Submitted by: Eric Pritchard, Business and Finance Partner, Kleinbard
Many companies grow by acquisition providing buyers the opportunity to perfect their efforts. Most companies that sell do so only once. This disparity results in a knowledge gap between buyers with significant acquisition experience and sellers with little or no experience. Compounding the disparity, seller likely is selling a company they’ve spent years (and blood, sweat and tears) building.
While acquisitions vary, certain key documents are present in just about every deal. Here’s a short list of operative documents and a brief explanation to educate would be sellers about each. My advice as a deal veteran – don’t sign any of these agreements without consulting legal counsel experienced in acquisitions.
Broker’s Agreement
Not every buyer uses a broker to find sellers. And not every seller uses a broker to find the best buyer. Those that do, however, know that the right broker can be invaluable in getting the best possible deal. A broker’s agreement is not a “shared” document executed by both parties. It’s an agreement between one of parties and the broker, executed before the deal, and details the broker’s services, time limitations on the relationship, and payment the broker may receive on closing.
Non-Disclosure Agreement (NDA)
Likely the first document buyer and seller sign, an NDA requires the parties to maintain the confidentiality of exchanged information. This document is crucial to seller – the party disclosing confidential customer, financial and sales information. An effective NDA must contain certain specific provisions, or it will be of little or no use. While these agreements generally follow a standard form, they are not mere boilerplate. The parties should resist the urge to adopt an agreement from another transaction and should negotiate terms specific to their deal. And most of all, seller should get their counsel to prepare the NDA. Otherwise, it could be a situation of the fox guarding the hen house.
Letter of Intent (LOI)
Often misunderstood, LOIs detail deal terms. Usually prepared by buyer, sellers often sign LOIs without asking counsel for review, believing an LOI to be non-binding. This classic mistake can have significant consequences. While the LOI permits buyer to walk away based on enumerated circumstances (e.g., the results of due diligence), LOIs often require seller to close the deal under the stated terms. An LOI typically precludes seller from speaking with other potential acquirers and may limit seller’s ability to conduct business during due diligence. Perhaps as important, Seller’s counsel will have a difficult time negotiating many protections once the terms are reduced to writing in the LOI.
Buyers also should take LOIs seriously. An inadequately drafted LOI, alone or in combination with the circumstances surrounding a proposed acquisition, may obligate the buyer to close despite dissatisfaction with due diligence. Courts have enforced LOIs against reluctant buyers, awarding significant damages to disappointed sellers.
Stock or Asset Purchase Agreement (SPA or APA)
The primary negotiated document in most acquisitions, the SPA or APA (for simplicity, the “Purchase Agreement”) memorializes most of the parties’ key terms and conditions. Typically, a Purchase Agreement has several important and inter-related sections:
Purchase Price calculation and business terms including true-ups and various types of performance guarantees.
Representations and Warranties are present in virtually every Purchase Agreement, typically to provide buyers with protection on issues relating to seller’s business and accounts. Essentially, the seller represents some set of facts or legal condition to be true as of closing, and then warrants the representation following the closing date. The warranty forms the basis for the buyer’s recovery, should the representation turn out not to be true.
Indemnity Provisions allow buyers and sellers to recover damages for breaches of representations or warranties, or for third-party claims, and are often the subject of extensive negotiation respecting liability caps, deductibles and time limitations. These provisions are highly negotiated and vitally important.
Restrictive Covenants limit the legal right of seller and seller’s principals to compete with buyer post-closing and prohibit the selling parties from soliciting or accepting business from accounts sold to buyer. Well-drafted provisions are enforceable but must be reasonable in scope and duration.
Regardless of whether they’ve done one deal – or 50 – the parties should read, understand and have counsel review these key documents before signing them. And first time sellers should never enter into a deal without a competent deal team in place.
