Here’s a sample of a (de-identified, of course) Sale & Purchase Agreement (SPA) we used for an asset-based purchase of a fairly small business a couple of years ago. These things can vary wildly between deals and are generally provided by the larger player – for smaller businesses, they’re usually prepared by the buyer but reviewed extensively by the vendor during negotiation.
This can be a very complex area of deal-making and it’s absolutely vital to have a qualified lawyer with some experience of these specific sorts of contracts review the document. As a corporate advisor, this is also an area we can offer considerable assistance in, both directly and in managing the lawyer.
We’ve found that lawyers will typically take a very 1-sided and adversarial approach to negotiating documents like these, which can get very expensive. It’s often difficult to evaluate what the real risk is of, say, and earn-out not being realised, and hence to value some of the technical safeguards built into strict legal language, and balance those against more commercial issues. We often have to spend considerable time with lawyers to help them understand what’s ‘material’ and what’s not.
Some interesting elements of this agreement include:
- The buyer is taking the ‘business and assets’ of the company, but not the corporate shell itself, so the vendor is left with the original Pty Ltd company. It’s important to note in this case that the ‘business and assets’ are being bought from the company, so whatever is paid for them go to that company, and not directly to the shareholders, who may need to think about how to get the funds out (with potential tax implications) or how they might continue to use this ‘cashbox company.’
- A ‘retention amount’ is withheld from the consideration paid to the vendors, so that the buyer has some security. These sorts of mechanisms are often implemented where the buyer is depending on some things that the vendor has told him (possibly built into the ‘warranties’ section of the SPA), such as ‘our customer contracts will all renew again this year.’
- Buyers may also make payments to the vendor(s) at a later time, which are often called an ‘earn out.’ These payments can be linked to performance and used both to balance the risk of future performance between the parties and to motivate the vendors (where they are continuing to run the company for the buyer) to work hard to improve performance. They may also be used as a financing mechanism for the buyers, in that the business can help pay for itself with funds it earns in the future.
- A ‘net working capital adjustment’ is used to help pay the vendors for the amounts of cash the business needs to absorb in assets in order to run the business. These are most common for businesses which trade in products, where the inventory is often paid for separately from the business. For ICT businesses this sort of payment can account for asset value of software or other IP, or may be useful where there is excess working capital (often cash) in the business, to provide a tax-effective way to extract those funds.
- ‘Vendor warranties’ are often a critical element of the contract, in that vendors must guarantee some specific things to the buyers, and should these guarantees prove false, the buyers have recourse to recoup some or all of the amounts they may have paid. This is a complex area of contract negotiation, but one that arises in virtually every deal we put together.
Those are a few highlights but there is a lot to know about negotiating these agreements and what to watch out for.
Please contact me directly and I’ll be happy to share some of my experience, either formally or informally. This is one area almost everyone should use a corporate advisor for – buyers and seller alike!