Negotiating an M&A Purchase Agreement | M&A Tips

by Jacob Orosz (President of Morgan & Westfield)

Executive Summary

Tips for Negotiating the Purchase Agreement

In most M&A transactions, the buyer’s attorney will prepare the purchase agreement and the seller’s advisor will respond with suggestions or a mark-up. This crucial exchange is the seller’s last chance to tilt the language and provisions of the purchase agreement in their favor. 

Sellers can improve their negotiating position and enhance the purchase agreement in the following ways:

• Minimize the Scope of Protections: As seller, you’ll be in a much better position to negotiate and limit the buyer’s protections if you hire an experienced negotiator, hold an auction of several competing buyers, conduct your own pre-sale due diligence, and remain trustworthy at all times. This way, you can weed out potential problems early and earn the buyer’s trust. 
• Read the Purchase Agreement Carefully: Few purchase agreements are boilerplate and most clauses are open to negotiation. If in doubt, representations should contain a knowledge qualifier such as “to the best of the Seller’s knowledge” or similar. 
• Don’t Negotiate Terms in Isolation: Purchase agreement terms are always interrelated and should be negotiated as a collective risk. The more assurances you’re willing to provide the buyer, the lower their risk and the higher the purchase price they can potentially pay – and vice versa. 
• Maintain Excellent Relations with the Buyer: The best antidote for disputes is prevention. Befriend the buyer – not just professionally, but personally. It’s easier to work out problems with a friend than a foe.
• Be Prepared to Give In (Sometimes): You can expect to encounter at least one substantial dispute along the way, and both parties must weigh the cost of a dispute against the potential benefits on offer. When the matter is immaterial, it may be most prudent to split the difference or simply let it go.
• Make Concessions Known: Never give the buyer something without them being aware of it, such as figures rounded up or down in their favor. The more concessions you make, the more likely the buyer will see you as a fair-minded negotiator and concede on minor points of their own.

Introduction

Much of the groundwork for the purchase agreement happened long ago, during negotiations over the letter of intent. But there’s still a chance the buyer will try to adjust important language and provisions in their favor. 

This article covers the most practical and intelligent ways to take this final step towards selling your business. It’ll come as no surprise that collaboration is key. Your willingness to befriend your buyer and be a frank and forthright partner to your M&A advisor and attorney will pay dividends, especially when tensions are running high. 

This is my advice on the best ways to prevent with the purchase agreement, the importance of a 360 view of its terms, and why you should never give the buyer a silent concession. 

Who prepares the purchase agreement?

• In Most Transactions: The buyer’s attorney prepares the purchase agreement and the seller’s advisor responds with suggestions or a mark-up of the agreement.
• In an Auction: The seller is charged with drafting the purchase agreement, so it can be more readily compared across competing bids. 
• In a Negotiated Transaction: The buyer usually drafts the purchase agreement. 

Tips for Negotiating the Purchase Agreement

Tip 1: Minimize the Scope of Protections

As the seller, your goal is to minimize the scope of protections afforded to the buyer in the purchase agreement. You can do this by:

• Hiring an experienced negotiator: An investment banker or seasoned M&A advisor is best placed to manage negotiations and limit the buyer’s protections.
• Conducting an auction: This will improve your negotiating posture because the more buyers there are negotiating, the stronger your position and ability to draft purchase agreement clauses in your favor.
• Conducting pre-sale due diligence: Performing your own due diligence upfront means you can identify and address problems before beginning the sale process, therefore improving your negotiating position.
• Being trustworthy at all times: Always be on time, always do what you say you will, maintain your composure during negotiations, and make conservative estimates.

Just as market conditions impact the price of companies and the terms of deals, they may also dictate the prevailing definitions of “reasonable” or “fair” when it comes to buyer protections in the purchase agreement.

The business’s complexity is also a factor. If you operate a basic retail or service business, the protections afforded to the buyer in the purchase agreement likely won’t be very broad in scope. But if it’s a risky or complicated business, you can expect the buyer to demand much more stringent protections.

For example, if your business handles hazardous materials, the buyer may request stringent representations about potential environmental concerns and workers’ compensation.

Market conditions impact the price of companies and the terms of deals, and may dictate the definitions of “reasonable” or “fair” when it comes to buyer protections. 

Tip 2: Read the Purchase Agreement Carefully

You should carefully read through the reps and warranties in the purchase agreement and never sign them as if they were boilerplate – they rarely are.

If you aren’t 100% certain about a representation, it should contain a knowledge qualifier such as “to the best of the Seller’s knowledge” or “to Seller’s knowledge.” At the same time, useful exclusions can be documented in the disclosure schedules. 

Breaching a rep or warranty can have disastrous effects on either party and should not be taken lightly. When drafting the purchase agreement, the buyer’s attorney normally focuses on the likelihood and amount of potential exposure – the financial risk – for the buyer. It’s also important to understand which clauses are subject to negotiation and which are boilerplate or less critical. 

Tip 3: Don’t Negotiate Terms in Isolation

Negotiating the terms of the purchase agreement can’t be done in isolation because they’re one of many pieces that constitute the deal. All of these components interact and should be examined on a collective basis during negotiations.

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

Risk and return are directly related. The more assurances you are willing to provide to the buyer, the lower the buyer’s risk and the higher the purchase price they can potentially afford to pay – and vice versa. 

Tip 4: Maintain Excellent Relations with the Buyer

The best antidote for disputes is prevention. Befriend the buyer – not just professionally, but personally as well. It’s easier to work out problems with a friend than a foe. 

If the buyer later suffers from buyer’s remorse, they’ll have sufficient recompense through the protections afforded them in the purchase agreement. These include escrows, post-closing purchase price adjustments such as a working capital adjustment, inventory adjustments, collection of accounts receivable, reps and warranties, earnouts, bonuses, etc.

The seller should try to maintain an excellent working relationship with the buyer after the closing. The transaction must be win-win for both parties.

Tip 5: Be Prepared to Give in (Sometimes)

During negotiations, be prepared to concede, occasionally, on some points. Both parties must weigh the cost of a dispute against the potential benefits on offer. Disputes are expensive and time-consuming and nobody really wins a fight over their business.

No deal is perfect. You can reasonably expect to encounter at least one substantial dispute along the way. When the matter is immaterial, it may be most prudent to split the difference or simply let it go.

Tip 6: Make Concessions Known

Never make a silent concession. In other words, never give the buyer something without them being aware of it.

For example, if you count the inventory and it’s $204,000, but you only plan to charge the buyer $200,000 for it, you should let them know of this small but obliging adjustment in their favor.

The more concessions you make, the more likely they’ll see you as a fair-minded negotiator and concede on minor points of their own.

Conclusion

If you’ve never sold a business before, be prepared for your M&A advisor to play an instrumental role in negotiating the purchase agreement. At times you’ll feel like a passenger in a F-35 jet, your pilot handling the banks and turns without a word, while you’re pinned to your seat, wondering at times if the plane is even right side up. 

If you have sold a business before, it might be you in the pilot’s seat, your advisor more a sounding board and sense checker for the finer points of the purchase agreement.

Remember that it’s not a dogfight with the buyer, it’s a formation flight. Your final destinations may be different, but for now, you’re both on this journey together.