Purchase agreement terms: NDA, APA vs stock purchase, reps and warranties, working capital peg, non-compete and transition

The document chain

Each document has one job. Knowing the job tells you what to push for in it.

The NDA

The seller will ask you to sign an NDA before sharing financials, customer names or other sensitive information. It limits what you may do with what you learn. Read it for the following points before signing.

• Definition of confidential information: broad is normal, but it should exclude information you already had or that becomes public.
• Permitted recipients: you will need to share information with your lawyer, accountant, lender, valuer and investors. Make sure they are allowed.
• Non-solicitation: many NDAs bar you from contacting employees, customers and suppliers. Respect it.
• Term: how long the obligations last.
• Return or destruction of information if the deal ends.
• No obligation to proceed: the NDA should not commit you to buy.

Asset purchase vs stock purchase

In an asset purchase the buyer takes selected assets and agreed liabilities. In a stock purchase (or membership interest purchase) the buyer takes the entity with its history. Buyers usually prefer an asset purchase for liability protection and tax basis; sellers often prefer a stock sale for simpler tax treatment. The SBA treats an asset purchase of all or substantially all of a business that continues operations as a change of ownership under Appendix 15.

For tax, the IRS requires buyer and seller in an asset acquisition to allocate the price among asset classes using the residual method, with goodwill and going concern value in Class VII, the last class. Goodwill and other section 197 intangibles are amortized ratably over 15 years starting with the month acquired. Both sides report the allocation on Form 8594 with their returns. The asset vs stock guide in this section expands on these points. Ask your accountant to model the allocation before you agree to a structure.

Representations and warranties

Representations and warranties are statements of fact the seller makes about the business at signing and closing. If one is false, the buyer can claim compensation. They also force disclosure, because the seller lists exceptions in a disclosure schedule. A thorough set covers the topics below.

• Organization and authority: the seller can sell and the sale is authorized.
• Title and sufficiency of assets: the seller owns the assets, free of liens, and they are enough to run the business.
• Financial statements: they are accurate and prepared consistently, and there are no undisclosed liabilities.
• Taxes: all returns are filed and taxes paid; no audits are pending.
• Customers and suppliers: no known loss of a major customer or supplier.
• Contracts: listed contracts are valid and in force with no defaults.
• Employees: wage, classification and benefits compliance; no pending claims.
• Legal compliance, licenses and permits.
• Litigation: none pending or threatened except as disclosed.
• Intellectual property and data: ownership and no infringement.
• Environmental, where relevant.
• Absence of changes since the balance sheet date: ordinary course only.
• Brokers: no other fee is owed.

Indemnity, caps, baskets and escrow

Indemnity is the seller's agreement to reimburse the buyer for losses caused by a breach of the agreement. The parties negotiate its limits. The common features are below, with illustrative figures for a $1,650,000 deal. The numbers are examples of how the terms work, not market benchmarks.

A representations and warranties insurance policy is sometimes used in larger deals as a substitute for part of the seller's indemnity. Ask your lawyer whether it suits a deal your size. Under SBA financing, the lender will review how the purchase agreement treats these items and will require that your documents match the loan terms.

Working capital peg

Net working capital is current assets (excluding cash and, usually, debt-like items) less current liabilities. The peg is the target level the buyer expects the business to have at closing so that it can run normally without extra funding. At closing, actual working capital is compared with the peg and the price is adjusted. This prevents a seller from collecting receivables and deferring payables just before closing to take cash out.

Example, with illustrative numbers. The parties set a peg of $300,000 based on a 12-month average. On the closing date, the business has $270,000 of working capital. The price is reduced by $30,000. If the actual figure were $330,000, the price would rise by $30,000. In practice, closing numbers are estimated at closing and finalized after closing within a period the agreement sets, with an independent accountant resolving disputes.

Write the definition carefully: which accounts are included, accounting policies, treatment of deferred revenue, customer deposits, taxes and accruals, and a sample calculation as an exhibit. Most disputes come from the definition, not the number. In SBA deals, a working capital true-up in the purchase agreement is not treated as a buyer rebate, so cash remitted to the borrower may be kept for working capital.

