Asset Purchase Handbook

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Asset Purchase Handbook

Asset purchases are commonly used in financial-advisor M&A transactions. Understanding how purchase price, financing, adjustment mechanisms, tax allocation and client transition work together can help buyers and sellers structure a more successful transaction.

One of the most common structures for the purchase and sale of a financial-services practice
is an asset purchase.

An asset purchase provides considerable flexibility. The parties can identify the assets being transferred, negotiate the payment structure, allocate the purchase price among the transferred assets and establish contractual protections addressing the transition of clients and revenue following closing.

Although every transaction is different, understanding the fundamental components of an asset purchase gives buyers and sellers a useful framework from which to begin negotiations.

Deal Terms

Deal terms can be as unique as the parties themselves.

A transaction may involve some combination of cash at closing, third-party acquisition financing and seller financing. The appropriate structure depends upon the purchase price, the buyer's available capital and borrowing capacity, the seller's objectives, the economics of the acquired practice and the amount of risk each party is willing to accept.

Seller financing is frequently documented through a promissory note payable over a negotiated period following closing.

In financial-services transactions, however, the final amount paid to the seller may also depend upon how successfully the clients and associated revenue transition to the buyer.

That is where an adjustment mechanism becomes important.

The Adjustment Mechanism

An adjustable promissory note—or another form of purchase-price adjustment—can allocate some of the transition risk between buyer and seller.

At closing, the parties establish a benchmark against which the acquired business will later be measured. Depending upon the practice and transaction, that benchmark might be based upon gross revenue, recurring revenue, assets under management or another objectively measurable component of the business.

The important principle is to compare like measurements.

The agreement should clearly identify the benchmark, the measurement period, the adjustment date, the method of calculation and any exclusions from the calculation. The more subjective or complicated the formula becomes, the greater the opportunity for disagreement later.

A common structure provides for an adjustment approximately 12 months after closing, corresponding with the period during which the seller assists with the transition of clients to the buyer.

For example, the parties might agree that no downward adjustment occurs if the applicable revenue at the adjustment date remains at or above a negotiated percentage of the closing benchmark. If revenue falls below that threshold, the remaining purchase price may be reduced according to the formula established in the purchase agreement or promissory note.

The particular percentage, measurement period and formula are negotiated transaction terms rather than universal standards.

The purpose is straightforward: the buyer does not want to pay the full purchase price for revenue or client relationships that do not successfully transfer, while the seller wants certainty that ordinary post-closing business fluctuations will not continually reduce the purchase price.

A properly drafted adjustment mechanism attempts to balance those interests.

What Is Actually Being Purchased?

In many financial-advisor transactions, much of the economic value resides in intangible assets rather than furniture, equipment or other physical property.

Depending upon the circumstances, those assets may include goodwill and other intangible rights associated with the business.

The transaction may also include restrictive covenants intended to protect the value being transferred, subject to applicable state law and other legal limitations.

Another important component is frequently the seller's agreement to assist with the client transition following closing.

The seller knows the clients and their history better than the buyer. An orderly introduction and transition process can therefore be critical to preserving the goodwill the buyer has purchased.

The parties should clearly document the seller's post-closing responsibilities, the duration of those responsibilities and the compensation, if any, associated with them.

Purchase-Price Allocation

The tax allocation of the purchase price is an important—and negotiable—component of an asset purchase.

As an illustrative structure, a financial-advisor transaction might allocate the overall economic consideration approximately as follows:

90% — Individual Goodwill
5% — Consulting/Transition Services
5% — Restrictive Covenant

The appropriate allocation depends upon the particular transaction and should reflect the assets and services actually being transferred or provided.

The tax consequences to buyer and seller can differ significantly depending upon the allocation.

Certain acquired intangible assets may constitute Section 197 intangibles for federal tax purposes and generally may be amortized by the buyer over 15 years. The seller's tax treatment may differ depending upon the nature of the asset, the seller's ownership structure and other circumstances.

Amounts paid for consulting or other services are treated differently from amounts paid for purchased assets.

For that reason, purchase-price allocation should not simply be an afterthought at closing. The buyer and seller should address it during negotiations and document their agreed allocation in the purchase agreement.

The parties generally report an applicable asset acquisition to the IRS on Form 8594, Asset Acquisition Statement Under Section 1060, and their respective reporting should be consistent with the allocation agreed upon in the transaction documents.

Buyers and sellers should work with their respective tax professionals to determine the appropriate allocation and tax treatment for the particular transaction.

The Seller's Transition Role

Closing the transaction does not necessarily complete the sale from a practical standpoint.

The legal transfer of assets may occur on one day. The transfer of client relationships happens over time.

A seller may agree to assist with introductions through letters, telephone calls, electronic communications, meetings or other agreed methods. The parties may also develop a schedule for introducing important client relationships and communicating the transaction to the broader client base.

The scope of that transition role should be clearly documented.

The parties should also distinguish between services intended to facilitate the transfer of client relationships and activities requiring securities, investment-advisory, insurance or other licensing or registration.

Broker-Dealer, RIA and Custodial Considerations

A financial-advisor acquisition does not occur in a regulatory vacuum.

Before completing the transaction, the parties should understand how the contemplated transfer will work within the applicable broker-dealer, RIA, custodial and regulatory framework.

Depending upon the transaction, considerations may include client consent, account documentation, repapering, licensing and registration, privacy obligations, books and records, compensation arrangements, supervisory requirements and the mechanics by which accounts or advisory relationships will transition.

Those operational issues should be considered while the transaction documents are being negotiated—not after they have already been signed.

Post-Closing Transition

Once the transaction closes, buyer and seller generally share an important objective: making the transition as seamless as reasonably possible for clients.

A written transition plan can identify who communicates with clients, when those communications occur, how introductions are handled, which clients require special attention and what role the seller will have during the transition period.

For an agreed period following closing, buyer and seller may effectively work together to move the client relationships from one advisor to another.

The seller brings the history and trust developed with the clients. The buyer brings the platform and service model that will carry those relationships forward.

A successful transition requires both.

Structure the Transaction Before You Document It

Finding the right buyer or seller is critical, but a good match alone does not create a successful transaction.

The parties also need to understand the economics of the deal, allocate transition risk, determine how and when the purchase price will be paid, address tax allocation, define the seller's post-closing responsibilities and coordinate the legal transaction with the operational and regulatory requirements of transferring the practice.

Those issues should be resolved as part of the transaction structure and then reflected carefully in the definitive agreements.

Understanding those fundamentals at the beginning of the process can make negotiations more efficient, reduce misunderstandings and help buyer and seller remain focused on the ultimate objective: a successful transition of the business and its client relationships.

AlphaBridge Law LLC represents buyers and sellers of financial-services practices in transactions involving valuation, deal structuring, negotiations, due diligence, acquisition financing, purchase agreements and post-closing transition planning.

This article is provided for general informational purposes only and does not constitute legal, tax, investment or financial advice. Transaction structures and tax consequences vary based upon the particular facts and circumstances. Buyers and sellers should consult their legal and tax advisers regarding their specific transaction.