In the intricate dance of buying or selling a business, a pivotal move is the crafting of a robust purchase agreement. This document serves as a protective shield for both parties involved, underpinning a seamless transition of ownership. However, what constitutes an all-encompassing purchase agreement when acquiring a business?
How can you ascertain that your negotiations are leading towards the most favourable terms for your deal?
This blog post will guide you on a journey through the fundamentals of comprehending, creating, and negotiating purchase agreements in the context of business acquisition.
Understanding Business Purchase Agreements
A business purchase agreement, sometimes called a share purchase agreement or an asset purchase agreement, is a legally binding contract between a buyer and a seller that outlines the terms and conditions for the sale of a company’s entire share capital or specific assets.
The agreement’s primary purpose is to facilitate the transfer of ownership, while safeguarding the interests of both parties involved in the purchase. Business purchase agreements of this nature are applicable to various business entities and tangible assets, such as sole proprietorships, partnerships, corporations, LLCs, and other similar types of entities.
As alluded to above, there are typically two types of business purchase agreements: asset purchase agreements and share purchase agreements.
An asset purchase agreement outlines the terms and conditions of buying a business’s assets, while a share purchase agreement pertains to the purchase and sale of company shares.
Each type of agreement has its distinct tax implications, and the purchaser’s obligations may differ depending on the chosen agreement type.
Key elements of a business purchase agreement include;
- party identification
- business description
- financial terms
The party identification section must include the legal names and contact information of the buyer and seller. The business description section should provide an overview of the company and its operations, as well as a statement verifying the seller’s legal authority to authorise the sale. The financial terms provision includes details such as the purchase price and any deposits required by the seller. Additionally, it also outlines the key date and times associated with the transaction.
Types of Business Purchase Agreements
Asset purchase agreement (APA)
An asset purchase agreement is a legally binding document that outlines the terms and conditions of purchasing a business’s assets, such as work in progress, equipment, inventory, and real estate, while also specifying any excluded assets.
In such an agreement, the purchaser typically does not assume the seller’s financial liabilities, although there may be exceptions. This process ensures the smooth transfer of business assets during the transaction.
Share Purchase Agreement
On the other hand, a share purchase agreement pertains to the purchase and sale of company shares, resulting in the purchaser assuming all of the business’s liabilities. It’s important to consider the tax implications of selling assets versus shares, as well as the responsibilities of the purchaser regarding pre-existing liabilities. Consulting with a lawyer or accountant can help you determine which type of agreement is most suitable for your particular situation, taking into account the relevant income tax and capital taxes legislation.
Key Elements of a Business Purchase Agreement
Below are some of the key considerations in a business purchase agreement:
- Parties Involved: Clearly define the seller and buyer, providing full names and addresses. This section might also specify the capacity of each party, e.g., “Seller, in his capacity as the sole proprietor of XYZ Business.”
- Business Description: A comprehensive description of the business being sold, including its legal structure (e.g., Ltd, DAC or LLP), its primary activities, and its location.
- Purchase Price: The agreed-upon amount the buyer will pay for the business. This section should detail:
- The total purchase price
- Any deposit or earnest money required
- The manner of payment (e.g., lump sum, installment payments)
- Any adjustments to the price (e.g., based on inventory levels or outstanding debts at the time of closing)
- Assets and Liabilities:
- A list of assets being transferred, which might include tangible assets like equipment and inventory, and intangible assets like trademarks, patents and goodwill.
- Any liabilities being assumed by the buyer or those that will remain with the seller.
- Employee Matters: If relevant, details about the transfer of employees under TUPE, including any employment contracts, benefits, and how accrued leave will be handled.
- Non-compete Clause: A provision preventing the seller from starting a competing business or working for a competitor for a specified duration and within a specified geographic area.
- Representations and Warranties: Statements made by both the buyer and seller to assure the other party about specific facts or conditions related to the sale, such as the seller having clear title to the assets or the business being free from undisclosed liabilities.
