Purchase Agreement: The Four Key Sections Buyers Absolutely Need to Understand

Is your company in the process of buying another company?  If so, you’re going to need a carefully negotiated, well-drafted purchase agreement in place that describes the deal you’ve struck with the Seller.

Depending on how your acquisition is structured, the document will likely take the form of an “asset purchase agreement,” “stock purchase agreement,” or “merger agreement.”  It will be critical that you understand what the agreement says and how it works but, unless you have experience buying or selling companies, gaining such an understanding can be a tall order.

To help you get started in the process, let’s identify the four sections of any purchase agreement that are most important to you as a buyer (other than the brief section describing the purchase price amount, of course), and discuss in plain English what those four sections do for you as the Buyer:

1.  Seller’s Representations. 

This lengthy section of the purchase agreement provides a number of statements by the Seller about its business, but all the statements taken together say one basic thing:  “Here is what my business consists of right now, including the good, the bad, and the ugly.”

The Seller’s representations can range from a statement that it is not engaged in any litigation, to an affirmation that it has complied with all applicable laws, to a summary of all contracts to which Seller is a party.

The Seller’s representations are often qualified by exceptions described in an attached “disclosure schedule.”  For example, one of the Seller’s representations may be that it is not engaged in any litigation “except as described on Schedule 1.”

Here’s the takeaway for you as the Buyer:  if a representation is later proven to be untrue, you will likely have the right under the “indemnification” provisions (described below) to recover damages from Seller.

2.  Seller’s Covenants. 

The “covenants” section of the purchase agreement provides a collection of promises made by the Seller to the Buyer that are most easily described by this statement:  “This is what we promise to do and not to do, both before the sale closes and after the sale closes.”

Unlike the “representations” section, which provides a snapshot of the Seller’s business at a particular time, the “covenants” section describes actions that the Seller will be required to take, or refrain from taking, during some period of time.

For example, as the Buyer, you probably want to include covenants that prohibit the Seller from taking any of the following actions prior to the closing: (a) shopping your deal to competitive bidders, (b) conducting the business in a way that is inconsistent with the way the Seller has normally conducted the business, or (c) selling any of the assets that you expect to be in the business that you’re buying.  Likewise, you’ll probably want to include covenants that require Seller to cooperate with you as you attempt to complete your pre-closing due diligence and that compel the Seller to assist you as you transition the business operations after the closing.

Your take-way: the covenants section won’t serve its purpose if it doesn’t meet your specific needs, so give careful thought to what those needs are and be sure you have a business-savvy lawyer who can help you craft the covenants.

3.  Conditions to the Buyer’s Obligation to Close the Purchase. 

The “conditions” section of the purchase agreement is, in effect, a statement by the Buyer to the Seller explaining the following:  “If the conditions listed in this section are satisfied, and the Seller and third parties deliver certain things to the Buyer, then the Buyer will be required to close the acquisition.  On the other hand, if the conditions are not satisfied by a certain date, then the Buyer can walk away from the deal without having to pay the Seller a single penny.”

For example, as the Buyer, you’ll want to provide that you’ll have no obligation to close the acquisition unless: (a) all of the Seller’s representations and warranties are true on the closing date, (b) the Seller has performed all of its pre-closing covenants, (c) the Seller’s business has not taken a serious turn for the worst (often referred to as a “material adverse change”), and (d) the Seller has delivered signed versions of any other agreements that may be needed as part of the acquisition, such as an escrow agreement or a transition services agreement.

Two quick points worth mentioning here: first, the Seller will require a reciprocal set of conditions that must be satisfied before it can be required to close the sale to the Buyer; and second, there may be no need to include conditions in the purchase agreement if the deal is structured to close at the same time the purchase agreement is signed rather than after it is signed.

4.  Indemnification by the Seller. 

The “indemnification” section of the purchase agreement includes the following promise by the Seller:  “If one of my representations about my business is incorrect, or I breach one of the promises (covenants) I’ve made to you in the purchase agreement, then here is what I will pay you for your losses.”

This section can be one of the most technical and difficult-to-read sections of the purchase agreement but it’s also one of the most critical for you.  On the one hand, it will provide the procedure by which you can obtain damages from the Seller if the Seller has given you a false representation or otherwise failed to comply with the purchase agreement.  On the other hand, it will likely limit the duration of the post-closing period during which you can make claims and limit the total dollar amount that you can recover for breaches of the purchase agreement.

So with that crash course behind us, go back and read the purchase agreement for your deal and ask yourself four questions: Do I understand the agreement?  Is there anything missing from the agreement?  Does the agreement accurately reflect the deal I struck with the Seller?  Am I adequately protected by the terms of the agreement?  Then sit down with your lawyer and work through any weaknesses you’ve identified.  Once you sign the purchase agreement, you’re stuck with it, so definitely get it right the first time and be sure you have an experienced lawyer to help you through the process!

Photo by SalFalko on Flickr