Definitive Agreement

What Exactly is a Definitive Agreement?

As the title suggests, it is the “end all, be all” of all agreements, and such is the case because it specifies in great detail the exact, final, definitive terms of a transaction that the parties involved (both the buyer and seller) are agreeing to and accepting. This agreement overrides and supersedes any and all prior agreed upon terms, both written and oral, as it is the absolute final agreement.

Once signed, sealed, and delivered, it is set in stone, and failing to follow the agreed upon terms after the sale of the business closes can trigger huge legal costs and the waste of countless hours trying to negotiate and resolve what now seems like complex legal issues.

DAs can be used for Mergers and Acquisitions, joint ventures, divestitures, and more, and are also known by many names, “Definitive Purchase Agreement,” “Stock Purchase Agreement,” and “definitive merger agreement,” to name a few.

Kinds of Definitive Purchase Agreements

There are two types of definitive agreements.  The first is a Stock Purchase Agreement and the second is an Asset Purchase Agreement.

According to the Corporate Finance Institute, Stock Purchase Agreement means that the seller transfers the stock or shares of the corporation to the buyer and places them under the ownership of the buyer.  This therefore provides the buyer with control of the business owning both the assets and liabilities of the purchased entity.

An Asset Purchase Agreement, on the other hand, deals with a company’s individual assets and transfers them collectively from the seller to the buyer, but not any real or potential liabilities that occurred or may have occurred under the ownership of the seller.

To be a little clearer, an Asset sale or Stock typically occurs when the buyer or seller is a private party.  Companies that trade on the Dow or NASDAQ or some other exchange, are publicly traded companies that offer a share or number of shares for sale.  Privately held companies, if they are formed as a corporation, do not and cannot offer their stock or shares on a public exchange as they have not gone through the necessary legal and securities process required by the SEC or Securities and Exchange Commission.

Clauses of a Definitive Agreement

These are the different sections of a DA that should be thoroughly checked and studied to ensure that there are no complications after the deal goes through.  Without exception, a seller and buyer should get this advice from an attorney or lawyer.  Critically, it should be an attorney that specializes as part of their practice, in business transactions.  A bankruptcy or divorce attorney are not the right parties to advise on a Definitive Agreement.

Definition of Key Terms

This is where the DA lists and defines the key terms, such as the type of transaction to be done, who the buyer and seller are, and the purchase price of the business.  Some Definitive Agreements can be as short as 20 pages but on more complex transactions, it can be 100 pages or more including different schedules that scope out key parts or supporting documents to the Definitive Agreement.

Treatment of Shares, Options, and More

The treatment of the shares, stock options, earnouts, seller finance, employment agreements, and other items can impact the purchase price listed in the transaction, so it is important that all these are clearly written and that the parties know and read about this and ask their attorney anything they are uncertain about. 

Representations and Warranties

This section of the DA is where both parties list down and indicate the different elements that relate to and affect the agreement. Representations include, but are not limited to, the seller agreeing to tax compliance matters, intellectual property requirements, guarantees about the financial disclosures about the performance of the business and more.

A warrant to the listed representations would then be made stating that each one of the listed elements is true and factual.

It is in the best interest of the buyer to get as comprehensive a list of representations and warranties as possible.  This is because it gives the buyer the best protection if they find out something the seller said during a conversation prior to the close of the sale is different after the buyer takes over the ownership of the business.

Indemnification Clauses

This is a support clause for the Definitive Agreement. The purpose of Indemnification Clauses is to state what happens if the seller agrees to a Representation and/or Warranty and the remedy the buyer can expect if it shows what the seller agreed to is not correct including any financial penalty.  That is, it is a clause that reinforces the integrity of the Representations and Warranties section of the Definitive Agreement. 

There are different indemnification provisions such as the sandbagging clause, survival, types of damages, baskets and deductibles, cap, and so on.  Once again, a business transaction attorney is the best source of advice on these matters.

Covenants

We Agree says that this section serves as protection for the buyer, stating certain rules that the seller must adhere to prior to the completion of the DA. For example, it can protect Buyer A from an event whereby the seller liquidates assets of the business to another buyer or Buyer B before the sale is complete, leaving Buyer A with little to no assets or a huge debt because of the unauthorized liquidation. 

There are specific covenants, like disentangled covenants and pre-closing covenants, both of which deal with certain situations that the buyer could encounter in trying to close the deal.

Solicitation

This section is where a “no shop”, “window shop”, or “go-shop” clause can be placed.  This prevents a seller accepting alternative offers from another buyer or what is considered unsolicited offers. 

Termination Fees

If either the buyer or seller cancels the deal at the last minute for whatever reason, this section states the monetary penalty that the canceling party would have to pay. The penalty is usually between 2%-4% of the Purchase Price, but to make it clearer and to remove the need for calculations, it is usually stated as a specific amount.

Closing Conditions

During the initial signing of the agreement and the final date when the deal is about to close, many things can happen and as such, this section lists down the specific conditions that both buyer and seller must adhere to in order to continue with the close of the transaction. Should one side not meet all of the conditions, then the other is absolved of its responsibilities in the transaction.

Importance of Understanding a DA

Why is it important for one to fully understand the DA even if this is usually a task that attorneys are  and in fact must do? Here are a couple of reasons:

1) Redundancy 

At the end of the day, it is still the buyer and the seller who have to make decisions and have to understand the DA. The attorney or other parties in the transaction may miss a detail that is critical to the deal.  Understanding  how to prepare and then have it explained to the seller or buyer and their shareholders is critical as the document only has its true legal importance after both parties have signed or executed the agreement.

2) Final Purchase Price

The DA is the only document that reflects the amount the seller is willing to accept and the buyer is willing to offer for the purchase of the business.  Both parties may have exchanged Indications Of Interest (IOI) or a Letter Of Intent (LOI).  However, a fully executed Definitive Purchase Agreement is what a court of law will want to see if the buyer and seller have a disagreement about the transaction.

Reading your Definitive Purchase Agreement

Just like any legal document you sign, it is crucial to read through the entire DA.  Just as important, it’s critical if you are the buyer or seller to ask your attorney for a full explanation of what you are unsure about.

Hopefully this article will help you know the parts of a Definitive Agreement and its importance.

Conclusion

Knowing what a Definitive Agreement is and how it works is crucial for the work I do as an M&A advisor.  There can be many months of work and analysis to prepare the business for sale and then more months of work and analysis to make sure the seller and buyer are in agreement on all the terms and conditions of the transaction.  The Definitive Agreement is a critical document and make sure you invest the time and energy to ensure it reflects your intentions.

References and further reading:

• https://corporatefinanceinstitute.com/resources/knowledge/deals/definitive-purchase-agreement/?fbclid=IwAR1W7Y7Zod9VzTpSTkANozANp22FI6yfuRT-y9n4zzlNShRcFkO3JVdCSUM
• https://www.midmarketbusinesses.com/definitive-agreement

• https://weagree.com/drafting-principles/8-particular-types-of-clauses/8-2-covenants/c-covenants-in-ma-transactions/
• https://www.mergersandinquisitions.com/definitive-agreement-mergers-acquisitions