- Indemnification: Provisions that outline the responsibilities of either party in the event that the other party incurs damages or losses due to breaches of warranties or representations.
- Contingencies: Conditions that must be met for the sale to proceed, such as the buyer securing financing or the business passing a thorough inspection.
- Closing Details: Information about when and where the closing will take place, and the actions both parties must undertake before this date.
- Termination: Conditions under which the agreement can be terminated before the closing, and any penalties or costs associated with such termination.
- Confidentiality: A clause ensuring that the details of the agreement and any information learned during negotiations remain confidential.
- Dispute Resolution: Outlines how disputes related to the agreement will be resolved, e.g., through mediation, arbitration or litigation.
- Governing Law: Specifies the jurisdiction or territory whose laws will govern the agreement and where any legal disputes would be resolved.
- Amendments: Describes how changes to the agreement can be made, usually requiring written consent from both parties.
- Notices: Specifies how official communications (notices) between the parties should be delivered.
- Miscellaneous Provisions: Other terms and conditions that may be unique to the specific sale or necessary to clarify potential areas of ambiguity.
- Signatures: The agreement should be signed and dated by both parties, and witnessed by their solicitors.
Purchase Price Allocation
Purchase price allocation is the process of assigning a portion of the purchase price to various goods, goodwill, fixed assets, and intellectual property for tax optimization purposes. This process is essential for both the buyer and seller, as it allows them to divide the purchase price between different assets and liabilities in a way that is advantageous for both parties.
In a business purchase agreement, the timing of payment is often apportioned, providing an opportunity for both the buyer and seller to reach an agreement on a payment schedule that is mutually beneficial. This flexibility can help ensure a smooth transaction and reduce the potential for disputes over payment terms.
Seller’s Representations and Warranties
The seller’s representations and warranties, which the seller represents, are crucial components of a business purchase agreement, as they clarify the seller’s legal authority, ownership of assets, and compliance with tax legislation.
These statements help protect the buyer by ensuring that the seller agrees they have the right to sell the business and that the assets being transferred are free from any legal issues or encumbrances.
In addition to the seller’s representations and warranties, the seller is also required to provide a disclosure letter that discloses pertinent matters related to the warranties, qualifying them accordingly. This letter helps the buyer make an informed assessment of the risks associated with the transaction and ensures that the seller is being transparent about any potential issues.
A warranty claim refers to any claim made by the buyer against the seller for a breach of the warranties provided in the agreement. By including comprehensive seller’s representations and warranties in the business purchase agreement template, the buyer can minimise the risk of encountering unforeseen issues after the sale is completed.
Purchaser’s Representations and Warranties
The purchaser’s representations and warranties are equally important in a business purchase agreement template, as they outline the purchaser’s legal authority, financial capability, and the survival of representations post-closing. These statements help protect the seller by ensuring that the purchaser has the financial means to complete the transaction and that the purchaser will continue to abide by the terms of the agreement after the sale is finalized.
By including comprehensive purchaser’s representations and warranties in the business purchase agreement template, both parties can have confidence in the transaction and ensure a smooth transfer of ownership. This transparency can help reduce the potential for disputes and misunderstandings after the sale is completed.
Legal Considerations in Business Purchase Agreements
Ensuring that all legal bases are covered when drafting a business purchase agreement is indispensable for a smooth transaction and to minimize the chance of conflict.
For instance, if the agreement doesn’t clearly stipulate the exact assets included in the sale, it could lead to a dispute post-purchase, with the buyer expecting certain assets they believed were part of the deal but the seller had not intended to sell. This kind of misunderstanding could potentially derail the transaction or even lead to costly legal battles.
Some of the legal considerations that must be taken into account when creating a business purchase agreement include
- non-assumption of liabilities
- transfer of third-party contracts and intellectual property
- governing law
- dispute resolution
- due diligence and confidentiality
- restrictive covenants and non-competition clauses
These legal considerations help ensure that both parties are clear on their respective responsibilities and obligations, as well as any potential risks associated with the transaction.