Non-compete and non-solicit

A non-compete stops the seller from competing for a set time and area. A non-solicit stops them from approaching customers and employees. Buyers pay for goodwill, and these covenants protect it. Sale-of-business non-competes are generally enforceable if they are reasonable in time, geography and scope, but the rules differ by state, and rules on non-competes have been changing. Ask your lawyer for the current position in the seller's state.

• Duration: long enough to protect customer relationships, short enough to be enforceable.
• Geography: the area where the business actually operates.
• Scope: the business lines the company actually conducts.
• Consideration: allocate part of the price to the covenant; the SOP lets a 7(a) loan finance non-competes as intangible assets if due diligence requirements are met.
• Remedies: injunction rights and fee shifting.

Transition services and the seller's role

The transition agreement covers what the seller will do after closing. Define the role, the hours, the duration, the pay and who they report to. In an SBA Initial Acquisition, the seller may not remain as an officer, director, stockholder or employee. The business can engage the seller as a consultant for up to 24 months in total, including extensions. Write the consulting agreement to match: independent contractor terms, no authority to bind the company, and a defined scope.

• Customer introductions: a calendar of meetings in the first 60 days.
• Supplier and vendor handover.
• Training: documented processes and knowledge transfer.
• Availability: response times and hours.
• Pay: fixed fee or hourly, and whether it counts against the note.
• End: what ends the engagement early, and return of company property.

Closing deliverables

Use this list with your lawyer to make sure nothing is missing on closing day.

CLOSING CHECKLIST

Seller delivers
[ ] Bill of sale or stock certificates with stock power
[ ] Assignment of contracts, IP and domain names
[ ] Lien releases and payoff letters
[ ] Officer's certificate and resolutions
[ ] Consents (landlord, customers, licensors)
[ ] Non-compete and consulting agreements signed
[ ] Keys, passwords, bank signatory changes, vendor accounts
[ ] Final employee list, benefit and payroll records

Buyer delivers
[ ] Closing payment per funds flow
[ ] Seller note and security documents, standby or subordination agreement
[ ] Evidence of insurance
[ ] Entity documents and good standing
[ ] Lender deliverables (guaranties, loan documents, equity verification)

Both
[ ] Funds flow signed
[ ] Working capital estimate and adjustment procedure agreed
[ ] IRS Form 8594 allocation schedule agreed (asset deals)
[ ] Employee and customer announcement timed and approved
[ ] Post-closing calendar: working capital true-up date, escrow release date, note payments, tax filings

Worked indemnity example

Suppose Example Co's purchase agreement includes a $15,000 deductible basket, a cap of 10 percent of the price ($165,000), and $80,000 in escrow for 12 months. After closing, the buyer finds that the seller failed to disclose an unpaid sales tax liability of $40,000, and a warranty claim of $12,000.

The numbers are illustrative. The point is to run your own deal's terms through a realistic claim before you sign, and to ask your lawyer whether the deductible works as a threshold or a true first-dollar deductible.

Disclosure schedules and the bring-down

The seller qualifies representations with disclosure schedules, lists of exceptions such as pending claims and customer disputes. Read them closely. Anything listed is not a breach, so ask for specific protection for listed risks, such as a special indemnity. At closing, the seller confirms that representations are still true on the closing date. This is the bring-down. If it cannot be given, you have a closing condition problem to resolve before funds move.

Questions to ask your lawyer

• Which structure protects me best given the contracts and licenses in this business?
• What are the biggest gaps between the seller's draft and market practice?
• How should the working capital definition handle deferred revenue and customer deposits?
• What survival period and cap are reasonable for tax and employment representations?
• How should the seller note and standby agreement interact with the purchase agreement?
• What state law issues affect the non-compete?
• What is the closing checklist and who owns each item?

Sign-and-close or split

Small deals usually sign and close on the same day. Larger or more regulated deals sign first and close later, after conditions such as consents, licenses or financing are met. A split closing needs more drafting: interim operating covenants (the seller operates in the ordinary course and does not take actions outside it), a closing condition list, termination rights and a plan for what happens if a condition fails. If you use an SBA loan, the lender's timeline often shapes which is practical. Ask your lawyer which fits your deal.

Termination and remedies

Between signing and closing, either side may need a way out. The agreement should say when a party may terminate: a missed deadline, a breach that is not cured, or a material adverse change. It should also say what each side can claim if the other defaults, including whether a deposit is forfeited. Keep the language clear, because disputes at this point are expensive.