Summary of Common Non-Economic Purchase Agreement Terms

Most Sellers focus on the purchase price contained in a potential buyer’s letter of intent, which may or may not detail important non-economic purchase terms to be incorporated in the stock or asset purchase agreement. A summary of these is presented below:

Net Working Capital Adjustment. Many Purchase Agreements will contain a Net working capital adjustment which targets a closing balance sheet net working capital amount. The target is usually based on an interim net working capital, average annual net working capital or forecasted net working capital amounts. To the extent the actual closing net working capital value deviates from the target an adjustment to purchase price may come into effect. These adjustments may be structured as one or two way adjustments to purchase price. This can be especially meaningful in highly seasonal businesses which experience material swings in working capital.

Seller Representations. Buyers will invariably ask the Seller to provide various assurances that assets being acquired do not come with any hidden unpleasant surprises. Typically a Buyer will require Sellers to make representations encompassing, but not limited to, the following:

  1. Accuracy and completeness of financial statements.
  2. Absence of undisclosed or contingent liabilities.
  3. Compliance with environmental laws.
  4. Collectivity of accounts receivable and adequacy of reserves.
  5. Salability of inventory and adequacy of obsolescence reserves.

The aforementioned representations may be structured in the form of guarantees or qualified as to knowledge of the seller at the time the representation is made.

Indemnification “Baskets” and “Caps”. The Purchase Agreement will require Seller’s to provide relief if a buyer suffers losses due to a breach of representation. Typically, the indemnification arrangement will include minimum indemnification thresholds and limitations customarily referred to as baskets and caps. The cap refers to the maximum amount of remuneration a Buyer can receive for losses caused by a Seller representation breach.

The basket refers to the minimum threshold which must be exceeded before a Buyer is entitled to receive remuneration for losses caused by a seller representation breach. It is common to employ a basket to eliminate redress for relatively small claims. Once the negotiated threshold is reached, the Buyer becomes entitled to remuneration.

Baskets can work in two distinctly different ways. A basket can be structured to either mimic an insurance deductible or as a tipping basket. If structured like an insurance deductible, the buyer is only entitled to receive the amount of loss in excess of the threshold. For example, if the basket were $250,000 and the buyer’s claim were $350,000, the buyer would receive $100,000 from the seller.

The second type of basket is a tipping basket. This structure provides that once the threshold of the basket is reached, it “tips” over and the entire liability becomes subject to remuneration by the seller. Using the same set of facts above, the buyer would receive the full $350,000.

Survival Periods. Refers to the period within which the Buyer is entitled to make a claim of losses caused by a breach of a Seller representation. This period can vary greatly due to deal related specifics; however typical survival periods run from 18 months to three years.

Escrow Terms. It is common for Buyers to escrow a portion of the purchase price to provide assurances Seller has readily available resources to meet any potential indemnification claims. The length of the escrow typically, although not necessarily, is closely aligned with the survival period.

The aforementioned is intended to highlight issues we have found that are more sensitive to the Seller and more important to the Buyer; however it is not an exhaustive list and each deal will have its own nuances.