehensive Environmental Response, Compensation, and Liability Act, which is the federal law that governs the cleanup of land that has been damaged by hazardous materials. Under the law, a list of sites with such damage is maintained by the federal government (the “National Priorities List”). CERCLA is relevant to business acquisitions because it can create liability for the Buyer if land used by the Business after the acquisition has been damaged by hazardous materials in the past, especially if the land in question is on the National Priorities List.
Change of Control
Plain English Definition: A business undergoes a “change of control” when a certain specified level of its shares change hands, or when it sells all or substantially all of its assets. The term is important in the context of an acquisition because some of the Business’s contracts may prohibit a change of control, in which case the contracts in question would be terminated on the Closing Date unless the third parties to the contracts consent to the change of control. Change of control provisions serve the same purpose as prohibitions on assignment, but they go further by extending the consequences to stock sales that involve a change of the majority owner.
Plain English Definition: These are potential liabilities that may materialize in the future due to the occurrence of some uncertain future event. One big reason buyers prefer asset sales is because they can select which assets and liabilities are included in the purchase, which allows them to limit their exposure to the risk presented by contingent liabilities.
Plain English Definition: This is simply a promise to do something or to refrain from doing something. Common covenants made in connection with an acquisition include non-competition covenants, confidentiality covenants, and “further assurances” covenants.
Plain English Definition: Disclosure Schedules are used to allow both parties to tell the other side about facts and circumstances that, if not disclosed, would make a representation or warranty untrue. They are often seen as a “get out of jail free” card because anything appearing on the Disclosure Schedules cannot, by itself, form the basis for an indemnification claim.
Plain English Definition: This is a tool that is used to tie a portion of the Purchase Price to some future performance metric. For example, if a Buyer is focused on building top line growth, it might offer the Seller an extra $1 million if annual revenue grows by 20% within 2 years of the Closing Date. Earnouts are often used when the Buyer’s valuation of the Business is substantially less than the Seller’s, because they allow the parties to tie the Purchase Price to actual future value rather than just guessing at that value. However, the usefulness of Earnouts is typically limited to situations where the Seller is staying involved in the Business post-Closing because sellers want to have as much control as possible over whether the earnout is achieved.
Legal Definition: “Encumbrance” means any lien, pledge, hypothecation, charge, mortgage, security interest, claim, option, right of first refusal or other similar encumbrance or imperfection of title.
Plain English Definition: Any right held by a third party that allows that party to restrict the use or transfer of some piece of property can be deemed an Encumbrance.
Plain English Definition: An equitable remedy is a non-monetary form of relief that can be granted by a court of law, such as an injunction or restraining order. The underlying principle behind equitable remedies is that money cannot always fully compensate someone for a loss, so the ability to compel or restrict certain actions is necessary to accomplish a fair result.
Plain English Definition: An escrow arrangement, in the context of an acquisition, involves placing a portion of the Purchase Price in the hands of an impartial third party along with clear instructions about when and to whom the money can be released.
Legal Definition: Seller shall retain all right, title and interest in and to all assets other than the Business Assets (collectively, the “Excluded Assets”), including, without limitation, the following assets: [the Agreement then goes on to list out specific assets that are excluded from the acquisition].
Plain English Definition: These are the assets that remain with the Seller after the Closing. Typically, the list will be framed as a catchall (e.g. “all assets other than the Business Assets”), but Excluded Assets that are especially valuable to the Seller or that could cause headaches for the Buyer will be listed out explicitly so there is no confusion whatsoever about whether they’re included in the purchase.
Legal Definition: Anything to the contrary in this Agreement notwithstanding, the Parties expressly agree that, except with respect to the Assumed Liabilities, Purchaser will not assume or otherwise become liable for any Liabilities of Seller or the Business of any nature whatsoever, all of which shall be retained by Seller, whether accrued or unaccrued, whether absolute or contingent, whether known or unknown, whether due or to become due, and regardless of when asserted (collectively, the “Excluded Liabilities”), whether or not any of the same have been disclosed to Purchaser and whether or not any of the same relate to the Business Assets. Seller will discharge when lawfully due the Excluded Liabilities. Without limiting the generality of the foregoing, the Retained Liabilities shall include, without limitation, the following Liabilities: [the Agreement then goes on to list out specific Excluded Liabilities].
Plain English Definition: These are the liabilities that remain with the Seller after the Closing. Like the Excluded Assets, this list is framed as a catchall so that any liabilities not specifically identified as Assumed Liabilities will not be transferred to the Buyer. The legal definition shown above includes language requiring the Seller to take care of any obligations related to the Excluded Liabilities because the failure to do so could have negative ramifications for the Business moving forward.
Plain English Definition: Exclusivity clauses prohibit the ability of the Seller to solicit, facilitate, and/or accept third party offers for the Business. While the exact restrictions will vary, the intent is always to provide enough security to the Buyer for it to feel comfortable investing the time and money necessary to complete the transaction.
