09 Oct Purchase & Sale Agreement Terminology (Part 1 of 2)
The process of buying and selling a business generally takes place over four phases:
III. Negotiation and
During the Negotiation phase, the parties negotiate the price and terms, the tax & financing structure, respond to and satisfy the buyer’s due diligence requests – all leading to attorneys drafting and negotiating a definitive Purchase and Sale (P&S) Agreement.
This following provides an overview of the terminology commonly seen in P&S Agreements. The information presented here was obtained from various treatises and other sources available in the public domain, and should not be considered as rendering legal advice.
Definitions of certain terminology commonly found within a P&S Agreement:
Allocation of Purchase Price: Where the structure of an acquisition is an asset purchase, it’s the allocation of the purchase price to certain asset categories. Tax rules require that that buyers and sellers report this allocation at the time their tax returns are filed.
Basket: The dollar amount set forth as the minimum loss that must be suffered by the buyer before the buyer can recover damages under the indemnification provisions. Deductible Basket: Seller is only responsible for damages exceeding the basket amount (e.g., under a deductible basket of $100, if a claim of $150 is made then the seller must pay $50). Dollar-One Basket (Tipping Basket): Seller is responsible for all damages once damages reach the threshold basket amount (e.g., under a dollar-one basket of $100, if a claim of $150 is made then the seller must pay $150).
Cap: The maximum amount of damages the buyer can recover from the seller under the indemnification provisions. Many agreements include separate caps for different types of breaches.
Collar: The ceiling and floor of the price fluctuation on an underlying asset. For example, the price fluctuation where stock in part of the consideration; or, the fluctuation in the amount of trued-up working capital compared to estimated working capital.
Conditions to Closing: Certain obligations that must be fulfilled in order to legally require the other party to close the transaction. Other than conditions to closing relating to corporate approvals and governmental filings and approvals, compliance with a particular condition to closing may be waived by the party that benefits from the condition.
Covenants: Negative covenants restrict the seller from taking certain actions prior to the closing without the buyer’s prior consent. Negative covenants protect the buyer from the seller taking actions prior to the closing that change the business that the buyer expects to buy at the closing. Affirmative covenants obligate the seller or the buyer to take certain actions prior to the closing.
Earn-Outs: An agreement in the sale of a company where the buyer agrees to pay the seller consideration in the future (typically cash or stock) based upon certain future events or performance of the business post-close. Because earn-out payments are contingent on the future performance of the acquired company, they are not included in the purchase price.
Escrow: A portion of the consideration that is deposited with a neutral third party (in the case of an escrow) or withheld by the buyer (in the case of a holdback) to be applied toward future indemnification claims by the buyer. After a specified period of time, any consideration remaining in the escrow or holdback account is released to the seller.
Escrow Period: The length of time (in months) after the closing date that the escrow is held before being released to the seller.
Parties to a business acquisition are advised to seek the assistance of legal counsel who are trained and experienced in drafting and negotiating P&S Agreements.