M&A Purchase Agreement | A Complete Guide
What is a Definitive Purchase Agreement (DPA)?
A Definitive Purchase Agreement, or DPA, serves as the final contract that officially transfers ownership of a business and its assets.
The term “definitive” is used because it signifies that this agreement is the ultimate and conclusive one executed between the involved parties. It supersedes any prior agreements, including a letter of intent or an offer to purchase.
Typically, the DPA is signed before the actual closing of the deal. However, the actual change of ownership occurs during the closing phase. In the case of an asset sale, this happens when the bill of sale is signed and delivered to the buyer. For a stock sale, it occurs when the stock certificates are signed.
It’s important to note that if the DPA is signed before the closing, certain conditions or contingencies may still be in effect. These could include the approval of key third parties like lenders, lessors, franchisors, or licensors. If these contingencies are not met before the closing date or the DPA’s expiration, the sale may be canceled.
The transaction can take one of two primary forms:
- Stock Purchase Agreement (SPA): This involves the transfer of shares of the entity, typically a corporation or LLC, that holds the business’s assets. By purchasing these shares, the buyer effectively gains ownership of the entity’s assets. In the context of an LLC, the shares are technically referred to as “membership interests,” but for simplicity, it’s often called a “stock sale.”
- Asset Purchase Agreement (APA): In this arrangement, individual assets are transferred from the seller to the buyer through the signing of a bill of sale. However, the seller retains ownership of the entity, while the buyer often creates a new entity to acquire the assets.
The DPA specifies a closing date for the transaction, which is the date when the actual transfer takes place. Before this date, the seller and buyer must address and resolve any remaining contingencies or outstanding issues.
On the closing day, the seller and buyer may meet in person, where the final payment is delivered, and the seller signs and delivers the necessary closing documents. Alternatively, they might conduct the signing electronically or through FedEx. In many cases, transactions are now completed virtually, with documents exchanged electronically or through next-day delivery services.
Continue reading to learn more about the process and what it entails.
The Process from LOI to Signing the Purchase Agreement
Here is an overview of the process from LOI signing to closing:
- Letter of Intent (LOI): The buyer and seller both sign the LOI, which is typically non-binding.
- Due Diligence: Due diligence kicks off once the LOI is accepted and typically spans 30-60 days.
- Purchase Agreement: Attorneys for both parties draft the purchase agreement. Negotiating its terms can take several weeks.
- Finalize Due Diligence: The buyer gives the green light for due diligence completion once they are satisfied. Some contingencies may still be outstanding before closing.
- Closing: The closing occurs either in a physical round-table meeting or virtually. The purchase agreement is signed either before or during the closing.
Supporting Documents to the Definitive Purchase Agreement (DPA)
Supporting documents are commonly attached to the DPA as schedules or exhibits. These typically include:
- Allocation of Purchase Price: This document itemizes the purchase price across different asset categories, often needed for IRS filing purposes (Form 8594).
- Assignment of Contracts: Transfers third-party contracts from the seller to the buyer upon closing. Not always necessary for stock sales if certain agreements are transferable.
- Assignment of Equipment Leases: Transfers equipment lease agreements for the premises to the buyer, with the seller often remaining as a lease guarantor until expiration.
- Assignment of Intellectual Property: This exhibit transfers intellectual property like patents, trademarks, or other registered/non-registered assets such as phone numbers, websites, and content.
- Assignment of Shares (for Stock Sales): Used exclusively for stock sales, this document facilitates the transfer of entity shares.
- Bill of Sale (for Asset Sales): For asset sales, this document itemizes all tangible and intangible assets included in the sale.
- Corporate Resolution: Required in asset sales when the seller is an entity (e.g., corporation or LLC), confirming major actions like asset sales.
- Deed of Sale of Entity (for Entity or Stock Sales): Necessary when selling entity shares.
- Independent Contractor Agreement: Needed if the seller plans to continue working with the buyer in any capacity, sometimes in the form of an employment agreement.
