What Is a Business Purchase Agreement?
A business purchase agreement is the legal means needed to purchase a business in California. Business purchase agreements are sometimes referred to as a stock purchase agreement, asset purchase agreement, or company purchase agreement. It may be called something different depending upon how the buyer is purchasing the business — its assets or its stock or interest. Regardless of what an agreement is called it encompasses all of the agreements that would make up the purchase of a business.
At the functional level in a deal, a business purchase agreement is the very important document that essentially details what the buyer in an asset deal is purchasing and for how much. It also outlines the assets being conveyed and the process for doing so. While every deal is unique, the various parts of a business purchase agreement will remain the same. Most state and federal laws that apply to one form of business acquisition will also apply to the other forms.
A business purchase agreement relates to the choice of method of business purchase. When drafting this document , a lawyer will think about the legal and tax implications of one choice over the other, including applicable taxes and transferability. If the proper considerations are not weighed, it could cost the buyer or seller more than anticipated in taxes or transaction costs.
In the context of a business purchase agreement, there are two basic methods of purchasing a business or company: (1) purchase of assets; or (2) purchase of stock (or interest). In a business purchase agreement, company is used to describe an entity, typically a corporation or limited liability company (LLC) for an incorporated business. Business is sometimes used to refer to sole proprietorship.
In California, in a stock or company purchase agreement the seller agrees to sell all or part of the company’s interest or stock to the buyer. Such a transaction involves the change of ownership of a company’s equity. In an asset or business purchase agreement, the seller agrees to sell some or all of the assets of the assets of a business to the buyer. Such a transaction involves the change in ownership of a business’ assets.
Essential Components of a California Business Purchase Agreement
A business purchase agreement needs to contain all the essential elements to create a binding, enforceable contract. Even though the terms of these agreements can be rather complex, they all must include the following essential elements:
- Pricing and payment terms of the purchase – terms of payment can include cash or financing needed for the purchase, the price being paid, any adjustments to the price (that may include the valuation of existing inventory) and closing costs
- Closing contingencies – this outlines any obligated actions that need to occur in order for the sale to move forward or the buyer to close the deal
- Confidentiality and non-disclosure agreements – how confidential information is protected can be extremely important and this is detailed in the business purchase agreement
- Indemnification agreements – if the buyer realizes a negative impact from the purchase as a result of information that was negligent or omitted, this section can serve to protect the buyer when the deal is completed
- Liability issues and remedies – potential liabilities that are implied or inherited can be detailed in this section
- Terms of employee employment or lay off – termination or assumptions of employment obligations needs to be addressed
- Unrelated personal obligations – unrelated obligations may be listed (i.e., covenants or legal claims) and may require a release
- Contingencies for post-closing if relocation is required for the buyer – if necessary, it will be listed
- Non-competition agreements and covenants – to protect the buyer from unfair competition
- Restrictive covenants – can include physical location, geographic area, or other restrictions upon sale.
Legal Necessities in California
All purchase agreements for California businesses must be in writing. If the agreement is not in writing, the seller of the business may sue the buyer for breach of contract without the necessity of showing that a contract existed.
If the terms of the purchase agreement will take more than one year to perform, the agreement must be in writing and signed by the party against whom performance is sought. However, a part performance by the seller of the contract creates an exception to this rule. If the seller has received payment from the buyer and has transferred at least some part of the purchased assets to the buyer, the buyer must still pay for those assets.
California law requires that business buyers be given written disclosures of any known defects in the business before they complete the purchase. In addition, California law entitles business buyers to a 17-day period to review key documentation before they sign the final purchase agreement.
How to Create an Effective Agreement – The Steps to Take
Although every purchase transaction is unique, the following steps are generally required to draft an effective business purchase agreement:
1. Determine essential contractual terms: In the initial meeting with the client, address the specific business being purchased and its fundamental terms:
a. All material terms should be reducible to writing.
b. Barring specific exceptions, all business purchase agreements will be subordinate to relevant business regulations.
2. Identify transaction structure:
a. Stock Purchase – The buyer purchases the target’s outstanding stock, including all of its transferred rights and liabilities.
b. Asset Purchase – The buyer purchases some or all of the target’s assets, which remain subject to its rights and liabilities.
c. Merger – The target merges with and becomes part of the buyer, which then becomes the successor to the target’s rights and liabilities.
