Important Clauses in Purchase Agreements – Part 2
August 15, 2018
If you have found this post I encourage you, if you haven’t already to read Part 1. This post and its predecessor explains just a few of the provisions in a standard purchase agreement for a business.
1. What is the Purchase Price? But, More Importantly, Are There Any Adjustments?
It is common in the purchase of the assets of a company to adjust the purchase price for inventory at the time of sale. Below are some sample clauses of how buyers and sellers deal with inventory:
A. Inventory below or above $#.##, shall decrease or increase the amount of the promissory note due to Seller.
This is advantageous to the Buyer because if it is over Buyer does not have to come up with more cash. If it is less, the promissory note is reduce but if such inventory is crucial to the business, Buyer then needs to go out and buy inventory. Which can be cumbersome if Buyer does not have the cash to do so. That’s why its very important to agree to a certain amount of inventory. Sometimes, seller’s unwittingly stop buying inventory when they sell the business and buyers end up having to quickly buy inventory, putting them at a disadvantage.
B. Inventory adjustments will adjust the cash amount of the purchase price.
If inventory is over the agreed amount, this is not good for the buyer if they don’t have the cash to pay the Seller. If inventory is below the amount, this is more beneficial than the paragraph A. above because the cash portion is reduced and buyer has the capital to quickly invest in more inventory.
C. Most Beneficial for buyer: Amounts over agreed inventory are allotted to promissory note; amounts under reduce cash portion of purchase price.
This provides the best of paragraphs A and B for buyer.
D. Most beneficial for seller: Amounts over agreed inventory paid in cash. Amounts under inventory reduce promissory note.
Seller then receives the same amount of cash, or more, and adjustments are made to the promissory note.
E. Gift Cards. Gift cards can be hazardous to a transaction because as the seller has sold the gift cards and recognized income, the expense associated with the gift cards has not occurred and may occur when the buyer owns the business. Therefore, it is important to adjust the purchase price for any gift cards outstanding at the time of the transaction. If seller doesn’t know, in dollars, how many gift cards they sold, buyer could set-off against the promissory note the amount of any gift cards redeemed. This however, poses an issue of the promissory note being of short duration, think six months or 12 months. Recently I reviewed a transaction where one buyer was suing the seller for just this reason.
2. Is the Purchase Agreement Subject to any Contingencies?
A. Financial contingencies.
A financial contingency is a contingency based on the buyer getting and approving financing. If a buyer is going to secure financing from a financial institution, the buyer wants to include a contingency which states, if buyer does not get financing on terms acceptable to buyer, buyer may terminate the purchase agreement and receive buyers deposit back (if any). This clause allows the buyer to save his deposit if buyer’s financing is inadequate. Seller on the other hand, does not want such a clause and should argue that if buyer doesn’t get financing they get to keep all of the deposit or a portion thereof in consideration of the time and effort the transaction takes.
B. Landlord contingencies.
Sometimes, Buyer will need to enter into a new lease with the landlord. Buyer wants to include a clause which states the lease must be acceptable to buyer. Buyer shouldn’t buy a business if the landlord is going to try to negotiate better terms than already available, thereby reducing the anticipated profit margins.
C. Franchise approval contingencies.
When buying chain stores, like GNC or subway, the franchisor needs to approve of the buyer. Recently I was drafting documents for a transaction and the buyer was not approved by the franchise to buy the business. Buyer wants to ensure they get their deposit back if this happens. Seller, again, should argue for a portion of such a deposit if the transaction has taken significant time.
D. Assignment of contracts contingencies.
Some businesses rely on contracts with suppliers and customers. When a buyer purchases such a business, these contracts should be “assigned” which means to transfer the contract from the seller to the buyer. Many contracts are not assignable without the consent of the third party. It is important for a buyer to state that if consent is not received, prior to closing, the transaction will not close, and buyer keeps the deposit.
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