Mergers & Acquisitions – Key Issues in Purchase Agreements5 Oct, 2015 By: Mike Dudek
This is the first of a series on key issues a business owner will encounter in a purchase and sale agreement when buying or selling a business.
Caution - this article is not intended and/or should not be construed as legal or tax advice.
Carefully review your purchase and sale agreement
Upon first read, the purchase agreement drafted to buy or sell your business might be misinterpreted as a cure for late night insomnia. However, do not make that mistake because a business owner might never be a party to a more important legal document in one’s lifetime than a business purchase agreement, so approach with caution. You need to be sure that you understand the binding agreement of which you are about to execute, for it could turn out to be a much more costly proposition post-closing than what you had anticipated.
Virtually every purchase and sale, and related purchase and sale agreement, is fraught with post-closing risk for both the buyer and seller; especially the seller because in large part, purchase agreements are crafted to protect the buyer.
Purchase agreements need to be carefully customized by the counsel for the business owner to each particular business purchase and sale transaction, including customizing it to your particular facts and circumstances and to accomplish the objectives of parties involved; both the seller and buyer.
So before you place your John Hancock on a purchase agreement, among other common sense steps that you need to take:
- Make sure your purchase agreement properly addresses both your business and the legal issues.
- Perform a “what if” analysis to determine if the purchase agreement properly addresses & describes the outcomes to resolve issues which might occur post-closing.
As a buyer, when you hire an attorney to draft your purchase agreement, or as a seller, when you retain your attorney to review and edit the purchase agreement, you should make sure that you retain an attorney who has business experience and M&A transaction experience; and if you happen to be able to retain an attorney who also happens to be a CPA with extensive industry experience, you should consider those attributes a plus.
Rest assured that inattentive buyers or sellers of businesses can be unconsciously exposed to substantial, unanticipated post-closing risk and monetary consequences, which could be avoided through careful crafting of the purchase agreement. While on the one hand, some risks are unavoidable and a natural extension of the business deal at hand; there are a host of avoidable negative consequences if the purchase agreement is better prepared.
Please keep in mind that when discussing the purchase agreement with your attorney, there is no such thing as a dumb question to ask your attorney. You know your business issues better than the attorney you are retaining, so apply that business knowledge when determining if the purchase agreement fits. You should not only review the purchase agreement to gain an understanding of its various provisions, you should also gain an understanding of the provisions implications if something does not go as planned after closing.
Now then, put on a fresh pot of coffee and let’s take a tour through some initial key purchase agreement issues:
Deal structure - Stock versus asset deal
Many business owners often pop the question: “What is the difference between an asset deal and a stock deal?” Many owners surmise by its names that in an asset deal, the buyer does not assume any liabilities. These same owners often surmise, due to the reputation of prior war-story stock deals, that in a stock deal, the buyer is at risk for all liabilities including unknown and unrecorded liabilities. Neither are valid suppositions.
As a summary introduction, while there are many different types and structures of merger and acquisition transactions with different tax and legal implications, an “asset deal” and a “stock deal”- terms of art in the industry, are the two most common forms of business purchase structures.
In an asset deal, the seller is selling and the buyer is buying certain assets or possibly all the assets of a business, and the buyer is assuming certain liabilities; possibly all the liabilities or possibly even no liabilities of the business, except of course, that no buyer in their right mind has any real interest in assuming unknown liabilities unless special circumstances exist and only if the agreement contains some type of related limiting language.
Conversely, as distinguished from an asset deal, in a stock deal, the seller is selling and the buyer is buying the capital stock of the business. Just like an asset deal, however, the buyer is entitled to some or all of the assets of the business and/or certain assets of the business might be excluded from the sale. Likewise, the buyer might assume all of the liabilities of the business (usually only the recorded liabilities), or certain liabilities might not be assumed, especially unknown and unrecorded liabilities.
It is important to understand this because it is a common misconception that just because an acquisition might be structured as a purchase of capital stock, it does not mean that the buyer is any more exposed on the liability side of the equation. Just like in an asset deal, a buyer can insert various provisions, protections and devices into a capital stock purchase agreement which mitigate post-closing risk from such concerns as unwanted or unknown liabilities.
Next month, look for my article that addresses additional key issues of concern.
Mike Dudek of Zygoquest also owns the Law Office of Mike Dudek, providing owners and executives with customized & affordable legal services on mergers & acquisitions and other complex business transactions. Complete info at http://www.mikedudeklaw.com