Business Purchase Agreement: What is it?
A business purchase agreement is a legal document that outlines the terms and conditions under which one party agrees to purchase the ownership interest in a business, product, or service. This agreement acts as a legally binding contract between the buyer and the seller and is essential for ensuring that the transaction functions smoothly and protects the interests of both parties. The agreement details important information about the terms of purchase, including the price, payment structure, responsibilities, and liabilities.
There are several types of business purchase agreements, and they can serve different purposes depending on the nature of the business transaction. If the buyer is looking to acquire an entire business, including physical assets and goodwill, they will likely use a "stock purchase agreement." In contrast, if the buying party wishes to purchase a specific product or invention from the seller, this would likely be formalized through a "product purchase agreement . " For businesses with complex relationships between owners or shareholders, there are agreements like the "buy-sell agreement" that clearly outline what will happen to the shares if certain events occur, like a death or a bankruptcy of one of the parties.
This type of agreement is not only meant to act as a sales contract for the purchase or dissolution of a business but can also serve as a means of preventing business litigation. If drafted properly, the purchase agreement can help decrease the risk of disputes over the ownership interests and responsibilities with regard to the purchased or sold entity. Once the parties have entered into the agreement, each party has the responsibility to uphold their side of the transaction and treat the other party fairly.
In order to protect themselves and avoid issues down the road, parties who choose to enter into a business purchase agreement are highly encouraged to get the help of an experienced business law attorney to draft and explain what should be covered in the document.
Purchasing Agreement Components: What Are the Requirements?
A business purchase agreement should contain certain essential components. A properly-stated purchase agreement should contain the following elements:
Parties – identify who is selling and who is buying the business
Purchase Price – clearly state the dollar amount the buyer is agreeing to pay for the business
Payment Terms – are there bank financing arrangements, payments over time or other financing arrangements?
Closing Date – at what date will the sale close? How will the date be determined, i.e. the parties will close the transaction within x days of signing the purchase agreement, such time period not to exceed xx days from the date of this agreement.
Conditions of Sale – are there warranties made by the seller that the business is free of any encumbrances; warranties regarding the condition of inventory, equipment, customer lists, or other necessary components of the sale, etc.?
The above elements are the essential starting points for any purchase agreement. In reality, almost all acquisition agreements are highly fact-specific and require considerable attention to detail to ensure that the proper nuances are crafted into the final draft.
Common Business Purchase Agreements
The main types of business purchase agreements are asset purchase agreements and stock purchase agreements, each of which contain different terms and conditions. Both agreements serve to transfer ownership from the current owner or owners of the target business to the buyer.
Asset Purchase Agreements
An asset purchase agreement is a contract between the buyer and seller where selected assets and possibly selected liabilities will be transferred from the seller to the buyer. In an asset purchase, each asset that is being purchased is identified, typically in a schedule attached to the agreement. Some assets may be excluded from the purchase agreement such as cash, accounts receivable, personal property, and other items described in the agreement. The buyer decides which assets it wants to purchase and the seller may be open to providing the assets at or below a value.
Stock Purchase Agreements
A stock purchase agreement is probably the most common type of purchase agreement. Business owners own a corporation, limited liability company (LLC), or an S corporation. These entities have owners, known as shareholders, or members, who hold membership units or shares for their investment. The stock purchase agreement is a contract whereby the buyer purchases the stock or membership units from the current owners for money or other compensation. If the business has multiple shareholders, each shareholder must enter into a separate agreement with the buyer. The sale often is structured as a per share or per unit basis.
How to Write a Business Purchase Agreement
When preparing to draft a business purchase agreement, it is vital to first engage in due diligence. Conducting thorough research on the business being purchased allows the buyer to better understand its strengths, weaknesses, and market position. It also equips the buyer with the necessary information to negotiate favorable terms and conditions for the purchase agreement.
Consulting an experienced attorney throughout the drafting process is essential for ensuring that the business purchase agreement complies with all legal requirements. An attorney can help identify potential legal issues that may arise during the transaction, as well as provide guidance on how to address them. Additionally, an attorney can help ensure that all necessary legal documentation is properly prepared and submitted on time. Finally, an attorney can provide valuable advice on the best legal strategies to use in order to achieve a favorable outcome.
The purchase price is one of the most important aspects of the business purchase agreement. The seller should consider all the details of the business when determining the purchase price. Then, the purchase price should be broken down into three categories, including the upfront price, contingency payments, and price adjustments. The seller should also consider the terms of payment, such as the length of time over which the purchase price will be paid and whether interest will be charged. Finally, the seller should include any additional terms related to the purchase price, such as non-competition agreements and confidentiality clauses.
