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The Purchase Agreement: Explained

30 March 2022

Our last installment concerned the due diligence process during the sales negotiations (read it here). This week, we discuss the all-important purchase agreement.

Your Transaction Advisory Team (we discussed assembling your team in our first installment, here) should have already researched any legal requirements applicable in your home state to the sale of a business – these requirements vary from state to state, so it’s important to have your attorney and financial advisor prepare thoroughly in order to comply with state law.

The purchase agreement is likely to be a long, technical and legal document; there will be exhibits and supporting documentation required, which will vary depending on your industry, your state laws, and the details of your unique business and the sale thereof.

Some things all purchase agreements should include:

  • A clear and complete statement of all parties to the sale – buyer, seller, and any individuals holding an interest in the business being sold. All signatories should be clearly named and their titles stated.
  • If your business has more than one location, the addresses of each of these.
  • A detailed list of every item being sold, and every item excluded from the sale. “Item” includes both physical assets such as cash, furniture and fixtures, equipment, inventory, real estate, and vehicles, as well as the business’ name, accounts receivable, customer lists, and goodwill.
  • Any liabilities the buyer will assume, such as loans and other debt, and accounts payable.
  • Business insurance requirements – e.g., general liability insurance, building and contents insurance, vehicle insurance, flood or other region-specific insurance, employees’ health insurance, etc.
  • The closing date, the agreed-upon purchase price, and the terms governing the payment(s) of that price. Include the agreed-upon allocation of the purchase price to the IRS-specified asset categories (read more on that topic here), as well as the details of how the purchase price may be adjusted on the date of closing to reflect pro-rated changes in such items as business expenses, inventory, and accounts receivable/payable.
  • If deferred payments are involved in the purchase, a security agreement, detailing the buyer-owned assets to be held as collateral. In addition, your Transaction Advisory Team may recommend business operation requirements, to protect against devaluation of the business and/or its assets prior to the price being paid in full.
  • Any agreements you make with the buyer, such as non-compete agreement, any management consulting arrangement you have agreed to, and any employment agreements.
  • Representations and warranties:
    • Your own representations and warranties clauses verify the accuracy of your financial records in presenting a fair picture of your business’ financial position, your power and right in law to sell, and your clear title to the assets being sold. You must verify, also, that to your knowledge there are no obligations or liabilities other than those disclosed and appended as an exhibit to the purchase agreement. Make sure the attorney on your Transaction Advisory Team, not the buyer’s attorney, drafts these clauses.
    • The buyer’s representations and warranties clauses verify the buyer’s power and right in law to authorize the purchase, and that the statements made by the buyer and his/her guarantors are free of untrue statements or omissions. These clauses will almost certainly be drafted by the buyer’s attorney.
  • Your covenants, which list in detail the provisions you will undertake to effect the transfer of your business to your buyer. This is another clause your transaction attorney should draft.
  • An employee termination clause, effective for all employees except those with transferrable contracts, with your agreement to pay all wages, commissions and benefits earned through the employment termination date. This holds even if the buyer has agreed to keep on every member of your staff, as the buyer will need to operate the business under a new Federal employee identification number, and hire these employees back through the new entity.
  • Default provisions and business transfer agreements. Include the bill of sale, the formal assignation of contracts, intellectual property, and any applicable stock transfer statements. State whether brokers and/or finders were involved, and how these professional fees will be paid by you and/or your buyer. Your post-closing rights and obligations should be spelled out in detail, and should include your right to inspect the business’ financials until the purchase price has been paid in full.

Once again, be aware that this is not a blueprint for creating your own purchase agreement, which we emphatically do not recommend – just some general guidelines. Your business is unique, and we strongly recommend that your Transaction Advisory Team be enlisted to:

  • Negotiate with the buyer’s team during the initial drafting process and the ongoing revisions thereafter,
  • Draft such clauses and provisions as they think advisable,
  • Review any drafting by the buyer’s team under a figurative microscope.

Please do not sign any purchase agreement your team recommends against. If they aren’t convinced this is in your best interest, it probably isn’t. Let them continue negotiations with the buyer’s team until mutually beneficial terms are reached, which both teams can recommend to their respective parties.

Remember that selling a business is often a long process. This may make for impatience, but it’s worth being thorough, consulting your experts, and trusting them.

If you are considering any potential sale of your business, I recommend strongly that you consult with us before making any major decisions – and the sooner the better, as the process of selling a closely-held business can take six months to a year, and sometimes longer.

Please click here to let me know how I can help you.

Until next time –

Peace,

Eric

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