Legal Definition: “GAAP” means United States generally accepted accounting principles in effect from time to time.
Plain English Definition: These are a set of standard principles that must be followed in order for a business’s financial statements to be “GAAP-compliant.” While public companies comply with GAAP because doing so allows investors to evaluate separate companies on relatively equal footing, many private companies do not because doing so would add extra costs to operations without adding any value for management or owners.
Plain English Definition: Goodwill is the value of the Business over and above the identifiable value of its assets and liabilities. It will usually be listed as a separate Purchased Asset and its value will be amortized by the Buyer to reduce the tax burden on the Business.
Legal Definition: “Governmental Order” means any order, restriction, judgment, consent, approval, license, registration, security clearance, authorization, certificate or permit issued, granted, given or otherwise made available by or under the authority of any Governmental Authority or pursuant to any Law.
Plain English Definition: Depending on the nature of the Business and the transaction, various governmental bodies have the ability to obstruct or facilitate a sale of a business. The Agreement addresses the potential impact of a Governmental Order by outlining the consequences that will result from either (i) a party failing to obtain a necessary license or permit granted by the government, or (ii) the government placing restrictions on or blocking the transaction.
Plain English Definition: The concept of indemnification is straightforward: if Person A loses money because of something Person B did, B must reimburse A for the amount of its loss. While there are some additional complexities to that scheme when it is used in the context of an acquisition, the appeal of indemnification is that it gives both parties a relatively quick, cheap, and simple method for making complaints and receiving reimbursement for problems caused by the other side.
Plain English Definition: This is a legal remedy that prevents the person subject to it from taking some sort of action, such as disclosing confidential information. In the transaction context, injunctions are often the remedy of choice for a violation of restrictive covenants because the damage suffered by the Business as a result of such a violation is difficult, if not impossible, to measure.
Plain English Definition: An investment vehicle is a business entity that is set up so that multiple investors can direct a specific amount of money to an investment while limiting their liability. It’s important for sellers to know when an investment vehicle is being used by the Buyer because it will impact the meaning of the Buyer’s representations and warranties. If unaware, the Seller may not receive the full protection it thinks is provided by the representations and warranties.
Plain English Definition: This term is used to describe a situation in which the Seller’s liability is tied to what the Seller knows or should know, and its function is to manage the Seller’s risk. Knowledge qualifiers are generally included where it would be unfair to ask the Seller to represent that a set of facts is 100% accurate. For example, sellers are asked to represent that nobody is infringing on the intellectual property of the Business, but it is impossible to make that representation with 100% certainty, so instead the Seller represents that it does not have knowledge of any intellectual property infringement.
Material Adverse Effect (MAE)
Legal Definition: “Material Adverse Effect” means any condition, change, circumstance or event that, individually or in the aggregate, has had or could reasonably be expected to have a material adverse effect on (a) the assets, properties, business, prospects, results of operations or financial condition of Seller or the Business, or (b) on the ability of Seller to perform in all material respects its obligations under this Agreement.
Plain English Definition: This term is used to represent the idea that the Business could experience a significant downturn, and its purpose in the Agreement is to help the Buyer manage risk. It may appear as a qualifier to a Seller representation or as an “out” for the Buyer, but in either case it provides the Buyer with a certain level of comfort that the Business it agreed to buy is the Business it will receive on the Closing Date.
Plain English Definition: Materiality qualifiers are used in the Agreement to set a bar for when a certain change or shortcoming is significant enough to act upon. In doing so, they allow sellers to rest easy knowing that they will not be on the hook for some minute inaccuracy, and they give buyers similar comfort knowing that they have some recourse if an inaccuracy or failure ends up negatively impacting the Business in a meaningful way.
Legal Definition: “Permitted Encumbrances” means: (a) liens for Taxes and other governmental charges and assessments which are not yet due and payable; (b) liens of landlords and liens of carriers, warehousemen, mechanics and materialmen, construction and other like liens arising in the ordinary course of business consistent with past practice for amounts that are not delinquent and which are no, individually or in the aggregate, material to the Business or the Business Assets; and (c) liens arising under original purchase price conditional sales contracts and equipment leases with third parties entered into in the ordinary course of business consistent with past practice which are not, individually or in the aggregate, material to the Business or the Business Assets.
Plain English Definition: Encumbrances can make a clean transfer of assets exceedingly complicated or even impossible, but not all Encumbrances will have such a devastating effect on the transaction. This term is used to distinguish between benign Encumbrances, which are allowed to exist on the Closing Date, and those that can interfere with the deal, which are not.
Promissory Note (or Seller Note)
Plain English Definition: A Promissory Note (also called a Seller Note) is a form of seller financing that allows the Buyer to pay a portion of the Purchase Price, plus interest, over a set time period after the Closing.