The final step in drafting a business purchase agreement is to establish the conditions that must be met in order for the transaction to close. This may include obtaining financing or approval for the purchase price, completing repairs or improvements to the property, and satisfying any other legal requirements. In addition, the seller may want to include other requirements, such as the buyer’s ability to obtain additional financing or meet specific performance milestones.
Once the drafting process has been completed, the buyer and seller should seek formal approval of the business purchase agreement. This may involve obtaining approval from lenders and shareholders, as well as any other applicable government agencies.
Contract Negotiation of a Purchase Agreement
As previously discussed on this blog, business purchase agreements are all about negotiation, and knowing where to compromise. Certain issues, like price, may become your battle grounds when it comes to negotiations. If you are a buyer, you may want to avoid another party’s offer to lower the asking price. A seller may want to exclude certain liabilities. Having a clear idea of your priorities is central to successful negotiations. Navigating negotiations can be particularly tricky if relationships among parties are strained by the time you reach the point of discussing the purchase agreement. When negotiating with someone you’ve had bad dealings with, or whose business style you simply dislike, it pays to be prepared. The following strategies can be helpful: Arm yourself with knowledge. By knowing all the terms and controlling the process of negotiation, you will come out ahead. Have a plan to address disputes. Determine in advance how you will address disputes regarding the purchase agreement so you can avoid stumbling over a sticking point. Prioritize. Be unemotional about what you need by having clearly defined priorities . If you know what you have to achieve and where you can concede, you won’t waste your time or that of the other party. Listen to your opponent. No one likes to feel that their words are falling on deaf ears. Let your negotiating partner express his or her opinions and listen actively by paraphrasing back to show that you are being fully engaged and understand what he or she is saying. Propose considering alternatives together. Rather than dictating your terms, say, "We can do it your way…" and then suggest an alternative that would work for you, with the other party having to approve or allow a proposed compromise in order for the deal to go forward. Choose your battles carefully. Sometimes a major concession on your part is worthwhile for the sake of the deal. Strategically reintroduce an issue that’s important to you. If you’ve reached an impasse on a particular point, such as price, and it’s mission critical to you, step away from the negotiating table for a while or move on to another point. Then revisit the issue later in the process, but don’t let it be a deal breaker. Successful negotiations involve not just tough talk but also a firm understanding of your objectives.
Legal Points of Concern and Due Diligence Checks
Due diligence refers to the process of examining a company’s activities and verifying the information in its financial documents and other records. It is an essential step in closing a business acquisition and is typically required by parties in a business purchase agreement. The purpose of due diligence is to ensure that the seller’s disclosures are correct and to let the buyer gain a complete understanding of its potential investment.
How due diligence can affect the terms of your business purchase: Undisclosed company liabilities can have a big impact on your valuation and the terms of your purchase agreement. A company’s debts, fines or potential civil liabilities can take a significant amount of cash from future profits and affect its day-to-day operations. Such liabilities should be addressed in the negotiation of your purchase agreement before the transaction closes and the buyer takes over the company. If you discover undisclosed debt or potential legal problems during due diligence, you can opt to back out of the deal, negotiate for a lower purchase price or delay closing to give the seller time to remedy the situation.
Buyers should be extra careful to review the financial records as well as legal and ownership matters during the due diligence period. In addition, it’s critical that you address how you will handle liens and encumbrances on personal property and real estate that’s part of the sale. If the seller is not able to clear up the encumbrances by the time of closing, you should have the right to back out of the deal.
Disclosure requirements and covenants: During due diligence, you should seek to identify the types of disclosures that will be required under the purchase agreement. For example, if your purchase agreement requires the seller to make a specific disclosure within a set period of time and deems any failure to do so a breach of the contract, you must understand those obligations in order to evaluate the degree to which noncompliance may affect the transaction.
It is also essential for you to thoroughly examine the purchase agreement’s representations and warranties. If a purchase agreement contains specific representations and warranties — such as the seller’s title to the property or compliance with applicable laws — the failure of those representations and warranties to be true at closing may be a material breach of the contract. In general, you want to request a broad range of representations and warranties, which would make it easier to pursue remedies if a breach occurs.
Common Mistakes with Business Purchase Agreements
In addition to the fundamental "must have" aspects of all business purchase agreements, there are a few pitfalls that you should avoid in order to get the deal sealed.
