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The Purchase Agreement
In tandem with due diligence, both parties also work on the official purchase and sales agreement. This is where it gets real.
The purchase agreement lays down all of the legally binding terms and conditions of the transaction, including all of the details and conditions for the closing and beyond.
This moves you from the LOI (i.e., “We might be interested in buying something if all the numbers work out for us”) to “We're ready to sign the contract and close the deal.”
There is a lot at stake here—not only a lot of money but also your team's careers, your customers, your credibility, your reputation with investors, and what you'll be committing to for the next several years.
The purchase agreement may be the single biggest and most impactful document you will ever sign in your life—probably the most significant until you sell another company. So, what should you be looking for in this document? Who should be helping you?
Of course, the lawyers are going to be heavily involved in this process. There's a good chance a lawyer will write up the original document, though there is more flexibility here than you might first perceive—and it always pays to be proactive.
Buyers may want to prepare and send the first draft of the purchase agreement, especially if they are active in M&A.
The first draft is the start of really meaningful negotiations. Multiple rounds of back-and-forth and refinement should be expected. In the name of preparedness, it's a good idea to strategize for this process.
However, just because the buyer typically makes the first offer, that doesn't mean the seller can't provide the first draft. In fact, there may be great advantage in doing so.
When you are given a legal agreement full of legal jargon and fine print, you psychologically take it as something official, something standard, and the way it is supposed to be. It has been designed this way, and we've all been programmed accordingly. (Think about NDAs, most loan documents, or all of the notorious privacy policies that no one reads.)
So when one side presents a sales agreement, the responsibility is immediately placed on the other side to try to make corrections, additions, and to negotiate edits to that document from a defensive position, and to do so while trying not to rock the boat of the overall “standard.”
If the buyer sends you an agreement first, it is an uphill battle for you as the seller from the start.
If you can switch the dynamics from the beginning by going first, then the buyer has to take on the uphill struggle and is going to have to give to get.
For the small investment of grabbing a template and putting in a couple of hours of legal work to prepare the agreement, you may save a lot more in the long term.
How to Review the Purchase Agreement
Every M&A transaction is unique, however, most of the main components will remain the same.
It is vital to review your purchase agreement in full and in-depth. As tempting as it can be (and no matter how many companies you have bought and sold before), do not breeze over the fine print. Do not ignore the details. They can make all the difference in the ultimate outcome.
It should go without saying that all decision-makers who will be signing the document should be reviewing it in full, and your lawyers should be going over every line before you even consider signing a single page.
Take your time here. Don't allow yourself to be pressured into being rushed. Don't sign anything until you are comfortable that you understand everything and the implications. It's okay to keep asking questions (even the same questions) until you get it. The foolish people are those who don't ask and pay steep penalties later.
The main components of an M&A purchase agreement are discussed in the following sections.
The Definitions
Although you might think that the definitions are standard legal jargon, some financial terms and definitions may be open to flexible interpretation. This is especially true when it comes to financial adjustments. Be sure to go over these with your CFO and attorneys so that you understand what they really mean for the deal and your net and how they will influence the impact on your company after the closing in a merger.
Purchase Price and Payment Execution
What is the final price being paid for your company? How will the seller pay? Is it cash or stock? Are you financing any part of the purchase price? When and how will your company be paid?
What adjustments can affect the price? There may be adjustments to the price to ensure a certain level of working capital at closing, as well as the amount of debt on the balance sheet. Operating metric adjustments can be used by the buyer to ensure the target company is still performing and growing in the proclaimed direction when the deal is scheduled to close. If you are missing target metrics or there is a serious deterioration in the business, there may be adjustments or bigger issues.
Almost all M&A transactions have purchase price adjustment clauses. Of those with adjustments, working capital adjustments can be the most common.
Warranties and Representations
This covers what you are representing to be true about your business as the seller and anything you may be warranting for the future.
These representations and warranties (R&W) are a way for buyers to weigh risks and protect themselves, which leads to the next section—indemnification or compensation for claims that prove not to be true.
Typical representations in a transaction like this include these factors:
- Accuracy of any financial statements being provided
- Condition of physical property
- Existence of any legal liabilities (e.g., lawsuits, judgments, and so on)
- Details of employee contracts
- Status and amount of taxes
This section may also cover the disclosure schedule, detailing when the buyer will have access to all the information behind claims for due diligence.
R&W insurance coverage can be important here.
Indemnification
Indemnification is a mechanism that protects the buyer in the event warranties and representations are breached. This section of the purchase agreement lays out the details so that the seller is clear on and protected against claims.
These provisions can actually apply pre- and post-closing. Misleading claims that are discovered during due diligence and prior to closing may lead to due compensation for the buyer. The coverage for the buyer also extends out through the predefined “survival period.”
This survival period can be anywhere from 12 to 24 months or longer for some items and some market conditions. The buyer may request monies be deposited into an escrow account for the duration of the survival period. This amount is negotiable.
This section should also lay out the minimum amount of any damage that can trigger an indemnification claim, as well as the cap, or maximum claim.
