“The superfluous is very necessary.” – Voltaire, French Essayist and Philosopher

Negotiating individual components of the purchase agreement can’t be done in isolation because there are many interconnected parts of a transaction that constitute its overall structure. All these components should be taken into consideration on a collective basis during negotiations. 

For example, if the buyer proposes a lower purchase price, you may concede but may request more cash down at closing or reduce the size of the earnout. Or, if you insist on providing minimal representations to a buyer, the buyer may concede but may tighten up other elements of the transaction structure, such as escrows, knowledge qualifiers, or thresholds.

The purchase agreement is a tool for allocating risk. As the seller, the more assurances you’re willing to provide the buyer in the purchase agreement, the lower the risk for the buyer and the higher the purchase price they can potentially afford to pay given the amount of risk they’re assuming. 

Risk and return are directly related. The higher the risk, the lower the return – and vice versa. By lowering the risk for the buyer by offering a collection of protections in the purchase agreement, you can potentially realize a higher purchase price. 

The reverse is also true – if you fail to offer the buyer significant protections in the purchase agreement, this increases their risk and they may attempt to negotiate a lower purchase price as a result. To maximize the purchase price, you must therefore be prepared to offer the buyer an adequate level of protection in the purchase agreement.

When it comes to deal structure, the objectives of the parties can be summarized as follows:

Buyer’s and Seller’s Objectives
Purchase PriceMaximizeMinimize
Cash DownMaximizeMinimize
TaxesPay Minimum TaxesMaximize Tax Deductibility
Earnouts MinimizeMaximize
Reps and WarrantiesMinimize ScopeMaximize Scope
IndemnificationMinimize Caps and Survival PeriodsMaximize Caps and Survival Periods

As you can see, when negotiating the deal structure, the parties objectives are at odds with one another. The most fiercely debated elements of the transaction are as follows:

  • Price and Terms:
    • Purchase price
    • Terms of the seller note
    • Post-closing purchase price adjustments, such as a net working capital (NWC) adjustment
    • Size and length of escrow
    • Contingent payments, such as earnouts and escrows
    • Specific terms of employment and consulting agreements
  • Deal Structure:
    • Allocation of the purchase price, which determines the tax implications of the transaction for both parties
  • Protective Mechanisms:
    • Reps and warranties
    • Survival period, knowledge, and materiality qualifiers of reps and warranties
    • Caps, baskets, and survival period of indemnification
  • Miscellaneous:
    • Conditions to closing, such as a material adverse change (MAC) clause