The Purchase Agreement

The purchase agreement (PA) is the next major legal document after signing the LOI. The purchase agreement incorporates the terms from the LOI and includes new terms and conditions. It is important for the seller to be involved in understanding and navigating this document, with assistance from an M&A advisor and attorney.

The following sections represent most of the common material terms found in a standard purchase agreement. Since each transaction is unique, yours may include other provisions that are equally important to those outlined below. The sections are ordered as they are generally found, but it varies by legal counsel and the other authors of the agreement.

DEFINITIONS

This section clarifies and defines capitalized terms used throughout the agreement to avoid misunderstandings or disagreements. Every term or word found in the purchase agreement that is capitalized is considered a defined term and should be found in the Definitions section. Clearly defining terms that are especially subject to multiple and highly varied interpretations like Adjusted EBITDA and Net Working Capital is crucial to prevent disputes later on.

“Vague or poorly-worded definitions can lead to major disagreements down the road.”

ECONOMIC TERMS

The Economic Terms section outlines the purchase price, payment methods, earn-outs, escrows, and purchase price adjustments. While these terms ideally should have been agreed upon in the LOI, it is not uncommon for some of them to be introduced after the LOI stage.

The purchase price is traditionally a combination of cash, buyer’s stock, or seller financing. If the buyer is a public company, then this is where the mechanics of how the buyer’s stock will be valued (e.g., average closing price on NYSE for the 10 days prior to the closing date). Negotiations related to earn-out targets, escrows, and purchase price adjustments can cause delays or even halt the process.

REPRESENTATIONS, WARRANTIES, AND SCHEDULES

The Representations, Warranties, and Schedules section involves both sellers and buyers stating that certain conditions and facts are true at the time of sale. Sellers disclose more information to buyers in this section, and their attorneys play a vital role in protecting their interests. Negotiations revolve around who will make the representations, the period they cover, and the definitions of terms like “materiality” and “knowledge.” Sellers aim to minimize personal liability for management or shareholders post-closing.

This section also requires supporting schedules, which provide detailed information and support the representations and warranties. Creating these schedules may involve extensive research and compiling of spreadsheets and materials to aid due diligence.

INDEMNIFICATIONS

Indemnifications are provisions that protect the buyer from future liabilities caused by the actions of the seller before the closing. These provisions require the seller to compensate the buyer for damages resulting from specified actions, such as intellectual property infringement, tax issues, employment matters, and securities issues. Negotiations often revolve around the breadth of actions covered, who provides the indemnification, the duration of the indemnification period, caps on damages, the relationship to escrow, and the materiality of claims.

INTERIM AND POST-CLOSING COVENANTS

Interim and post-closing covenants outline the promises made by the seller and buyer regarding how they will conduct business before and after the transaction. Interim covenants typically restrict the seller from taking certain actions, such as hiring new employees, granting bonuses or salary increases, or making significant purchases. Post-closing covenants may include non-compete agreements, transition services, and ongoing insurance for former management and directors. Non-compete terms can vary widely depending on the seller’s state of residence.

CLOSING CONDITIONS

Closing conditions are a list of items or events that must be completed before both parties sign all the deal documents. These conditions may include obtaining regulatory approvals, securing written consent from landlords, customers, and vendors, and meeting other specific requirements. Although it is possible to close without satisfying all conditions at the parties’ discretion, there may be associated fees.

In conclusion, selling a company involves the preparation and review of various complex documents, and seeking assistance from professionals like bankers, brokers, lawyers, and accountants is highly recommended. Understanding the important components of these M&A documents is essential for business owners involved in the transaction process.