The forging of a purchase agreement in M&A transactions
Every merger & acquisition (M&A) transaction is unique. As a deal travels through the process, from “indication of intent” to “letter of intent” (LOI) to the due diligence phase and to ultimately the closing, negotiations become very specific to the goals of both the buyer and the seller. Still, as one considers selling their business, it’s important to understand what is in store moving forward. I’ll give a general overview of what’s involved within a typical purchase agreement, plus a few suggestions to keep things running smoothly moving forward as the deal works its way toward the finish line.
The purchase agreement is a fully detailed version of the LOI, which includes all the terms agreed upon, and in more detail, as well as additional terms and conditions. Here are some of the most common segments included in these agreements, though of course the specifics will vary with each transaction.
Well-written definitions are critical to minimizing problems throughout the process. This is where one gets very specific on exactly what all the terms in the agreement represent — example, does a recast of Adjusted EBITDA include “market” adjustments to retained seller’s salaries or not? Does net working capital include only receivables? There are many common terms in a purchase agreement that are subject to different interpretations depending on who is reading it and where their interests lie, which is all the more reason to make sure the definitions reflect a mutual understanding before signing the agreement.
- Provisions of the execution
While provisions of the execution vary by transaction, they will include the purchase price (usually a combination of cash, buyer’s stock, seller financing, and perhaps other items), payment terms, earnout details/timing, escrows, purchase price adjustments, etc. Some of these may be in the LOI but some of them may be new. Earnouts are one example of a common addition at this point in the process, typically if the buyer has unearthed any new issues during the due diligence phase.
- Representations, warranties and schedules
As part of a purchase agreement, buyers ask sellers to lay out certain conditions and facts that are true at the time of sale. These statements might include things such as the accuracy of the financial statements; the existence of any important contracts, physical property, and environmental liabilities; sufficiency of assets; condition of accounts receivable; employee benefits; taxes; etc. A seasoned M&A attorney can help the seller negotiate issues such as who will make the representations on the seller’s behalf and for what period, as well as definitions of “materiality” and “knowledge.” While buyers often try to pin down individual executives and shareholders, it is in the seller’s interest to try to avoid opening up these individuals to liability after the deal closes. The reps and warranties section will generally include a disclosure schedule that includes information like employee benefit plans, any ongoing litigation and material contract employees. Such schedules can be a time-consuming hot topic when it comes to negotiations.
Indemnification statements help define who would be liable for issues that arise after the transaction closes.
Sellers hope they will be able to walk away with their money and minimum liabilities, but the buyer wants to tack on liability to the seller in cases where the business was described inaccurately or the problem originated under the management of the seller. Common areas of conflict when negotiating these provisions include what actions are covered, who must provide the indemnification, how long the period laps, caps on damages, relationship to escrow and materiality of claims.
Interim and post-closing covenants provide a guide for how sellers and buyers are expected to conduct themselves during and after the purchase. Interim covenants should be specific and may include phrases prohibiting raises, bonuses, new hires and purchases above a certain level. Post-closing covenants might include non-compete agreements, any transition services and directors and liability insurance for sellers.
- Closing details
The closing conditions detail requirements for the seller and buyer between the signing of the purchase agreement and the ultimate closing date. This could include regulatory approvals, written third party permissions from all seller landlords, customers and vendors as needed, and provisions indicating reps and warranties have been satisfied by all parties and are valid. If a buyer needs to raise capital for the transaction, there can be a financing condition. It is common to include a material adverse change clause, which says that the transaction will still go forward in the case of minor changes to the business before the closing date.
- Break-up fees
A typical purchase agreement also will include termination provisions and will detail in what circumstances either party has the right to terminate the transaction and by when. Many agreements include break-up fees, which state that the party terminating the transaction will pay a pre-determined fee to the other party. These fees aim to reduce liability and cover the costs associated with the transaction. They also can be a strategy for buyers to reduce the risk of the seller entertaining better offers down the line.
- Points to sellers
Negotiating the purchase agreement and traversing the steps that come after can be stressful, and it’s easy to let this stress interfere with the responsibilities that come with running a business. However, keeping the business on budget and performing well during negotiations leading up to the transaction closing are essential. The potential buyer will be overseeing the business’ every move during this stage and if the financial results are incorrect, it could make the buyer hesitate about their offer or reconsider the transaction altogether.
As one works toward a deal, tensions will inevitably arise. After all, everyone is looking to protect their own interests and secure the terms that are most favorable to them. Understanding the basics of negotiation can help ensure both parties advocate for their interests most effectively. This is where a great deal team is crucial.
Remember that price isn’t everything. Terms and conditions form the deal — how much control each party has, what stake is being transferred, whether there is seller financing and what the liabilities are post close.
These are some of the most important points to consider in an M&A deal.
Bob Wolter is Mergers & Acquisitions Advisor of Creative Business Services/CBS-Global.
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