Cheapest Insurance Ever: Disclosure Schedules in an Asset Purchase Agreement
Things are looking good: you have accepted an offer on your business, and both you and the presumed buyer have signed a letter of intent. And the good news just keeps coming. The buyer has wrapped up due diligence with no issues surfacing; the bank has issued a loan commitment which meets with the buyer’s approval; and the draft of the asset purchase agreement (APA) and collateral documents are acceptable to both you and the buyer.
So what could go wrong? The answer is “nothing can go wrong now,” but that is not the right question. You should be asking yourself, “What could go wrong 12 months from now?” And the answer to that question is unfortunately “a lot,” especially if you and your attorney have skimped (or even worse, skipped) on the disclosure schedules.
You ask, “What are disclosure schedules?” These are attachments (addendums) which are added to the APA by you, the seller, which memorialize lots of little things which have been reviewed, discussed, and generally agreed upon verbally. If these matters, and there could be many, are not added to the APA in writing, at some point in the future a dispute on one or more of these items could occur. The matter will start as a simple disagreement between you and the seller, and depending on the size and scope of the disagreement, it could result in a lawsuit and/or cause the buyer to withhold payments on the seller note.
As an example, the buyer is thrilled because your largest customer has embraced the sale, and the customer has confirmed your verbal statements that there is a multi-year sales contract in place. What you, the seller didn’t even know, and what your customer did not tell the buyer is that the sales contract can be cancelled on 60 day notice without cause. If you had inserted that sales contract as a disclosure schedule (addendum) to the asset purchase agreement, you would have shifted the responsibility of knowing all there is to know about the sales agreement from you to your buyer. So, if the large customer decides to switch the work historically done by your former company to a new vendor, the buyer will correctly be upset. When he learns that this move is kosher, the buyer cannot accuse you of withholding information (which could result in the buyer looking to you for compensation for lost business) as he, the buyer, had perfect information available to him before closing under a disclosure schedule typically entitled “Contracts with Major Customers.”
You get the picture. You can protect yourself from similar scenarios from potential lawsuits, issues with MIOSHA, environmental matters, pending price increases from vendors; potential union organizing activity, pending retirement of key employees, etc. by disclosing what you know (or ideally what you have in writing) on such subjects as appropriate APA disclosure schedules. The good news about schedules is that there is little to no cost – just your attorney’s review to make sure everything is properly disclosed. The bad news is that the preparation of these schedules is often both tedious and time consuming. However, given the potential cost to you of not taking disclosure schedules seriously, schedule preparation will be the best boring days of your business career.
Contributed by Michael Greengard, Praxis Business Brokers.