BUYING AND SELLING A BUSINESS: Deal Documents
At some point in the transaction cycle of a business sale, some type of definitive documentation will have to be executed by the parties. And, it is a rare deal that really only has one definitive agreement. Frequently in business sales there are the main contract, employment agreements, covenants not to compete, assignments, financing documents, and many other types of agreements to cover matters either not addressed in the definitive agreement or to amplify points contained in it.
The type of definitive documentation will depend on the structure of the transaction. If the transaction involves the sale of assets of a business, then an asset purchase agreement (“APA”) is the main definitive document. In an asset purchase, the buyer is getting exactly what it sounds like, specific assets identified in the APA. In this case, one of the things that need to be made very clear is exactly which assets are being purchased and which ones are not. The process of specific identification can seem tedious, but in the case of any dispute, it will be critical.
In an asset purchase, traditionally it was assumed that no liabilities of the business were transferring to the buyer as part of the deal. However, this is usually not true any longer. There are many situations addressed in case law and certain statutes where a buyer in an asset sale can become liable for obligations of the seller. The APA may identify specific liabilities that are being assumed by the buyer and which ones are not. Of equal importance in an APA are the representations and warranties, which are the way the seller is held to stand behind the purchase. The specific language of these representations and warranties is critical to understand the quality of the assets being purchased and will have a direct impact on the future value of the company for the buyer.
Sometimes the stock or other equity interests are being purchased. In this instance, the definitive document will be a stock purchase agreement or a similar acquisition document. Here the sellers are the owner of the business, not the business itself. Traditionally, all assets and all liabilities follow a stock purchase (or the purchase of the membership interests in an LLC).
One difference in a stock purchase situation is that the representations and warranties come from the owners. Frequently, you will want the business entity to stand behind them as well. And because all liabilities are presumed to transfer along with the business, due diligence is especially important in a stock transaction.
Many buyers reject the idea of a stock transaction out of hand because of the possibility of picking up unanticipated liabilities. However, there are at times tax advantages to this type of structure. In addition, where the business is primarily built upon long term contractual relationships with vendors and customers, or when there are significant governmental licenses required to operate the business, it may be easier to transfer these through a stock purchase.
An additional way to acquire a business is through merger. In this instance, the buyer’s business entity is combined with the seller’s business entity. Either one could be the surviving entity depending on how the deal is structured. Here, the documentation is similar to the types we have already noted but is heavily dependent on corporate formalities being followed by both the surviving business entity and the entity that will disappear into it. Shareholder consents, which sometimes are difficult to get, as well as valuation issues, feature prominently in merger transactions.
As noted in the previous article, definitive documents often provide for a period of due diligence and preparation to take place after they are signed but before the closing. This may be a matter of a few days or a matter of many months depending on how large the deal is. In some instances, however, the parties sign the definitive documents and close in one step. Either way can be fine, but a lot of aggravation can be avoided if the parties address the sequencing of the execution of the definitive documents and the closing in the letter of intent or term sheet. This timing will drive a large portion of the content of the definitive agreements.
At this point in the transaction cycle, we are ready to move to closing and that will be the subject of our next article.