- List of Assets: A detailed inventory of tangible assets transferred. While not required for stock sales, it helps clarify ownership, reducing potential disputes.
- List of Intangible Assets and Intellectual Property: This exhibit enumerates intangible assets like phone numbers and websites included in the sale.
- List of Titled Property: It covers assets like real estate or vehicles, which require separate transfer procedures.
- Non-Competition Agreement: This agreement outlines what the seller can and cannot do, specifying its duration. It’s a standard part of most M&A transactions and can be included within the purchase agreement or as a separate exhibit. The agreement should become void if the buyer defaults on payments.
- Promissory Note and Security Agreement (for Asset Sales with Seller Financing): Required in asset sales involving seller financing. The promissory note details repayment terms, while the security agreement allows the seller to place a lien on business assets until full payment. A UCC-1 filing is needed to formalize the lien.
- Seller’s Disclosure Statement: This statement by the seller informs the buyer of any adverse conditions in the business. Providing written notice of significant adverse conditions helps prevent potential legal disputes.
- Share Pledge Agreement (for Stock Sales with Seller Note): In stock sales, it’s common to have shares held in trust or escrow until full payment. This functions similarly to a lien on company assets. A third party often safeguards the shares until the note is fully paid.
- Release of Holdback: Some buyers request a percentage of the purchase price be held in escrow until the completion of a training period or to cover unforeseen variables (e.g., warranty claims). The amount held can range from 5% to 20% or more of the purchase price.
- Training Log: Maintaining a log of the training period’s completion is a wise practice to prevent potential future disputes.
Definitive Purchase Agreement Clauses
Common Clauses Found in a Definitive Purchase Agreement:
- Definitions: A well-crafted purchase agreement begins with clear definitions of key terms used throughout the document. This section removes ambiguity, answering questions like the distinction between “closing” and “change of possession,” ensuring everyone is on the same page.
- Price: This section outlines the purchase price, often breaking it down into components like earnest money deposit, down payment, additional deposit post-due diligence, seller financing, third-party financing, and holdback amounts. It may also detail the presence of an earnout.
- Inventory: Here, the agreement describes the inventory included in the sale. It specifies who will conduct the inventory count—buyer, seller, or a valuation service. Additionally, it addresses price adjustments based on inventory differences between signing and closing, and assesses the condition and salability of the inventory.
- Contingencies: If signed before closing, the purchase agreement includes contingencies. Buyer contingencies can relate to securing financing, obtaining licenses, lease transfers, or gaining franchisor approval.
- Closing Costs and Prorations: This section clarifies the responsibility for covering various closing costs. Many expenses are evenly split between the buyer and seller, with each party covering their advisor’s fees.
- Representations and Warranties: Representations and warranties are seller statements and guarantees regarding the business’s assets, liabilities, and contracts being sold. These assurances convey the accuracy of representations. In the event of discrepancies, buyers may seek legal remedies, potentially leading to damages awarded. Reps and warranties are pivotal in larger transactions, serving to uncover potential issues. As a seller, ensuring factual and precise statements is crucial. Examples of representations include:
- All assets are in good condition.
- Taxes will be settled upon closing.
- Seller holds the legal capacity to sign the agreement.
- Seller complies with all relevant laws.
- Training: This section provides a comprehensive breakdown of the training arrangement’s duration and specifics. It’s essential to be highly precise about the training period’s length, the number of hours involved, and the agreed-upon terms. Failing to do so can result in post-sale disputes, with buyers occasionally taking legal action against sellers for inadequate training.
- Confidentiality: While a separate confidentiality agreement may already be in place, this clause is sometimes included to reiterate the importance of maintaining confidentiality throughout the transaction.
- Default and Remedies: In this segment, conditions for terminating the agreement and penalties for default are outlined, often including provisions for a break-up fee.
- Miscellaneous Legal Provisions: This section covers various legal aspects, such as attorney fees, mediation procedures, indemnification terms, entire agreement clauses, severability provisions, governing law, risk allocation, and other general elements applicable to legal agreements.