Whether you’re deciding to buy a home or sell a business, you will have to confront – and understand – the ins and outs of a purchase and sale agreement. If you’re selling your lemonade-stand business for $1000, a purchase and sale agreement is probably overkill. But the bigger the deal is, the more vitally important it is to get all the details down correctly.
Below I will walk you through the process of drafting a purchase and sale agreement (also known as a sales and purchase agreement (SPA)), highlighting the most important contents and sections. Learn more about the processes the pros use with this five-star course on corporate valuation and how to value companies and mergers.
Let’s just cover a few of the basics. I also want to note that I’m approaching this article through the point of view of acquiring or selling a business, although in general the process is relatively stable.
First of all, if the agreement is large enough to necessitate a purchase and sale agreement, then it almost surely necessitates a lawyer, accountant and possibly broker (real estate). This is because a lot of negotiations take place during and after the drafting of the agreement. The agreement is where many of the most important decisions are made, including pricing, payment (as in, how will payment be made?), etc.
To return to my introductory example, if you’re selling a small business or property then you probably don’t need expert advice. Let’s say your lemonade stand is worth $10,000. At that price, you can’t justify hiring a lawyer; any slight loss would be so small that it would be cheaper to pay off the potential difference than to hire professional help. Most relatively small agreements, especially when both parties are well acquainted and trust each other, are only one or two pages long (and often downloaded from the internet or drafted by hand). Still, getting a lawyer to look over an online form is a good idea just to make sure it represents a legally binding and correct agreement.
On the other hand, if your tech company is being bought by Google for $10 million, you’ll want to invest in a good lawyer (you know Google’s will be good, unless you decide to share a lawyer). This type of agreement can be book-length, addressing every asset, every detail – everything. If you want to find out more about mergers and acquisitions, this course demystifies the process by exposing how the biggest deals are done.
Purchase And Sale Agreement: Contents
It probably goes without saying at this point, but being aware of the contents is not the same as understanding them from a legal standpoint. Do not assume the descriptions below are sufficient for handling a deal on your own, especially because I cannot possibly address every possible detail.
The Basics: Obviously, the agreement will list things such as the parties involved (businesses, representatives, etc.), the closing date, the location, etc. In other words, if there is any place where formalities are strictly followed, it’s a purchase agreement.
Closing Price: A separate clause will list the purchase or sale price, depending on which side of the agreement you’re on. Large deals will include price allocations, as well, for determining tax implications.
Price Adjustments: The closing price is often not the final agreed upon price. Adjustments are typically made to account for the specific place in time the transaction takes place, in which case the price can be prorated or inventory and final account balances can be readjusted. Check out this step-by-step guide on how to build a complete merger model in Excel and start making your own financial predictions.
Assets: The list of assets can be quite lengthy indeed. Certain sales will literally include details concerning everything being transferred by the final sale price. Obviously the most valuable assets will be listed: accounts receivable, cash, clients, patents/names, inventory, equipment, real estate, buildings, machinery/automobiles, etc. But someone who takes great pains to cover all the bases would even include clauses covering the furniture and fixtures in the buildings (yes, this means such things as shelving, signs, desks, counters, lighting, etc.).
Liabilities: Naturally, liabilities will follow close behind the assets. Liabilities are largely accounts payable because a buyer is not likely to agree to a deal in which the seller gets to sell off dangerous/complicated liabilities. For this very reason, you would be wise to include a clause stating that the buyer is not responsible for any liabilities except those explicitly accounted for in the purchase and sale agreement.
Payment: Payment is often more complicated than just instantaneous cash reimbursement. It often includes a plan in which the payment is going to be made at intervals in the future.
Payment Security: In the case the payment is not made in one up-front lump sum, a payment security clause will be added. This protects the seller by including verified assets owned by the buyer. These are used as a safeguard or guarantee of sorts. Similarly, the buyer wants to be protected and this is accomplished through business operation requirements. In other words, once the sale agreement is signed, the seller is not allowed the waive its obligations and allow the business to fall apart.
Detailed Assets: We aren’t done with assets yet. Usually, for large companies, each asset will eventually receive its own section. For example, if the company owns a large amount of equipment, there will be an equipment clause detailing it. Inventory, too, is often recorded in detail.
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Buyer And Seller Representations And Warranties: While I am including these as one clause here, they will each have their own space on the agreement. Each party will make a statement guaranteeing their ability and legal right to enter into the agreement. In other words, the seller is not posing as a fraudulent owner of a business (the seller actually owns it and has the right to sell it) and the buyer is not posing as a fraudulent buyer (the buyer can legally purchase the business and has the necessary means).
Employee Termination: In many cases the seller must be willing to terminate those employees that are not contractually transferable. This is not a personal vendetta whatsoever or even the end of the employees tenure. It simply means the seller will pay its employees’ wages, benefits, etc. until the transfer actually takes place. Then the employees who were “terminated” are typically “re-hired” by the buyer. This is necessary for tax purposed; wages, commissions, benefits, etc. must be transacted under the buyer’s FEIN. For more information on employer and employee agreements, read this informative post on service level agreement examples.
Post-Closing, Provisions, Transfers, Fees: The end of the agreement may or may not be filled with a number of smaller clauses. A post-closing obligation means the buyer can make final adjustments after the sale for unforeseen expenses or liabilities. A default provision sets forth means for handling disputes if either side is unable to fulfill the agreement obligations. The transfer agreements simply cover things like transferring all assets, stocks, etc. And finally the fees clause protects the lawyers, accountants and brokers involved by making methods for payment explicit.
Hashing out the purchase and sale agreement is when all the negotiations take place. This is the template or blueprint upon which details are constructed. If you’re interested in investigating the details of mergers and acquisitions yourself, check out this top-rated CFA approved course on financial modeling and valuation.