This is part eight of our series discussing the sale of a business from the seller’s perspective. We’ve covered deal structure issues, seller financing, earn-outs, letters of intent, due diligence, and the first two sections of the purchase agreement dealing with (i) major business points and (ii) representations, warranties, and disclosure schedules. In this post, we’ll discuss the portion of the purchase agreement dealing with the period after the signing date and up until the closing.
We’ve previously noted that most deals are of the “sign and close later” variety as opposed to a “simultaneous sign and close.” The interim period between the signing of the purchase agreement and closing (which we’ll refer to as the “Pre-Closing Period”) is usually necessary to work through issues with parties who aren’t involved in the transaction. Examples of such issues include getting consents from third parties to the seller’s contracts, obtaining governmental authorizations, getting the buyer’s financing in place, and working through issues with employees. From the seller’s perspective, the Pre-Closing Period is critical. You’ve got a deal “signed” but haven’t closed and you want to minimize any risk that the deal falls apart.
The buyer’s draft of the purchase agreement will probably include numerous covenants (both affirmative and negative) requiring the seller to take or not take certain actions and will contain many conditions that must be met for the closing to take place. Once the seller executes the agreement, it is committed to the deal but wants as many “outs” as possible if something goes wrong between signing and closing, if it learns of information it might not like, or maybe even if it changes its mind.
Sample affirmative and negative covenants that a buyer might require from the seller include the following:
Affirmative Covenants. The seller will (between signing and closing):
- Operate the business only in the ordinary course
- Keep its business relationships intact (those with employees, customers, vendors, etc.)
- Maintain its properties and insurance
- Comply with all laws
- Update the buyer on any changes or developments concerning the seller’s business
- Continue to keep the deal confidential
- Continue to assist the buyer with its due diligence
Negative Covenants. The seller will not (between signing and closing):
- Increase pay of officers, employees, etc. or enter into termination or severance agreements
- Terminate customer or vendor agreements
- Make any capital expenditures
- Pledge or transfer any company assets outside the ordinary course
- Negotiate with any other party concerning the sale of the business
And sample conditions to closing might include:
- All of the seller’s representations and warranties remain true
- The seller shall have complied with all of the covenants
- The buyer shall have been satisfied with its due diligence investigation in its sole discretion
- The seller shall have obtained all necessary authorizations and consents
- There shall have been no adverse change in or development in the seller’s business
- The buyer shall have obtained financing to fund the purchase price
The buyer’s draft of the purchase agreement will typically contain language giving the buyer maximum opportunity to get out of the deal if any condition or covenant is not true. The seller needs to do its best to minimize this risk. Here are some tips for sellers in handling these portions of the purchase agreement:
Tip 1 — Keep the Pre-Closing Period Short. To state the obvious, the longer the period between signing and closing the greater the risk that something will go wrong (e.g., a material adverse development with respect to seller’s business). So keep the period as short as reasonably possible while allowing time to get third-party consents and handle other post-signing, pre-closing matters.
Tip 2 — Review Covenants Closely and Narrow Them Down. Be sure the covenants are reasonable and necessary to protect the buyer from adverse events specific to seller’s business during the Pre-Closing Period and are not overly broad. As an example, be sure the buyer’s “walk right” for a material adverse development excludes events such as a downturn in the economy or the industry in which the seller operates. When the purchase agreement is signed, the buyer shouldn’t be able to get out of the deal merely because there is a negative development that affects all businesses in the seller’s industry. That’s the buyer’s risk to take.
Tip 3 — Eliminate Closing Conditions that Are within the Buyer’s Sole Control. Many buyers will include closing conditions that are within the buyer’s sole control, such as the example above that the buyer must be satisfied with its due diligence investigation in its sole discretion. From the seller’s standpoint, this gives the buyer too easy of a walk right. When the purchase agreement is signed, the seller wants to make sure it’s a firm deal and will close absent some extraordinary negative development between sign and close. Delete contingencies such as this.
Tip 4 — Keep It Material. The seller should attempt to introduce materiality or material adverse effect language in its closing conditions. For example, there may be a closing condition that states no lawsuits are pending against the seller as of closing. The seller should limit this to lawsuits that could reasonably be expected to have a material adverse effect of some sort on the seller’s business. Another example is the condition that all of the seller’s representations and warranties remain true at closing. Again, the seller is best served by limiting this broad condition by using language such as “in all material respects.”
Tip 5 — Beware the Financing Contingency. Many deals will be contingent on the buyer having obtained financing on terms acceptable to it in its sole discretion. As a seller, you want to be comfortable that the buyer will in fact obtain the necessary financing before you spend your time and resources negotiating a deal, and certainly before the purchase agreement is signed. Ask for and review the buyer’s bank commitment letter early on; and if the buyer is telling you that it will have the financing in place, then attempt to eliminate the financing contingency in the purchase agreement. If you’re unable to eliminate it, then consider placing a covenant on the buyer that it will use its best efforts or reasonable best efforts to obtain the financing on terms set forth in the commitment letter.
The covenants and conditions to closing sections are very important parts of the purchase agreement and the transaction and should not be taken lightly. Sellers should pay careful attention to these provisions to maximize the likelihood that the signed deal actually closes.
© 2013 Casey W. Riggs — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.