Importance of the Purchase Agreement in Business Sales

What Is A Purchase Agreement?

A purchase agreement in the context of business sales is the governing contract between the buyer and seller as it relates to the buyer’s purchase of the seller’s business. The deal terms, contingencies, included assets being sold, closing date, and the disposition of the deposit are all covered in the purchase agreement. Any relevant aspect of the deal – especially if they are of particular concern to either party – should be addressed in the purchase agreement. It is always the buyer’s responsibility to propose the purchase agreement. This often involves legal fees, which is why many buyers prefer to have a signed Letter of Intent (LOI) in place prior to moving forward with a proposed purchase agreement. The LOI is not binding (the purchase agreement is binding) but does memorialize the general terms to be finalized in the purchase agreement. A strong purchase agreement ensures a smooth transfer of ownership, prevents future disputes, and addresses all warranties and closing contingencies.

Structure of Purchase Agreement

Prior to proposing a purchase agreement, the buyer must determine whether they wish to purchase the business via an asset purchase or a stock purchase. An asset purchase deal is by far the most common type of transaction, since it minimizes the buyer’s liability from previous activities of the seller’s corporate entity. In an asset purchase deal, the buyer creates their own corporate entity (which is the legal buyer in the contract) and purchases the assets of the seller’s corporate entity (the legal seller in the contract). In a stock purchase deal, the buyer individually purchases the shares or stock of the seller’s corporate entity, and replaces the seller as the new owner. Buyers of businesses should always consult with an attorney or tax professional before creating their corporate entity and especially if contemplating a stock purchase deal.

Meeting of Minds

  • The principals to a business transaction must have a meeting of the minds on all significant issues of the deal.
  • The meeting of the minds as expressed in the purchase agreement should cover every facet of the transaction and the post-closing transitional period.
  • Otherwise, ambiguities may cause subsequent disagreements and disputes between the parties.
  • This may lead to legal problems for both the buyer and the seller.
  • It may also affect the seller’s ability to collect on payments owed from the buyer as a part of any seller-financing.
  • A common example of ambiguities in a purchase contract is the nature of the buyer’s free training period after the sale.
  • Almost all business buyers receive a free training period (usually 2-4 weeks) after the closing where the seller trains the buyer and introduces the buyer to key customers, suppliers, and employees.
  • The free training period should be addressed in the purchase agreement, and should specify the exact manner and time in which the seller will provide free training.
  • Many buyers are upset after the closing that they do not receive the free training they think they are entitled to receive under the purchase agreement.
  • If the purchase agreement stipulates that the seller will provide “30 days of free training after the closing,” what does this mean exactly?
  • Does that include weekends?
  • How many hours per day or week of free training is the seller expected to provide?
  • Is the seller obligated to travel with the buyer in order to meet customers and suppliers during the 30 day free training period?
  • The contract must clarify these ambiguities, and direct communication about all important issues between the parties should be fostered to avoid subsequent legal disputes.

Disposition of Refundable Deposit

A critical aspect of the purchase agreement is the agreed upon deposit that the buyer may be required to place for the business. The purchase agreement should specify the deposit amount, describe whether and to what extent the deposit is refundable, and disclose where the deposit will be placed. Unlike in real estate sales, deposits in business sales are almost always refundable if a contingency of the deal (such as the successful completion of formal due diligence and the assumption of the seller’s lease) is not met. Business valuations change over time, and formal due diligence may reveal impairments of a company’s valuation that can not otherwise be discovered. Nevertheless, most sellers require a buyer to place a refundable deposit in escrow as an expression of their seriousness when proposing a formal purchase agreement.

Formal Due Diligence Request List

An often overlooked part of the purchase agreement is the buyer’s formal due diligence request list. Formal due diligence is the process by which the buyer is granted access to all available information (such as bank statements, payroll records, and customer invoices) pertaining to the valuation of the business. Formal due diligence occurs after a deal is ‘under contract’ and involves substantial time and compliance costs for the seller. Sometimes the seller may not have the requested information, or may be unwilling to comply with the request (such as meeting with employees prior to closing). A well prepared and serious buyer should always include their formal due diligence request list within the proposed purchase agreement. This way, the seller knows what is expected of them and may discuss any unreasonable requests with the buyer.

Both buyers and sellers of businesses should always put all the relevant terms, contingencies, and representations in their binding purchase agreement. It is the buyer’s role to propose the purchase agreement and to structure it to suit their own needs. Along with examining the proposed price and terms of the deal, sellers should minimize any ambiguities in the contract to ensure there is a proper meeting of the minds between the parties. Buyers should be prepared to submit a refundable deposit when proposing a purchase agreement and submit their formal due diligence request list in the contract. This will greatly improve the odds of a successful closing.

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