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September 14, 2011

Firm News for September 2011: Best Practices: Business Purchase Agreements

By: Janet M. Dery, Esq.

In any purchase of a business, the Purchase Agreement is the master document defining the relationship and obligations of the parties involved in the transaction. This document may be referred to, in certain contexts, as an Agreement of Sale, a Purchase and Sale Agreement or a Stock Purchase/Redemption Agreement (herein the “Purchase Agreement”). Regardless of the name of the document, the issues that lenders should be sensitive to are the same.

Many Lenders will commit to a loan based solely on a Letter of Intent (the “LOI”). However, lenders should keep in mind that an LOI is not the binding instrument on the parties, and that once a Purchase Agreement has been negotiated and executed, its terms and conditions will control. Lenders should obtain a copy of the executed Purchase Agreement, including all of its Exhibits, as soon as it becomes available and ensure that there have been no material changes to the transaction as was contemplated in the LOI. Often, the buyer and seller want to execute the Purchase Agreement at closing. While the best practice is to have the agreement executed early in the process, so as to avoid unnecessary work and expense on the part of the lender, if the lender elects to allow the Purchase Agreement to be executed at closing, then Lender will need to obtain the final draft for review prior to closing and review same against the agreement actually to be executed at closing to ensure that there have been no last minute changes that could render the loan ineligible.

The most important terms of a Purchase Agreement include the purchase price, the description of the property that is being sold, and an allocation of the purchase price. These terms should be reviewed to ensure consistency and conformity to the lender’s underwriting, and adjustment must be made to either the underwriting or the Purchase Agreement if discrepancies are noted. If there is any Seller financing involved, then the terms of such should be specifically referenced and described in the Purchase Agreement. Any standby requirements should be described and confirmed with the Seller to ensure that there will be no impediments to closing due to disagreements over any such requirements. In general, the sooner a Lender has the Purchase Agreement for review, the sooner these types of discrepancies can be discovered and addressed, thus eliminating chaos at the closing table.

Lenders should also review Purchase Agreements for any provisions that could allow the purchase price to change either at closing (i.e. to account for inventory) or after closing (i.e. if certain value not as expected by the parties after some period of time). If a provision which could reduce the purchase price at closing is included, Lender will need to know the reduced purchase price as soon as possible, as it may have to reduce its loan amount if the purchase price is lowered significantly. In this situation, a Lender should inquire if the parties would be agreeable to making any inventory determination or other determination that will affect the purchase price at least a day prior to closing. Any provision in the Purchase Agreement which allows for a possible increase in purchase price days, months or years after closing (such as an earn-out) should be removed from the Purchase Agreement as these types of provisions are deemed to be ineligible by SBA, as they do not allow for a complete conveyance for a price certain.

Lenders should also review Purchase Agreements to ascertain Seller’s role in the business, if any, once the sale has been accomplished. Section H.2. on page 148 of SOP 50 10 5(C) states that the Seller may not remain as “an officer, director, stockholder or key employee of the business.” It further states that a Seller can contract with the business as an independent consultant to provide transitional services to the business for a period not to exceed 12 months. Therefore, if Lender sees (i) any statement that Seller will remain as an employee, salesperson, or in some other role that is not for transitional purposes, or (2) a payment to Seller for services past 12 months from sale, the loan will likely be ineligible.

By employing these best practices when dealing with Purchase Agreements, Lenders will ensure that their loans are eligible and that any issues raised by the Purchase Agreement can be resolved well before the closing occurs. For more information on Purchase Agreements, contact Janet at jdery@starfieldsmith.com or (215) 542-7070.