A Guide to the Purchase Agreement for Business Owners
During the sales process, you’ll probably sign a letter of intent (LOI) that initiates the process of due diligence and grants the buyer a limited period of exclusivity. After that, you’ll need to draft a purchase agreement. This incorporates the terms in the LOI, adds negotiated terms and conditions, and will be the point of reference for any issues that arise during or after the sale.
You should rely on an attorney and M&A Advisor to understand this important and complex document, because you will be bound by its terms. This means it’s important to be actively involved in the process. This can be time consuming, and requires some education from your M&A Advisor and lawyer, but it’s time well spent.
A purchase agreement typically contains, at minimum, the following sections:
Definitions: This might appear to be boilerplate, but it’s one of the most important sections. This section defines every capitalized term or word. Many agreement terms are subject to highly subjective understandings of meaning, and the definitions section eliminates any uncertainty.
Economic terms: This section outlines most financial considerations, including purchase price, escrows, purchase price adjustments, earn-out targets, and payment mechanics. Well-defined terms can prevent later disputes, since economic terms often become a subject of disputes.
Warranties, representations, and schedules: At the time of the purchase, both parties will ask one another to assert the truth of certain facts. The seller usually has to make more assurances, so should lean heavily on legal counsel to ensure those facts are true. Your lawyer will be charged with negotiating who makes representations, for what period of time, and how knowledge and materiality are defined. This section often requires extensive supporting schedules.
Indemnifications: This section indicates whether either party will take on liability for the actions of another party. This section is generally designed to protect the buyer against future liability for seller actions. For instance, the seller might indemnify the buyer for the costs of lawsuits arising from the seller’s actions. In some cases, there may be financial limits on indemnification, and the agreement should clearly state those limits.
Post-Closing and interim covenants: This section outlines how the seller and buyer will conduct business during and following the transaction. There are often many covenants constraining the seller’s behavior, such as prohibiting them from hiring new employees or limiting bonuses. The business is valued based on its current state, and covenants aim to preserve that state.
Closing conditions: These are items that must be delivered prior to closing. It might include financial documents, written contracts, regulatory documents, and other documentation. It’s sometimes possible to close without supplying all documents, but only with the express consent of both parties. The lawyers will take control of negotiating closing conditions, and adjusting these conditions if doing so becomes necessary.
This is just a sample of what you can expect from the purchase agreement. This important document must be rigorously negotiated and carefully drafted. Each section could easily yield a multi-page article on its role, so you should rely on your lawyer for more details about what you are signing and why.