The Components of a Purchase Agreement
Are you ready to buy a business? Are you a business broker putting together a deal? In either case, you have to know the components of a purchase agreement, a document rich in detail – and enough archaic legal jargon to put a normal, sentient human being to sleep in under five minutes. But these are serious documents, mes amis, and scrimping on the preparation of them is done at your peril.
I recently posted about the wisdom of using a letter of intent to get the ball rolling and that still holds true. But the purchase agreement is different from the letter of intent. Though the letter of intent does – or should – include the most important points of the deal (price, financing, anticipated closing date, etc.), little, if any of the “boilerplate” (default events, cures, timelines for the completion of certain requirements, etc.) is included.
The purchase agreement is the definitive contract that binds the parties and is understood to contain all aspects of the transaction. It is MUCH better to spend a little money on the preparation of a thorough, comprehensive purchase agreement now than it is to spend a TON of money later battling in halls of justice over an issue that, had the purchase agreement been properly drafted, would have been resolved by simply reading the agreement.
That is not to say that a comprehensive purchase agreement will eliminate the possibility of an unhappy party suing your posterior – especially in the United States where, given the proliferation of law degrees, such activity is a growth industry – but it will reduce the likelihood of finding your highly-offended self in front of a judge over a misinterpretation of some innocuous or completely missing aspect of the contract. It is impossible for one post to include a description of every conceivable component of a purchase agreement if for no other reason than that each deal has its own unique aspects that each require their own unique solution but it is possible to describe a general overview that will serve in most instances. (In addition, at the end of this post, you’ll find a way to get a list of addenda and exhibits that I’ll send to you free.)
So let’s get started.
The Basic Components
As with most contracts, a purchase agreement for the acquisition of a business contains certain general categories such as the identity of the parties, a description of the item (business) being sold/purchased, the price, the date and place that the closing will occur, non-compete affirmation and various covenants of the parties. But there is much more involved in an agreement to purchase a business.
Parties to the contract. This is generally the very first paragraph of the agreement that notes the date of the agreement and identifies all the parties to that agreement. I italicize “all” because many agreements include parties other than the seller and the buyer. For example, many times a buyer will want to include certain language in the “commission” or “brokerage” section that, by default, makes the broker a party to the agreement. In such an instance, the broker must be identified and the most logical place to do that is in this first paragraph.
Recitals. This is often referred to as the “WHEREAS” section in which certain statements specific to this transaction are made. For example:
- WHEREAS, Seller operates a _________ business
- WHEREAS, Seller wishes to sell all assets associated with ________ and located _______
- WHEREAS, Buyer wishes to purchase ____________
- WHEREAS, Seller owns _____% of the shares ________.
- NOW, THEREFORE, in consideration, etc., etc., etc.
Definitions. Most thorough purchase agreements will include a list of terms that one or more of the parties feel must be defined. Examples might include “Business Day”, “Intellectual Property”, “Key Individuals”, “Litigation”, “Person”, “Proprietary Process”, etc.
Assets Included. A description of the assets included in the sale as well as any that are specifically not included. An example of the latter might be the company owned Jaguar F-type automobile that the seller’s CEO has been tooling around in.
Liabilities and Obligations. What liabilities and obligations will the buyer assume? What ones stay with the seller?
Operation of the Business. A buyer will generally want a paragraph requiring the seller to covenant to continue to operate the business in a manner that will not jeopardize the business’ value or reputation.
Purchase Price and Allocation. As there are when selling a business, there are tax implications when buying one. The different assets of the business – real property, FF&E (Furniture, Fixtures and Equipment) and goodwill – are taxed differently at sale. Even at the purchase of the business, the wise buyer will have an eye on its future exit. How the purchase price is allocated impacts both buyer and seller differently; as a rule, allocations more favorable to one will be less favorable to the other and financial advisors should be involved to try to negotiate an allocation that is equitable to all parties.
Financing. If the transaction contemplates the seller providing some financing – and most transactions will – that needs to be described in detail. What amount will be financed? Will a government-backed loan be involved? What interest rate and term? Are there prepayment penalties? What happens in the event of default? There are many issues to consider for this section alone.
