As business owners contemplate the significant decision of selling their company, navigating the complexities of the M&A process can be overwhelming. A critical step in this process is drafting and negotiating the purchase agreement and related legal documents. In this article, we’ll unravel the layers of this legal blueprint, providing insight on its structure and importance, as well as how expert guidance from investment bankers and M&A attorneys can make all the difference in completing a successful transaction.
What is a Purchase Agreement?
A purchase agreement is a legally binding document defining the terms and conditions of the sale of a company. Beyond the legalese, it encapsulates vital details such as the purchase price, payment terms, representations and warranties about the state of the business, certain conditions to closing, and indemnification obligations post-closing.
The purchase agreement and related documents represent an important allocation of risk between the buyer and seller for liabilities and other potential issues which may arise with respect to the business after the transaction is complete. These documents are drafted after the parties have reached a consensus on the fundamental aspects of the deal (typically memorialized in a Letter of Intent), including preliminary negotiations, due diligence, and valuation. The initial drafting of the purchase agreement by legal professionals is a vital step that signifies a commitment by the buyer and the seller to move forward with the transaction.
Essential Components of a Purchase Agreement
While no two M&A transactions are the same, the following sections shed light on a few of the main items addressed by a purchase agreement:
1. Purchase Price and Closing Mechanics: The initial few sections of a purchase agreement typically cover the purchase price, payment terms, transaction structure (asset versus stock purchase), and other payments terms and conditions such as escrow arrangements and earnouts. These primary provisions act as the bedrock, providing a comprehensive overview of the transaction and how it will be executed.
2. Representations and Warranties: In this section, the seller provides assurances with respect to the current state of the business, its financial status, the condition of its assets and key relationships, and its historical performance. These statements provide the buyer with protection in the form of indemnification in the event the representations are inaccurate. Similarly, the seller will make certain representations and warranties to the buyer regarding the seller’s authority and ability to close the transaction. The representations and warranties establish the basis for allocation of risk between the parties for any liabilities, obligations, and the condition of the business going forward.
3. Conditions to Closing: Since the purchase agreement is a binding obligation of the seller to sell and the buyer to buy the business, it is important that the parties outline any conditions under which they are not obligated to close. These conditions to closing can include things such as the buyer obtaining sufficient financing, seller paying off its existing debt obligations, and the parties obtaining any necessary approvals or consents from third parties which are required for the transaction to close.
4. Indemnification: In this section, post-closing protection and risk management are the main focus, framing the interests of the buyer and the seller. Survival clauses, indemnification obligations, and dispute resolution mechanisms are outlined, providing structure and ensuring a controlled approach to potential post-closing issues.
5. Covenants: The covenants section is somewhat unique in the purchase agreement in that it deals primarily with the period following the closing and provides for certain obligations of the parties as to how they will behave once the transaction is completed. Some of the most common post-closing covenants include obligations by the seller to not compete with the buyer for a specified period in a particular type of business, non-disclosure requirements, and mechanisms governing how the parties will work together in addressing post-closing events or requirements such as the preparation and filing of tax returns that impact both parties.
Considerations When Drafting a Purchase Agreement
The purchase agreement is a summation of the months of work leading up to the closing of an M&A transaction. A well-crafted purchase agreement can protect sellers’ rights, ensure their best interests are met, and enable a smooth and seamless close to the transaction. A poorly written purchase agreement can lead to disagreement, confusion, and disappointment in the outcome of a transaction. To ensure that this step of the M&A process is executed correctly, business owners should consider the following:
1. Engaging Professional Advisors: Given the complexities involved, seeking the guidance of experienced investment bankers and M&A attorneys is imperative to drafting a purchase agreement. Their expertise can efficiently navigate the M&A process, minimize risks, and ensure the purchase agreement aligns with the business owner’s goals.
2. Flexibility and Contingency Planning: In a dynamic business landscape, infusing flexibility into the agreement is prudent. Anticipating challenges and incorporating contingency plans fosters resilience in the face of uncertainties.
3. Communication and Relationship Management: Transparent communication between the buyer and seller builds a positive and collaborative atmosphere. Trust is essential for a successful transaction and post-closing integration.
Conclusion
For business owners currently engaged in or contemplating an M&A process, the importance of the purchase agreement is critical. Beyond the legal intricacies, this document serves as a basis of trust, transparency, and collaboration between buyers and sellers. To navigate this pivotal phase of the M&A process, prudent business owners are well-advised to engage the services of experienced investment bankers and M&A attorneys. These professionals not only understand the complexities of the agreement but will also ensure the preservation and fulfillment of the unique interests and objectives of each party involved. With the help of professional advisors, a strong purchase agreement can be crafted to culminate a successful M&A process that is mutually beneficial to all parties.
Have Questions?
If you have any questions regarding the process of selling your business or are interested in discussing how Crewe can assist you, please do not hesitate to contact us. Our goal is to provide maximum value and establish a relationship of trust and transparency with our clients.