If you are interested in selling your business, you should be aware of some of the key provisions that typically appear in the deal documentation. Customarily, these clauses are expected by the buyers to support an agreement on price, timing and deal structure (i.e., merger, stock purchase or asset acquisition). While the specific details contained in such an agreement are fully negotiable, your deal will go more smoothly if you anticipate the topics that must be addressed in one form or another before the buyer will close.
Holdbacks. Oftentimes the buyer will insist that a substantial portion of the purchase price – typically between 10 and 30 percent – be held in escrow with a financial institution or other third party for some period of time – perhaps as long as two to four years. This is done to cover claims the buyer may have against you in the event of a breach of contract or fraud.
Representations and Warranties. Invariably, buyers will insist that you confirm in writing that the business is what it purports to be and what you have claimed in the due diligence and deal negotiations is true. Matters usually covered are debts and accounts receivables, commitments to employees, customer contracts and termination, accuracy of financial statements, GAAP compliance, tax compliance, legal claims (both pending and threatened), environmental compliance, intellectual property ownership, status of good standing, and authorization to enter into the transaction. If any of these assurances turn out to be false or inaccurate, and expose the buyer to financial losses, the buyer will want to recoup its losses from funds in the holdback escrow.
Contingencies. Buyers will not want to be required to consummate the transaction and pay even a portion of the purchase price until they are comfortable that the deal can happen. Larger deals will usually require filings with the U.S. Department of Justice and Federal Trade Commission, which will have opportunities to review and possibly object to the transaction on various grounds. In many cases, buyers will not want to be bound until completion of due diligence. In other cases, there will be a requirement for third party approval from key customers, suppliers, lenders and lessors. Buyers may also want an escape clause if they cannot obtain agreement to key employment contracts with non-compete or non-solicitation clauses from senior executives or if they cannot obtain a commitment for financing. If your business has multiple equity owners, in the absence of a right of first refusal, you may wish to pursue other offers to ensure you are maximizing the sale price of your stock or the company’s assets.
Indemnities. Buyers will insist on being protected from both underlying liability and the legal costs associated with business-related claims arising prior to the closing. These provisions can encompass both known and unknown claims, as well as past, present and future claims. For example, if your business faces a pending lawsuit for patent or copyright infringement or wrongful employment termination, the buyer will demand you take full responsibility for the underlying claim and all legal costs associated with defending against it. The same is usually true of claims that have not been presented at the closing but which arise within some specified time after closing. The wise buyer will include tax claims in the transaction’s indemnities as well.
Price Adjustments. Some deals provide for an earn-out whereby the purchase price is adjusted based upon bottom line performance or other financial metrics during a specified period, typically one to three years following the closing of the transaction. This is often a way of bridging the gap between the buyers’ evaluation of the value of the deal and yours. In other cases, adjustments are tied to post-closing audits and levels of inventory, working capital and/or collection of accounts receivable.
Formalities. It’s customary for the buyer to require shareholder and board approval and certificates of good standing from you. In more complex transactions, some buyers will demand seller’s counsel provide written legal opinions as to the legality of the transaction, prior securities offerings, compliance with material contracts, and absence of pending or threatened litigation. In other words, confirming what you have warranted in the purchase and sale agreement.
In our experience, it is usually the case that deals go more smoothly if buyer and seller discuss at an early stage not only price, but also other material terms of the transaction. These key provisions are normally set forth in a term sheet or letter of intent, and are non-binding upon the parties. These transactions also proceed more smoothly if the buyers prepare and submit comprehensive due diligence requests early in the deal and focus on the most important aspects of the seller’s business. This allows you and the buyer to proceed in an orderly fashion, and if either or both of you do not like what they discover in due diligence, there is no obligation to proceed with the deal. Time and money are saved even if the deal is ultimately lost.
Our corporate partners are available to assist you with preparing and responding to a term sheet, letter of intent or due diligence request in any merger, stock purchase or asset purchase transaction you may be considering. As an additional resource to our clients, we offer a free legal checklist that you or your company can use to assist in the review of your records, preferably with the support of counsel, to prepare you for such a transaction. As we noted, a checklist can be useful to a company before undertaking any meaningful financial transaction, whether it be a company sale, other merger and acquisition transaction or strategic investment.