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August 8, 2018

Best Practices: Reviewing Purchase Agreements

by Andrew Marrinucci

When dealing with any type of acquisition financing, the purchase agreement plays a vital role in both the Lender’s underwriting process and loan documentation. Because of its significance, Lenders should obtain a copy of the draft Purchase Agreement and all exhibits as soon as they become available. Having this information early on in the process will allow the Lender to avoid delays caused by changing deal terms or unforeseen eligibility issues. This article will touch briefly on a few of the areas where Lenders should focus their review.

Know Your Parties. The borrower’s name must match the buyer’s name on the purchase agreement and the entity documents. In situations where the buying party is an entity that hasn’t been formed yet, the purchase agreement may have been executed in the name of the individual owners of the entity to be formed. In this case, an assignment of the right to purchase to the newly formed entity is needed. Lenders should make sure that there are no provisions present in the purchase agreement that prohibit such an assignment or it may be necessary to obtain the seller’s consent to such assignment. It is also important to make sure that the seller’s name matches the entity documents in your file. Depending on the transaction, there are different types of searches that may need to be run on the seller in order to fully protect the Borrower, and in turn, the Lender. The Buyer and Seller might also have to comply with Bulk Sales statutes, depending on the state laws governing the transaction. Lenders must make sure that all searches and any Bulk Sales documentation list the proper legal name of the seller.

The Purchase Price. The purchase price of the business, assets, or real estate being purchased must match the Lender’s approval and the loan documentation. Two typical eligibility issues that arise in this area often involve seller financing or adjustment provisions in the agreement that may impact the purchase price after closing has taken place. Seller financing may only be considered as part of the required equity injection if the seller note is put on full standby (no principal or interest payments) for the life of the loan and does not exceed half of the required equity injection. Lenders should obtain a copy of the seller note and a standby agreement from the parties in order to fully comply with SBA rules. Lenders should also be on the lookout for any adjustment provisions that may increase or decrease the purchase price after closing has occurred, such as earn-out provisions. For example, where a buyer agrees to pay the seller an agreed upon percentage of total EBITDA over a benchmark figure for next two years following closing, an eligibility issue arises under SBA rules. Any post-closing decrease or increase in the purchase price will effect the Lender’s underwriting, LTV ratio, and may effectively reimburse the borrower for a portion of their equity injection if allocated towards the purchase. Ultimately these provisions should be eliminated from the purchase agreement prior to closing so all parties can work with a confirmed purchase price.

Ownership Restrictions and Non-Compete Agreements.  Specific considerations arise when a borrower is purchasing ownership in a new business or redeeming the ownership interest of the seller as a current owner.  In both of these instances, Section H.2. on page 133 of SOP 50 10 5(J) states that the seller may not remain with the business as an officer, director, stakeholder, or key employee of any kind for more than twelve months from the date of closing.  In these instances, the SBA requires the borrower to acquire 100% of the ownership interest of the purchased business, which makes the transitioning of the seller a critical point to focus on. Lenders should also pay close attention to whether or not there is a non-compete agreement or provision in the purchase agreement for any change of ownership transaction.  While, not a specific requirement of the SBA, having a non-compete agreement in place is deemed a prudent lending practice in situations where the goodwill makes up a significant portion of the purchase price.  Laws governing non-compete agreements vary based on state laws, but non-compete agreements with reasonable and limited duration, geographic scope, and industry are typically held to be enforceable as long as legitimate business interests are being protected.

For more information on reviewing purchase agreements, contact Andrew J. Marrinucci at 267.470.1211 or at amarrinucci@starfieldsmith.com.