Post Closing Work. If one or more of the business’ existing owners has agreed to stay on with the business after the sale, what are the terms under which they will continue to work for the business?
Employees. Are the existing employees to be protected? Are accrued vacation days, pay or other benefits to be honored by the buyer?
Closing. Time, date, place and any other details of the closing.
Deliverables. List what is to be delivered by one party to the other.
Study Period and Due Diligence. In most cases, a buyer will have a period of time with which to examine all aspects of the business. This section should include the items the buyer wants to see (shareholder records; corporate documentation; tax returns; financial records; employee, vendor and customer contracts, etc.) It should also include dates by which certain aspects of the due diligence must be completed and how and under what conditions the buyer can terminate the agreement.
Warranties of the Parties. For example, the seller would warrant that the business is duly organized and in good standing; that the signer has the authority to sign and consummate the deal; that the transaction will not violate any law or any restriction in the corporate documents, etc. Similarly, the buyer would make comparable warranties.
Brokerage and Commissions. Whether there is a broker involved or not – and, if so, whether the broker is made a party to the agreement or not – a section describing the involvement or non-involvement of a broker is essential. It should include language indemnifying the parties in the event a claim is made for a commission, referral or other fee post closing.
Non-Competition. A buyer is very likely to want a restrictions prohibiting the seller from competing and poaching employees.
Defaults. What events would result in a default on the part of one party or other? Are there time periods within which the defaulting party is able to cure such defaults? In the even of a default, what are the remedies available to the non-defaulting party? Are penalties to be assessed for certain defaults? Under what circumstances can the non-defaulting party terminate the agreement?
Non-Disclosure. Is the transaction to be kept confidential? (Why a buyer would want this is explained here.)
Assignment. Do either of the parties have the right to assign the contract? If so, what are the restrictions on assignment?
Notices. Most purchase agreements will contain one or more notice requirements. This section provides how each party will accept such notice, what manner of notification (certified mail, fax, overnight courier, etc.) is required and/or permitted, who should the notification be addressed to and, if necessary, who should be copied.
Indemnifications. As a rule, the parties will generally indemnify each other of certain liabilities under certain conditions.
When acquiring a business, the importance of a properly drafted comprehensive purchase agreement – and the review of such agreement by competent legal counsel – cannot be overstated. Though we prepare rough drafts of purchase agreements all the time, we require the party that requested the draft to present it to its legal counsel for review and revision.
The purchase agreement is rarely the only document that is needed for the purchase of a business. There are exhibits, addenda, schedules, etc.; the more complex the business and complicated the deal, the more supporting documents will likely be required.
I’ve prepared a list of some of these documents that are likely to be part of any purchase of a portion of an existing business. This list will not replace the important advisors that the acquisition of a business requires but it will give you a better understanding of the scope of the effort required to complete an acquisition securely and so that the parties involved all feel that their concerns have been addresses fairly. The list is free and will be delivered to your in-box immediately upon telling me in the box below where to send it.
“Competent” Legal Counsel”
Finally, a word about competent legal counsel, the operative word being “competent”.
If you represent a company that is seeking a strategic acquisition, you probably have a legal department or an existing relationship with a business law firm. Good on you, Bucko! But, if you are acquiring a business for the first time and have customarily called your brother-in-law Bernie for basic legal advice in the past, at the risk of Bernie taking offense, make sure the Bern – well, not that Bern! – is well-versed and experienced in business acquisitions. Using your cousin the ambulance chaser or your nephew, the maritime attorney, to handle the acquisition of a business – most likely the largest financial deal you’ll do in your lifetime – is like using an Ear, Nose and Throat guy to replace your kidney. Get somebody whose practice is focused on small and mid-size business law and steer clear of everyone else.
If you have any questions, comments or feedback, I want to hear from you. Put them in the Comments box below. I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week!
The author holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) and can be reached at joe@WorldwideBusinessBlog.com