CLOSING THE DEAL–M&A Series of Articles

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Dr. John Psarouthakis is a Distinguished Visiting Fellow-Professor, Institute of Advanced Studies in the Humanities, University of Edinburgh, Scotland. Founder and former CEO, JPIndusries,Inc., a Fortune 500 industrial corporation. He is the Executive Editor of

In this article we review the key elements of the purchase agreement. Once you have found the right company, lined up your financing, completed due diligence and agreed upon a price, you are ready to close the deal.


                The Purchase Agreement as a Due Diligence Acquisition Tool

            Although you don’t sign the purchase agreement until due diligence is complete, you should begin work on the purchase agreement at the same time that you begin formal due diligence.  This is very important.

            First of all, negotiations may take some time, and there is no reason for added delay.  More importantly, as mentioned in the chapter on formal due diligence, the negotiation of the purchase agreement document itself might surface problems that the owner forgot about, overlooked, or purposely hid during the course of due diligence.   It is desirable to learn of these problems as early as possible in the negotiations and due diligence process, so that further investigation of them will not delay closing, and, in the worst case, that you have minimized your expenses on due diligence if you decide to walk out of the deal altogether. 

            The warranties and representations section of the purchase agreement holds the owner liable after the close of the deal for expenses or charges that he or she could have foreseen and did not warn you about.  However, from a practical standpoint, you should always assume that it may be difficult, if not impossible to collect damages once the deal is closed.  Therefore, the key purpose of the representations and warranties section is to learn about major problems during the due diligence period and address them in the purchase agreement.  Unsettled lawsuits or other threatened liabilities can then be addressed with appropriate amounts of money held in escrow for a reasonable period of time, based on the specific contingency being protected against.

                                         Elements of the Purchase Agreement

            The four basic sections of the purchase agreement include:

(1) price and terms of the sale; (2) representations and warranties; (3) conditions and covenants; and (4) general statements of law.

            In an asset purchase agreement, assets are transferred from the seller to the buyer in the sales transaction.  This is often the case when a larger corporation divests itself of a particular division.  In a stock purchase agreement, the purchaser may acquire stock ownership in the company rather than assets. Because of the lack of hard assets, a stock purchase agreement is the most common form in service companies although it can occur in other types of industries as well.

            The actual purchase agreement for a medium-sized corporation may be quite lengthy, with about 20-50 pages of narrative in the core document, not counting all the attachments, which may involve other agreements, such as the escrow agreement.  The total agreement is quite lengthy.  Exhibit 14.1 shows a table of contents for an asset purchase agreement.   Exhibit 14.2 shows a sample of a stock purchase agreement. 

            Price and terms, and conditions of the sale  Terms of the purchase agreement cover the sales price, and the amount of cash, stock and assets that will change hands and any earn-out agreements.   This section also describes what is being purchased.        


            Representations and warranties  This section may elaborate further in describing certain aspects of the business, such as financial statements, benefit plans,  patents, etc.  More importantly, it is a statement of guarantee by the seller that everything he or she has told the buyer is true and that he or she has told the buyer everything of significance about the company to be purchased.  How strong the guarantee itself is worded is often a heavily negotiated area.  Disagreement over this section has caused deals to fall apart.  However, it is vital that some language be included to protect the buyer that the company has been fairly and accurately represented.

            Conditions and covenants  This section lists all those items which must be completed by both buyer and seller prior to the close.  For instance, in an asset sale, the seller must comply with the state’s Bulk Sales Act.  Or if the buyer wants to continue with the same insurance policies, the seller promises to deliver such policies prior to closing.  Another example is the transfer of a real estate or equipment lease.  This section is fairly straightforward and a good attorney should be able to help you with all the necessary aspects. 

            General statements of Law  Other technical issues relating to state laws, arbitration procedures and other legal issues need to be included with which a good contract lawyer should be familiar.

                                Types of Set Asides and the Escrow Agreement 

            Set asides are specified sums of money put into an escrow account by the seller at closing to be transferred to the buyer under certain conditions described in the purchase agreement or related escrow agreements.  Two common types of set asides include inventory escrow and escrow for potential liabilities.  