Legal Definition: Subject to the terms and conditions set forth herein, at the Closing, Seller hereby agrees to sell, transfer, assign and deliver to Purchaser, and Purchaser hereby agrees to purchase from Seller, all right, title, ownership and interest in the Purchased Assets, free and clear of all Encumbrances, except for Permitted Encumbrances. The “Purchased Assets” means all of the assets, properties, rights, privileges, and claims of Seller of every kind and nature, real and personal, tangible and intangible, absolute or contingent, wherever located, to the extent such Purchased Assets are in any way associated or used in connection with or related to the Business, including without limitation the assets set forth in Exhibit B (the “Asset Schedule”), but expressly excluding the Excluded Assets. The Purchased Assets shall include, without limitation, the following assets of Seller: [the Agreement then goes on to list specific categories of assets].
Plain English Definition: The Purchased Assets definition dictates which assets will be purchased as part of the transaction. The parties should pay special attention to whether the list is all-inclusive or whether the Purchased Assets include all assets not specifically listed as Excluded Assets, as that distinction will determine how exhaustive and precise the list of Purchased Assets needs to be.
Reasonable Best Efforts
Plain English Definition: This term is used to communicate the minimum standard of effort that the parties must use in carrying out certain obligations under the Agreement. What constitutes “reasonable best efforts” is usually not defined in the Agreement, as most parties do not want to determine what would be reasonable in a given situation before knowing the context of the situation. Instead, they use a flexible standard that sets a relatively high bar for the amount of effort that must be used in carrying out each side’s obligations.
Plain English Definition: This term describes a representation that must be made by both parties within the Agreement. Because the subject matter is the same, the language of each representation will typically mirror one another. The result is that the Buyer must be willing to speak to anything it asks the Seller to make a representation about, and vice versa.
Representations & Warranties
Plain English Definition: Representations and warranties are statements made by both parties within the Agreement that speak to specific aspects of their respective businesses. The Seller’s representations and warranties are much more extensive than the Buyer’s because the Seller’s company is the subject of the acquisition. While the Buyer wants to know all about the Seller’s Business, from IP to employment issues, the Seller mainly wants to know whether the Buyer can legally complete the transaction and make the payments required by the Agreement.
Legal Definition: “Representative” means, with respect to any Person, any and all directors, officers, members, managers, partners, equity holders, employees, consultants, financial advisors, lenders, counsel, accountants and other agents of such Person.
Plain English Definition: The Representatives of the Buyer and Seller are the individuals working on behalf of each respective entity to contribute to the transaction. Because “Person” includes both the Buyer and Seller entities, Representatives include the leaders of those entities as well as others working on and providing advice about the acquisition, including the accountants, attorneys, and intermediaries involved in the deal.
Plain English Definition: Money can move both ways in connection with a transaction, but invariably the majority of funds will flow from Buyer to Seller. In dealing with payments that do move the opposite way, many parties prefer to allow the amount due to cancel out the next payment to the Seller rather than actually having to move that money back and forth between Buyer and Seller. The right to reduce that future payment to the Seller to the extent money is currently owed to the Buyer is called a “set-off right.”
Plain English Definition: Specific performance is an equitable remedy that requires the person or entity subject to it to perform a promise they’ve made in a contract. It is most useful in situations where money damages are difficult (or impossible) to calculate and forcing performance will not lower the quality of performance, such as in the sale of a business.
Plain English Definition: A stock sale is one of the two transaction structures that can be used to purchase a business. This structure involves the sale of the actual ownership interests in the Seller’s company rather than the sale of the underlying assets owned by the company. The result is that the Buyer controls a business that is viewed (in most situations) as the same business previously owned by the Seller.
Plain English Definition: This term describes a situation where the Buyer and Seller have fundamentally different opinions on the value of the Business. While not uncommon, if the differences are significant enough they can create a disconnect between Buyer and Seller about the appropriate Purchase Price that may be difficult to overcome.
Legal Definition: The Worker Adjustment and Retraining Notification Act of 1988, as amended.
Plain English Definition: The WARN Act is a federal law that requires employers covered by the law to provide notification to certain employees and governmental agencies if the sale of the Business will result in large layoffs or plant closings.
Plain English Definition: This term is used to describe the difference between the value of a business’s current assets and current liabilities. The concept is used as a quick way to evaluate the short-term health of a business, and in the context of an acquisition it will determine whether or not the Buyer needs to pour more money into the Business immediately after the purchase.
Plain English Definition: The purpose of this tax election is to allow a transaction that is structured as a stock sale to be treated as an asset sale for tax purposes. The typical result of such treatment is a lower overall tax on the transaction, but a higher tax burden on the Seller (who will typically seek some compensation from the Buyer for its higher tax bill).