Note that some unscrupulous buyers will knowingly acquire a company in which they know the seller has misrepresented something, and then will use this clause to claw back a substantial cash refund on the purchase price. This is called sandbagging. Depending on the jurisdiction, it may not even matter if you can prove the buyer had advance knowledge of the issue at the time of closing. An anti-sandbagging clause could save you big with a risk like this.
Termination Provisions and Breakup Fees
This section spells out the conditions under which the transaction may be cancelled by either party (for example, if the buyer cannot obtain the expected financing or there is a breach of the agreement or misrepresentations in the process).
Obviously, by this point in the deal, both sides have made substantial investments of time and money. A great deal of goodwill and reputation may be on the line, as well as risk, after making disclosures and revealing data and other sensitive information. Breakup fees dictate who pays, and how much, in the event the transaction is cancelled by either party.
Closing Conditions
This section lays out the conditions that must be met prior to the deal's close and funding. It may include regulator approval, disclosures, assignments, debts being settled, verifications, shareholder approval, and proof of title to assets.
Covenants
The covenants mainly govern which actions each party must take, or must not take, during the transaction process. The most obvious of these is that the seller will continue to operate the business in good faith, with all effort to keep it running and growing as presented. Covenants can also cover issues such as incurring more debt or firing key employees, which may affect the value.
Terms and Clauses to Watch
Throughout the purchase agreement, there are a number of clauses and terms that you need to understand. The following sections examine some of the most common and important ones.
Jurisdiction
What legal jurisdiction governs this agreement and any disputes? Certain states are far more buyer-friendly than others and may routinely side a certain way in some clauses, such as anti- or pro-sandbagging clauses.
Stock Exchange Ratio
If your company is being purchased whole or in part with stock in the new parent company, what is the exchange ratio? The most likely stock price trends are worth taking into consideration between now and the closing, as well as how they can affect the net proceeds.
Asset Purchases
If your transaction is being structured as an asset purchase, everything that's included should be listed and inventoried in detail. If it isn't on the list, it isn't being transferred. And be sure to watch out for any mandatory repurchase provisions that could require you to buy back unnecessary or damaged inventory.
Earnouts
If part of the purchase price is being delayed or is subject to earnouts, what are the specifics? How long will you have to wait? What performance metrics will you have to sustain? What milestones are included? What provisions are in the agreement that will help or hinder you from meeting these payout requirements?
Make sure those earnouts are not completely out of your reach. Be conservative and push back if necessary. The buyer will try to put as much as possible on earnouts because it reduces for them the risk on the actual transaction.
Express Nonreliance
Express nonreliance, or “no other representations,” inserts wording that indemnifies sellers from assumptions or any other factors not specifically included in the agreement. It states that the buyer is completely responsible for its own due diligence. You are not making any other warranties or representations beyond what is specifically listed in this section.
No-Shop versus Go-Shop Clauses
Will you be banned from shopping your company to other potential buyers during this period? Or will you be allowed? As the seller, you will ideally use the offer to go shop your business and create fear of missing out with other potential acquirers, which can help you push for higher bids. Just note that after signing this agreement, breakup fees could eat up a sizable portion of any higher bid you receive if you jump ship. At the same time, the buyer may want to lock you in and prevent you from soliciting other offers.
Pandemic and Epidemic Carve-Outs
Most contracts of all types provide provisions to carve out exceptions for material adverse effects, such as war, acts of terrorism, natural disasters, and acts of God. Post-COVID-19, expect epidemic and pandemic language to be specifically included, because it may be argued that these events do not fall under other, standard carve-outs.
Typical Purchase Agreement Outline
Purchase agreements often follow a fairly standard organization and structure. The following outline depicts what you can expect to see in a standard purchase agreement.
- Purchase and sale of the purchased assets
- 1.1 Purchase and sale of assets
- 1.2 Excluded assets
- 1.3 Assumed liabilities
- 1.4 Excluded liabilities
- 1.5 Purchase price
- Representations and warranties of sellers
- 2.1 Organization and power
- 2.2 Authority to execute and perform agreements
- 2.3 Non-contravention
- 2.4 Capitalization; subsidiaries
- 2.5 Title to purchased assets
- 2.6 Financial statements
- 2.7 Legal compliance
- 2.8 Tax matters
- 2.9 Tangible personal property
- 2.10 Real property
- 2.11 Intellectual property
- 2.12 Contracts
- 2.13 Employees
- 2.14 Employee benefits
- 2.15 Litigation
- 2.16 Environmental, health, and safety matters
- 2.17 Insurance
- 2.18 Certain business relationships
- 2.19 Customers
- 2.20 Indebtedness
- 2.21 Restrictions on business activities
- 2.22 Absence of certain changes and events
- 2.23 Brokers' fees
- 2.24 Stockholder representative
- Representations and warranties of buyer
- 3.1 Organization of buyer
- 3.2 Authorization of transaction
- 3.3 Non-contravention
- 3.4 Valid insurance of securities
- 3.5 Brokers' fees
- Covenants and other agreements
- 4.1 Confidentiality; publicity
- 4.2 Social media accounts
- 4.3 Consents
- 4.4 Name change
- 4.5 Tax matters
- 4.6 Employee matters
- 4.7 Covenant not to compete
- 4.8 Omitted assets
- 4.9 Agreement of stockholder
- Indemnification
- 5.1 Indemnification by sellers and recipients
- 5.2 Indemnification by buyer
- 5.3 Survival
- 5.4 Limitations on indemnification
- 5.5 Settlement of adverse consequence
- 5.6 Third-party claims
- 5.7 Sole recourse
- Closing
- 6.1 Closing
- 6.2 Conditions precedent to obligations of buyer
- 6.3 Conditions precedent to obligations of sellers
- General provisions
- 7.1 Representative
- 7.2 Notices
- 7.3 Succession and assignment
- 7.4 No third-party beneficiaries
- 7.5 Expenses
- 7.6 Entire agreement; counterparts; headings
- 7.7 Governing law
- 7.8 Amendments and waivers
- 7.9 Construction; severability
- 7.10 Exhibits and schedules
- 7.11 Arbitration
- 7.12 Injunctive relief
Lawyers and the Purchase Agreement
Lawyers are the players in the deal whom everyone loves to hate. In sentiment, they often rank with car salespeople, real estate agents, and accountants.
