Business Purchase Agreement Provisions: A Beginner’s Guide
November 5, 2020 /
Business Law /
Nicholas S. Kovach
The purchase of a business requires much more than just a simple handshake. While the deal may be done in principle, it’s important to understand what a typical purchase agreement will contain before signing it.
As Michigan business attorneys, we get asked to draft, review and negotiate lots of business agreements. The purchase agreement details several important, and material aspects of the transaction that should not be overlooked.
Here we explore just a few of the common provisions that an asset sale agreement for a business will include in its terms.
Payment Terms
Payment terms are perhaps the most crucial aspect of any purchase agreement. This section should contain all the details about how much the business is being bought for and on what terms: cash, financing, etc. It’s important that this section be clear for the parties. This section will cover the initial deposit, if any, and how much money is required to be brought to closing.
Due Diligence / Inspection
The due diligence period is critical for any buyer in purchasing a business. The inspection clause gives the buyer the right to evaluate the business to ensure that it is a good deal that they wish to pursue.
A due diligence period will usually be limited in time, and once it expires, certain aspects of the deal then “go hard” such as the money deposit becoming non-refundable or the deal itself may then be set to close, subject to any other terms in the agreement.
Financing Contingency
If a loan is required for the business acquisition, then the buyer should have a financing contingency clause. This will permit him to seek financing on reasonable terms and walk away from the deal if he or she cannot obtain favorable financing. These contingencies are usually met when a buyer enters into a binding loan commitment prior to the end of the financing contingency period.
Assignment of Contracts
Contracts often form an important part of the target business. To the extent feasible, the seller should assign all these contracts over to the buyer. These can be vendor contracts or customer contracts.
Sometimes, however, assignments are not automatically possible due to the terms of those underlying contracts. The buyer should review these contracts during due diligence to understand the associated risks. The buyer may have to approach the other parties to those contracts to negotiate assignments.
Lease
Businesses with physical locations will often lease their premises. In such cases, the new owner will have to either assume the lease over from the seller or enter into a brand new lease with the landlord. There are advantages and disadvantages to each approach, depending on the circumstances.
The purchase agreement should identify the terms of how the lease is to be handled. The buyer will often want to make the deal contingent on a successful lease negotiation with the landlord so they will not be at the landlord’s mercy after closing, which could jeopardize the entire business.
No Assumption of Liabilities
Generally, in an asset sale, the buyer will not pick up corporate debts owed by the seller. Conversely, in a stock equity sale, the buyer will assume all the liabilities because the corporate entity will continue to exist. In any case, the purchase agreement should identify which liabilities are being included or excluded.
Sometimes contracts and other assets which need to be included in the sale will have corresponding liabilities which may be owed or which will become due. Depending on the particular circumstances, the buyer may want to insist that the seller take responsibility for those debts associated with its activities prior to closing and that the buyer be responsible only for new liabilities.
Prorations
Business expenses like taxes and rent are often paid in advance. At closing, the seller will want reimbursement for the items on a pro rata basis. For example, if rent was paid one month in advance, but the buyer takes over the business mid-month, then the buyer should reimburse the seller for half of the month’s rent.
Prepaids and Customer Deposits
Businesses often take deposits or prepayments from customers. The buyer will want to retain these funds if the goods or services are to be provided or performed after closing. In such cases, the purchase agreement should require the seller to forward these funds to the buyer.
Similarly, the seller of the business will want to retain pre-payments for goods or services which are to be provided or performed prior to closing . Having a clause clearly outlining how prepayments are to be handled is important to avoid disputes after closing.
Representations and Warranties of Seller and Buyer
Sellers and buyers of a business want assurances about the state of the business prior and up to the closing date. Buyers should ensure, at minimum, that the seller represents
- they have title to the assets
- the assets are free of liens (or liens are identified)
- the condition of the assets
- there are no claims or lawsuit against the business
- there are no breaches in any underlying contract
- taxes are paid
- the business complies with applicable law
- all the information conveyed as part of the transaction is true.
The buyer usually only warrants that they have had the opportunity to evaluate the business and its associated risks independently, and that they were satisfied with the result of the due diligence.
Indemnification
An indemnification provision allows the parties to divide risk between themselves in case issues arise in the business either before or after the sale. These provisions will contain language requiring the buyer and seller to indemnify (i.e. reimburse), hold harmless, and defend against those claims which arise out of their respective time operating the business. In a small business acquisition, these clauses will be kept relatively simple, and they will become more complex in larger transactions. Regardless of the size of the deal, they are always important to have in a purchase agreement.
Conclusion
These are just a few of the common provisions founds in an asset purchase agreement. Each deal is different. We recommend that a business attorney review your transaction carefully so that you have no surprises.