Inventory escrow 

            Some money, often between 20-50% of the value of inventory, is held in escrow for about 30-60 days until an audit is finished, to verify that the dollar amount of inventory promised is indeed in the warehouse and is saleable.  There may be set asides for other price adjustments based on the results of the final audit.  Sometimes an alternative approach is to sign the purchase agreement and then delay the actual closing for a period of 30 days or so, to complete the final audit and then transfer ownership on the day of closing.  Either way, you want to be sure to have a final audit to verify that everything that is included in the contract is physically present.  Inventory moves in and out the door every day so you need an accurate audit as to the value when you actually transfer ownership. 

Escrow for potential liabilities 

             A second type of set aside is included in an escrow for potential liabilities.  You would be wise as a buyer to negotiate this second set aside as well.  Usually an agreed upon percentage of the total price, possibly as high as 10%, may be kept in escrow for up to 24 months or more to cover potential liabilities, such as employee or product related lawsuits or other unforeseen liabilities that can be traced to problems occurring prior to the sale.  Especially in medium sized to larger companies, news media attention seems to bring various lawsuits out of the woodwork that had been dormant for a period of time.  The twenty-four month time span is useful because it is typically during this time that media attention triggers interest by people who believe that this is their golden opportunity to sue the company.  Transfer of ownership also may attract the attention of government bureaucrats.  In theUnited States, you might catch the attention of the U.S. Environmental Protection Agency, the Occupational Safety and Health administration (OSHA), the Equal Employment Opportunity Commission or any of a number of other agencies that monitor business activities. 

            The set aside carries interest in favor of the seller and if nothing comes up within the designated time period, the buyer releases the money to the seller in addition to agreed upon interest.   The escrow agreement clarifies what these funds should cover. You are wise to cover possible liabilities in this way than to assume that you can collect from the seller after the closing.  Without sufficient escrow, you can try to pursue the seller through the courts but collection can be a serious problem in all but the largest corporations, and can be extremely difficult from a private seller.  In addition, you incur the added time and expense of investigating the situation and taking it through the courts. 

            Legally, disclosure is key in determining whether or not the seller is obligated to pay the purchaser for liabilities created prior to the transfer of ownership.  Disclosure laws do not require that the seller discuss problems openly with the purchaser.  Provision of related documentation, even if buried in thousands of other documents is usually considered sufficient.

            Consider the following example. Say, for instance, a former employee who worked for the previous owner sues and wins a two million dollar settlement.  Perhaps you had information that the employee was disgruntled which surfaced during due diligence procedures and requested one million dollars be held in escrow. Because the seller disclosed the problem to you and you agreed to the one million dollar amount, he or she does not owe you the difference.  On the other hand, in company B, suppose that the seller, for whatever reason, had not revealed a problem to you about this one employee.  Then, you are entitled to the extra million dollars.  On the face of it, it may seem better to allow such problems to remain hidden.  However, consider that it may be very difficult to collect such funds.  To reiterate, you are wise to investigate any letters, suits, warnings, or other signs of disgruntled employees or customers prior to closing rather than to attempt to collect from the seller after the fact.  Such information will then be used to establish an appropriately sized escrow account.

                                                        The Closing Dynamic

            Aside from the preparation of the legal documents, the closing may have two affective aspects worth understanding–the fear of closing, and the closing momentum. 

            The fear of closing,  especially within privately owned companies, the seller may have ambivalent feelings toward the sale.  If the business has been in the family for a long time, or the seller is coupling the sale with retirement, a variety of emotions may come into play.  On the other hand, when you deal with corporate sellers, such as the division of a larger corporation, you are not likely to experience this dynamic. 

            Closing momentum  Ideally, you want the momentum of the acquisition process to keep moving forward through closing, so that negotiation does not stall out.  As the private seller nears closing, business ambivalence may give way to the excitement and momentum that builds as they begin to plan for their transition after the sale.  The seller is more personally involved with the consequences of the sale going through or not than in the case when you are dealing with the corporate sale.  Thus, whereas you are less likely to encounter a fear of closing among corporate sellers, you may run into a greater likelihood of the process slowing down or losing momentum as closing approaches.

                                                    RECOMMENDED READINGS  

How to Aquire the Right Business: (John Psarouthakis and Lorraine Uhlaner),  Xlibris 2010.

From Tuller, Lawrence, Buying In, Liberty Hall Press

Review Goldstein, Chapters 9 and 10.

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