- Not securing a lawyer’s assistance – It is common for business owners to want to keep costs down by doing as much work as possible themselves, but do not attempt to purchase a business without first getting professional legal help. While the cost of hiring a lawyer will be higher at the early stages, doing so could save you thousands of dollars later. Your legal counsel will be able to assist with providing general information on the business buy-sell process as well as negotiating the purchase agreement to include all provisions necessary to protect your interests.
- Not providing enough time to complete due diligence – The due diligence process provides both the buyer and the seller sufficient time to investigate a potential transaction before the sale is finalized. Under typical circumstances this process can take as long as 60 days (or longer if the parties do not negotiate in good faith), and while the sales agreement should include a negotiated due diligence period, there is no harm in gaining an additional month or two to perform due diligence on the target business and limit your risk. Rushing the transaction means you may miss out on material issues such as litigation pending against the company, corporate tax compliance neglect or pending criminal charges against owners that could seriously impact the business’ operations and long-term viability.
- Failing to identify assets that are not expressly included in the sale – If the seller is a corporation or a limited liability company, unless otherwise specified, a sale of the company shares or membership interest will include everything owned by the business (including assets and liabilities) without regard to any exemption or exclusion of assets or liabilities. For this reason, it is essential that you work with your lawyer to be clear on what is included in the purchase agreement. This means including specific assets (such as real estate, equipment, or bank accounts) and liabilities (including debts, leases, pending lawsuits, liens, and trade payables). Failing to deal with the issue of exclusions will leave you open to liability on the day after closing for the issues that were expressly uncovered in the agreement and you didn’t protect yourself from.
- Omitting verbal representations – When dealing with a business owner who is looking to sell, it is typical for the owner to make verbal misrepresentations about the state of financial records, employee relationships, or pending litigation, as well as representations about future performance. Unless statements make it into the written contract, you cannot rely upon them. Together with your lawyer you should be prepared to either have written statements included in the purchase agreement or ensure that a warranty statement not permitted under the statute relating to warranties in a sale of goods is included. Verbal promises are not enough – you must protect yourself by including in the agreement what relied on verbally.
- Not complying with finders fee and broker obligations – If the buyer has hired an agent or a finder to assist in the transaction, in addition to paying the agent a fee, the buyer may be obliged to reimburse the seller for expenses incurred in connection with the sale of the business.
Business Purchase Agreement Case Examples
To give you a feel for how really successful business purchase agreements should operate, here are several case studies. In each instance, the facts and circumstances varied somewhat, but the underlying causes for the success of the transaction were the same. It’s essential that you adhere to these standards or you could find yourself among the thousands of businesses that have failed every year. You really can’t afford to leave anything to chance when you’re purchasing a company. A poorly negotiated agreement can be a deal killer.
The better examples were those in which the parties sought advice from their respective attorneys in advance of any compromises. This way, the lawyers could deal with the issues before they became points of contention. For example, one client came to my office and asked me if I could come to an agreement with a prospective purchaser without risking his entire company. He had recently started a dental practice, providing in-house dental services to area companies. His major concern was the fact that he’d signed a 1-year non-compete with an earlier employer, so we needed to address the issue. He was adamant that he didn’t want to buy into an oral-only agreement, but he also didn’t want to shove a non-compete down their throats. By contract, an implied agreement was reached that gave them both time to review the non-compete . After spending time mapping out the details of the agreement and conferring with my client about how much he was willing to include, I was able to draft a final contract that was acceptable to all parties. The lesson here was that you should never leave issues unresolved. Even though oral agreements are hard to prove, if you have to rely on them, come up with a solution before you finalize the transaction.
In another case, a successful business owner had spent time searching for the perfect acquisition. After months of searching, he thought he had finally found it. But in the back of his mind, something was still niggling at him. So despite the fact that the business was exactly what he wanted (the location was great, it was in an industry which he had experience, the terms of the deal were workable), there was just enough uncertainty to cause a problem. He and the owner got into an argument over the terms of the deal. My client called me to tell me that they had finally agreed on the terms. When I heard the story I found it hard to believe that the issues had been resolved. I suggested that my client contact the prospective purchaser, just to see what actually was going on. As it turned out, the other party had been very reluctant to sign a deal that hadn’t been presented in writing. My client had signed a piece of paper that the purchaser’s broker had drawn up, but not even bothered to read it closely. He essentially bought the proverbial ‘pig in a poke’ and found himself in a no-win situation. The lesson here was to get everything in writing.