The purchase agreement is a major component of an M&A deal. It is the contract that documents all of the terms agreed upon between the buyer and the seller in a transaction. Without one, it would be nearly impossible to bring a deal to a successful closing. However, for a buyer and seller to reach deal closing, they must settle a few key matters within the final contract.

Below are five important topics to consider in an M&A transaction’s purchase agreement:

1. Purchase Price

Most M&A deals are negotiated on a “cash free/debt free” basis. In simple terms, this means the seller keeps all of the cash and pays off all of the debt at the time of the sale of the business. In almost all circumstances, shareholder loans, bank debt, unpaid dividends and overdraft facilities will be treated as debt.

2. Earn-Out

Earn-out is a mechanism used in an M&A transaction through which a portion of the purchase price is paid contingently upon the occurrence of certain events. This amount is usually calculated based on the performance of the acquired business over a specified period of time following the closing.

Earn-outs are most commonly used to bridge the business valuation gap between a seller and a buyer. It allows sellers to potentially facilitate a higher price and provide buyers with an additional financing option to pay for the acquisition through future profits of the acquired business.

3. Establishing a Net Working Capital Peg

A net working capital peg is used to ensure the seller is not collecting most of the A/R out of the business, liquidating inventories, or slowing payment of accounts payable prior to close. In the case of a deficit of net working capital at close, the buyer may reduce the cash to the seller by the amount of the deficit.

4. Equity Roll

Many buyers often encourage selling owners to “roll over” a portion of their equity. Meaning, the seller will own a minority equity position in the company after the transaction closes. Rollover equity is a form of seller financing and it is often used to bridge financing and valuation gaps. Rollover equity also represents a powerful tool for aligning the seller/founder’s interests with the buyer’s interests.

5. Other

Other topics outlined in a purchase agreement include:

• Non-competes
• Warranties
• Employment agreements
• Consents on certain contracts

All of these terms represent important legal components of the purchase agreement that should be given consideration when contemplating the sale of a business. Consulting with an M&A advisor on these matters can help your business deal come to a successful closing. Please contact Lutz M&A for questions on this topic or for transaction assistance.