The only time you love them is when they are saving you money, and this is probably one of the moments in your life when an attorney may add a lot of value and save you millions of dollars and untold amounts of stress.
Of course, the attorney will be well-compensated for his or her contribution, but if you know how to manage the attorney well and hire well, the person will prove invaluable.
Here are just some of the ways a lawyer can add value during this process:
- Helping you see clauses and negotiation points that can create the optimal outcome
- Spotting undervalued assets and strategies
- Saving enormous amounts of time
- Providing a valuable third-party buffer in negotiations (good cop, bad cop)
- Identifying areas of legal and financial liability and ways to protect against them
- Asking the what-if questions you don't know to ask
- Holding the other party responsible to its duties in the agreement
- Renegotiating terms
- Negotiating the best breakup if needed
Choosing the Right M&A Lawyer
There are a lot of things you should look for when choosing the right M&A lawyer for your transaction.
Experience Fit
Does the law firm have the right experience? Consider this not just in terms of the time in business or the volume of M&A transactions the firm has handled and closed successfully, but also in terms of the dollar range and domain you are in.
For example, does the firm specialize in $10 million to $100 million traditional business deals? Or $100 million–plus software startup transactions? Give them extra points if they know the buyer's M&A tactics. This kind of experience can make all the difference.
Global versus Local
If you are an NYC-based startup selling to an NYC-based corporation, then working with a local law firm that knows the market and playing field can be the way to go. But if you have international investors or are selling to a global conglomerate, you may need a firm with global expertise—one that understands the nuances in culture and paperwork between these jurisdictions.
Value for the Money
Lawyers for these deals are not going to be cheap. As with every role in your startup, you want to hire the best you can. Look at the returns you can expect to receive and evaluate the efficiency of more experienced experts. Don't get hung up on the hourly rate. Look at the total cost versus what being cheap could cost you.
Alignment
Alignment in philosophy here is far more important than the hourly rate or the law firm's name. You don't want an attorney who will tell you only what you want to hear. You want someone who is honest to a fault. You want someone who shares the same mindset on the best use of time and money and knows when to play hardball, rather than just getting it done and moving on.
Bandwidth and Priority
Does this lawyer and firm really have time for you? What level of priority are you going to have among their clients?
A famous attorney and firm may have its advantages, but that's not necessarily the case if you are their tiniest client and they are busy representing Oracle, Uber, and Google. Could it be more advantageous to find a less famous (but equally competent) firm? If you're their biggest client of the year, you can imagine the difference in attention and service.
Are there any conflicts with your time line? Is your lawyer due to head out to the other coast for a big case that could tie him or her up for months? Is your lawyer planning a vacation, having a baby, or counting down the days to retirement?
Dealing with Legal Counsel
Law firms have become a lot like franchises and realtors. You see the signs and hear the radio ads. If you are really lucky, you might get to speak with that big brand-name personality for about five minutes. They'll assure you they have you covered, but you may find out later that your case has been relegated to a junior staffer—after you hand over the big retainer. Make sure you ask the right questions and get to know the exact individual in charge of helping you.
It should go without saying that you shouldn't be communicating directly with the buyer or the buyer's legal team(s) during the purchase agreement process (at least not without your representation present). This is a big part of what you are paying your legal team for.
You will not only have your own M&A legal team but also your company's general counsel and your own personal lawyer.
M&A lawyers are deal-focused. They bring their expertise to the purchase agreement and getting through closing. Then, their job is pretty much done.
After this, your corporate general counsel may be involved with the integration and any post-closing issues. They are also the ones you'll go to if you have issues with your M&A team.
Your own personal attorney may be consulted on your obligations and risks in this process, as well as ensuring your rights are protected.
All of these legal professionals may be useful in breaking stalemates with opposing legal teams. Just watch your budget. Don't skimp on legal help, but make sure you find a balance in legal costs. Understand their roles, motivations, priorities, interests, and their mindset, and know when you need to reel them in and just get the deal finished.