3. Determine whether the target is within a regulated industry or is subject to other potentially complex legal requirements. For example:
a. Businesses that transact or finance consumer credit, such as banks, credit unions and savings associations.
b. Businesses that extend credit for goods or services that are subject to California finance or Consumer Credit Reporting Agencies laws.
c. Sellers for agencies licensed by the California Department of Real Estate.
d. Businesses involved in commercial real estate leasing, financing or sales.
4. Draft all contractual provisions:
a. Payment terms.
b. Liabilities and indemnification.
c. Closing and post-closing mechanisms.
d. Representation and warranties.
e. Governing law.
f. Dispute resolution.
What to Avoid – Common Mistakes
When drafting a business purchase agreement, there are several common pitfalls to avoid. An experienced California business purchase agreement lawyer will advise on best practices to avoid bad situations for both buyers and sellers. A common mistake that many buyers make is assuming that present sales will continue indefinitely. Even in the best of economic climates, buyers should include contingencies in the business purchase agreement to allow for some level of attrition. Otherwise, if sales drop once the new owner takes over , they may face immediate financial challenges despite the desire to succeed. In addition, buyers should be wary of indemnification clauses that may not serve their best interests. Sellers often let their enthusiasm cloud their judgment. For example, sellers may misrepresent their product or services or even inflate their sales numbers to secure a higher sale price. Not only does this lead to a lower price for the buyer, but it can open the seller up for potential litigation if the misrepresentation is discovered.
Role of Legal Professionals in the Process
The comprehensive preparation and review of business purchase agreements is essential to ensure that businesses meet the benefits of the law and have full protection. By using a qualified lawyer who is experienced in business transactions in California, prospective owners are best able to receive the maximum benefit of the law. Attorneys can provide invaluable services in the preparation of all business purchase agreements and have the experience necessary to know which requests made by other parties are unreasonable or will end up hurting their own clients at closing. With legal advisors, business purchase agreements in California are much more likely to be in compliance with the laws and offer adequate protections to the purchasing entity.
Negotiation of Terms and Conditions
Negotiating the terms and conditions of a business purchase agreement in California requires a strategic approach similar to the negotiation of other agreements. The buyer and seller typically negotiate various terms relating to the sale, including purchase price, ongoing covenants, post-closing obligations/deal structure, and the like.
A great first step for you is to prepare a list of points you want addressed in the agreement. The list can be sorted by priority and then addressed in order of priority. Along with the list, it is helpful to create a proposed deal structure to provide clarity on what you want from the deal and a framework for guidance in negotiating.
After you have developed a framework for negotiation, provide that framework to the other side in advance of negotiating, so they can come up with a framework to offer you. Then meet with the other side and discuss both frameworks, how they do or do not work together, and talk about potential movement from each framework on either side. This approach creates common ground, a list for negotiation, and clarity of the business deal during negotiations on paper.
If you have a business lawyer involved (which you should), they will help facilitate the negotiation of the different necessary provisions. The process will typically include discussing the provisions to understand how they drive the purchase agreement. Once both sides clearly understand the big picture and individual points that need to be addressed, they can start fine-tuning individual terms and conditions to help facilitate an agreeable outcome for both parties to the transaction.
A final note: business terms in a purchase agreement often vary person to person and transaction to transaction. Take the time to refine your desired terms and conditions before starting the process of negotiating and finalizing your purchase agreement. While much of the process is the same, there are many ways to negotiate the terms and conditions of a purchase agreement to help both parties maximize their benefit from the deal.
Signing Off on the Deal
A business purchase agreement is typically signed soon after the parties have negotiated the terms of the sale. The purchaser may wish to include a "due diligence" period in the purchase agreement during which the purchaser may cancel the purchase if it finds undisclosed items in the due diligence process that materially affect the property being purchased.
Normally, the purchase agreement will designate a closing date . This date is the deadline for the purchaser (or the seller) to complete any requirements that were conditions of the sale. It is common for a purchase agreement to allocate these requirements to either party, and then to provide that if the deadline passes and the conditions have not been satisfied, the other party can terminate the contract.
In any case, a closing document is usually signed by the purchaser and the seller at the closing. Once signed, the purchaser pays the purchase price and takes title to the purchased property.