Non-Assumption of Liabilities
The concept of non-assumption of liabilities in a business purchase agreement, implies that the purchaser is not responsible for any of the liabilities, debts, or obligations of the seller, resulting from the ownership or operation of the seller before and on the closing date.
This clause protects the buyer from being held liable for any pre-existing liabilities that were not disclosed or agreed upon during the negotiation process.
The seller, on the other hand, is obligated to indemnify and protect the purchaser from any costs, expenses, losses, claims, and liabilities arising from the ownership or operation of the seller prior to and including the closing date. This indemnification ensures that the buyer is protected from any unforeseen issues or liabilities stemming from the seller’s actions before the sale.
Transfer of Third-Party Contracts and Intellectual Property
Transferring third-party contracts and intellectual property can be a challenging aspect of a business purchase agreement. In some cases, existing contracts with third parties may not be legally transferable from the seller to the purchaser, which could potentially impact the value of the business being acquired.
To address this issue, the purchaser may be responsible for securing new contracts with third parties if the existing contracts cannot be legally transferred from the seller.
This responsibility ensures that the purchaser can continue to operate the business without interruption after the sale is finalised.
Governing Law and Dispute Resolution
The governing law and dispute resolution mechanisms in a business purchase agreement are essential components that specify the substantive law that will be used to interpret the agreement and the process of resolving any disputes between parties related to the subject matter hereof.
Choosing the appropriate governing law and dispute resolution mechanisms can have significant implications for both parties, as they can impact the enforceability of the purchase agreement and the process of resolving any disputes that may arise.
By clearly outlining the governing law and dispute resolution mechanisms in the business purchase agreement, both parties can ensure that they have a clear understanding of their rights and obligations under the agreement and a defined process for resolving any disputes that may arise. This clarity can help minimise the potential for misunderstandings and costly legal battles.
Tips for Negotiating a Business Purchase Agreement
Negotiating a business purchase agreement can be a complex process, but with the right approach and preparation, it’s possible to secure favourable terms for both the buyer and seller. One essential aspect of negotiation is conducting thorough due diligence to identify any potential risks associated with the purchase. This process involves investigating and verifying information regarding a company or investment opportunity, and it can include financial, legal, and operational due diligence.
Confidentiality is another crucial aspect of negotiation, as it helps to protect sensitive business information during the negotiation process. Including confidentiality clauses in the agreement can ensure that confidential information is not divulged to third parties or used for purposes other than the transaction at hand.
Lastly, restrictive covenants and non-competition clauses play a vital role in protecting the purchaser’s interests and ensuring a fair transaction. These clauses can help prevent the seller from competing with the buyer after the sale or from soliciting the buyer’s clients, thus safeguarding the buyer’s investment in the acquired business.
What is included in the purchase of a business?
When purchasing a business, the financial terms of the agreement typically include the purchase agreement cost, legal fees and who will be responsible for them, as well as either a share/stock transfer or an asset purchase.
The purchase agreement cost is the amount of money that the buyer pays for the business. Legal fees are the costs associated with the legal process of the purchase, negotiating agreements, filing documents and obtaining necessary clearance certificates and consents. The buyer and seller will need to decide who will be responsible for these fees.
How do you draft a purchase agreement?
A purchase agreement should include the buyer and seller information, a description of the property being purchased, the purchase price, payment and delivery terms, and other contingencies.
It should also include both parties’ signatures for legal validity. It is best to get your solicitor to draft the agreement for you.
What is an asset purchase agreement in business?
An asset purchase agreement is a legal contract to buy the assets of a business or to purchase specific assets from it.
It outlines the terms and conditions of the sale, including the purchase price, payment terms, and any warranties or representations made by the seller. It also sets out the rights and obligations of both the buyer and the seller.
What is the difference between an asset purchase agreement and a share purchase agreement?
Asset purchase agreements relate to buying a business’s assets, while share purchase agreements involve purchasing company shares.