The Inner Workings of a Deal: Tips for a Successful Transaction
Part VIII – The “Docs”
Last month, we discussed the worst part of the deal process – due diligence.
By now, while the due diligence isn’t over yet (but that might be a light at the end of the tunnel), it is time to start putting together the deal documents.
The Deal Documents
Suprisingly late in the process, you and the buyer will need to negotiate final deal documents. The primary deal document most often takes the form of an Asset Purchase Agreement or a Stock Purchase Agreement. However, in most transactions, there are a variety of other documents as well, including but by no means limited to employment agreements, loan agreements, and shareholder agreements.
Who Drafts the Deal Documents and When Will I Get Them?
It is fairly typical for the buyer in lower middle market transactions to provide the first draft of the deal documents. Also, because the documents are somewhat expensive to create, buyers tend to want to make sure that any questions related to the transaction are answered before they commission attorneys to draft them. So, you probably won’t get draft documents until well after the financial due diligence that we discussed last month has been completed.
You can often determine when a buyer shifts from the mindset of “we would like to do this deal” to “we are going to close this deal” by delivery of the documents. If the buyer is delaying delivery of the documents, then he is probably still trying to sort out one or more risks prior to committing his own team to the deal.
At this stage, if you haven’t already involved him, you’ll want to bring in your M&A lawyer to assist you with negotiating the final documents. You’ll want a lawyer who has expertise in completing the sale of companies. Don’t hire someone who just dabbles in the space.
What will be in the Purchase Agreement?
Depending on whether the transaction is structured as an asset sale (your company is selling its assets to the buyer) or as a stock sale (you are selling your stock in the company to the buyer), the main document will be either an Asset Purchase Agreement or a Stock Purchase Agreement. While there are some fundamental differences between the two, they are largely similar.
The most notable portions of the purchase agreement include:
- The Deal Terms (a description of what is being sold and the price)
- Representations and Warranties (and the corresponding Schedules to the Agreement)
- Indemnities/Dispute Resolution
The Deal Terms
Usually, the first part of the purchase agreement includes a detailed description of what is being sold and what the terms of the deal are. This is where you are likely to see the parts of the deal that you are most concerned with: what you are receiving in exchange for your company.
This is where you will also find any consideration in addition to cash that you are getting. It is not unusual for buyers to pay a portion of the sale price in the form of a note back to the seller, an earn out (a payment based on future performance of the company) or some amount of equity in the buying entity.
Representations and Warranties
The next section of the purchase agreement will include many pages of representations and warranties about every aspect of your business. This is really a risk sharing mechanism, and it is the way that the parties allocate risks, both known and unknown about the company.
As an example, a typical representation and warranty might say that the seller is not aware of any employment related disputes other than those listed on a corresponding schedule to the agreement. Then, the parties may allocate the risk associated with employment related disputes by having the buyer handle any known and disclosed disputes and any unknown and undisclosed disputes, but having the seller handle any undisclosed disputes that the seller should have known about.
Because the risks addressed in the representation and warranty provisions can in some circumstances be very meaningful, it is important to closely work with your attorney in identifying any items that should be disclosed on the schedules. Your attorney will also be working hard to make sure that future risks associated with your company are appropriately shared.
The next portion of the purchase agreement will contain covenants. This is where you will find the parties’ agreements to do things at the closing or after the closing. For example, typical covenants include:
- The parties’ agreement to enter into an employment relationship at the closing.
- The parties’ agreement to enter into a stock holder agreement at the closing.
- Seller’s agreement not to compete with the buyer for a period of time after the closing.
- The parties’ agreement to cooperate on certain items after the transaction has closed.
Finally, the purchase agreement will contain indemnities and dispute resolution agreements. This portion of the agreement will work hand in hand with the representations and warranties section described above.
Indemnities will address what happens if liabilities occur after the transaction closes – whether they will be paid by the buyer, the seller, or shared in some way.
Purchase agreements also often include alternative dispute resolution provisions that address how disputes post sale will be addressed. These can include arbitration, mediation, or other mechanisms.
If you have gotten to this stage of the process, you are getting close. The deal documents can be complex, and you’ll need a competent M&A lawyer to assist you at this stage in the process. It is important to retain a lawyer that specializes in deals like yours, and doesn’t just dabble in transactions. If you don’t know anyone that can help you, your M&A advisor can undoubtedly suggest one or more good candidates.
Michael Schwerdtfeger is a managing director at Chapman Associates. Michael and his team are focused on providing exceptional results through sell-side mergers and acquisitions advisement to entrepreneurs and business owners exclusively. Michael leverages his 20 years of diverse experience handling complex business transactions to help guide his middle-market clients to the best possible deal outcomes.