When selling your company, it’s crucial to iron out the details, crossing your “t’s” and dotting your “i’s.” Both the buyer and the seller need to sign a contract to finalize the sale.
During the process of drafting the contract to transfer ownership of the business, one phrase that’s likely to come up is the Definitive Agreement (DA). The Definitive Agreement is a legal document that is responsible for transferring ownership of your business.
Today, you’ll learn everything you need to know about Definitive Agreements, including what they entail and the role they have in the sale of a business. You’ll also discover what you specifically need to know about this document when selling your business so you clearly understand how it will impact your merger or acquisition.
What Is a Definitive Agreement?
In the simplest of terms, a Definitive Agreement — sometimes called a DA — is the primary legal document that transfers the ownership of a business from one party to another. It contains everything agreed upon in the term sheet or Letter of Intent (LOI).
Term Sheets are non-binding agreements that outline the basic terms and conditions of the sale. Letters of Intent are non-binding agreements stating the intention of one party doing business with the other. Definitive Agreements solidify both of these documents into legally binding agreements.
If you look online, you may find that there are standard templates for certain types of Definitive Agreements, such as those for real estate transactions. But don’t get lulled into thinking that selling real estate is like selling a business, or that you can use these templates for the sale of your company. Real estate transactions and business mergers and acquisitions (M&A) are very different, and definitive agreements are one area where that is quite evident.
Unlike real estate DAs, templates do not exist for Definitive Merger Agreements (or Definitive Acquisition Agreements). There are no cookie-cutter forms for transferring the sale of a business. Each agreement for a merger or acquisition is unique based on several factors, including the:
Generally speaking, there are two different types of Definitive Agreements for mergers and acquisitions (M&A): asset purchase agreements and stock purchase agreements. Both can impact the sale of a business and it’s critical to know the difference between the two.
What Are the Differences Between Asset Purchase Agreements and Stock Purchase Agreements?
An Asset Purchase Agreement is a Definitive Agreement that specifically pertains to the sale of a company’s existing assets. This can include intangible assets like intellectual property and goodwill, as well as tangible assets like:
- Fixtures and equipment
- Accounts receivable
On the other hand, a Stock Purchase Agreement involves the transfer or sale of shares. In short, the buyer is acquiring all assets and all liabilities. Stock purchase agreements are commonly seen in M&A transactions for publicly traded companies and larger privately-held businesses.
For our purposes, we’ll focus primarily on Asset Purchase Agreements. Most lower- and middle-market businesses utilize this type of transaction when selling their company. Having said that, there are certainly some exceptions. As mentioned, Definitive Purchase Agreements are not cookie-cutter sales. Speaking with an M&A professional can help you determine which deal structure is likely given your company and potential buyers.
What Components Make Up a Definitive Agreement?
Although every Definitive Agreement is different, a few of the components and key terms that you can expect to find include:
- Names, addresses, and contact information of the parties involved (including advisors like attorneys)
- A solicitation clause outlining whether the parties are exclusively negotiating with one another
- Purchase price, which comes as a result of working through the valuation gap during preliminary discussions
- Payment and financing structure, such as when the down payment is due and whether these monies will be held in an escrow account
- A list of the assets being acquired along with their valuations and available warranties
- Termination clauses that outline under which circumstances the sale can be terminated and whether there is a termination fee associated with doing so
- Closing conditions and costs; most costs are split equally between the buyer and the seller
- Earnouts clauses, which define whether the seller is entitled to any future payouts based on the success of the business
- Confidentiality agreements, which can prevent certain matters from being discussed with outside parties
- Indemnification clauses, which shift responsibilities for identified post-sale costs or losses from the buyer to the seller
Additionally, Definitive Agreements will likely contain numerous schedules and supporting documentation. These can include:
- Non-Compete Agreement preventing the seller from entering into direct competition with the buyer
- Employment or Consulting Agreement in case the buyer wants to secure future services of the seller
- Promissory Note, which further outlines the payment amount and schedule
- List of Machinery & Equipment, which is a comprehensive list of the assets being turned over in the sale (otherwise known as a list of Acquired Inventory); there can also be a list of Excluded Assets
- Acquired Contracts, transferring the company’s stake in outside contracts from the seller to the buyer
- Acquired Intellectual Property, which is a list of intangible assets being transferred
- Lease or Rental Agreements for any property being transferred
- Financial Statements, Cash Flow Statements, and other documents; these are legally binding once entered in the Definitive Agreement and must be representative of what’s turned over to the seller
What Role Does the Definitive Agreement Play in the Sale of a Business?
The Definitive Agreement is incredibly important when it comes to the sale of the business. The negotiation process for a merger or acquisition can take anywhere from three to six months on average, though there are hurdles that can happen along the way to slow down the deal.
During the negotiation process, attorneys will draft Term Sheets and Letters of Intent. These are preliminary documents and demonstrate progress in the sale. However, they are not legally binding. The sale is not cemented until all relevant parties sign the Definitive Agreement.
It’s easy to make the case that a Definitive Agreement perhaps plays the most critical role in the sale of a business, as it is the document that actually completes the sale. Once all parties sign this document, the sale process is legally binding and the transition process can begin.
What Do Business Owners Need to Know About the Definitive Agreement When Selling a Business?
If you’re a business owner looking to sell your business for the first time, there are a few things you need to know about Definitive Agreements.
First and foremost, it is typically the buyer’s responsibility — not yours as the seller — to draft the Definitive Agreement. This will not begin until both the buyer and the seller sign a Letter of Intent indicating their intention to buy/sell the business.
Sellers should not navigate these waters alone. Always hire expert M&A professionals and attorneys to get through this process. When looking for legal counsel, be sure to hire a firm with an excellent reputation and one that has “M&A” or “Corporate Transactions” as a practice specialty. Hiring the wrong legal counsel can be the downfall of your sale.
A Letter of Intent states an intention to complete a successful transaction, but there is still an inordinate number of details to work out, as well as due diligence to complete, before closing. There will be a lot of back and forth between the buyer’s and seller’s legal counsel during the negotiation process of the Definitive Agreement. During this time, something known as “deal fatigue” can set in.
These agreements are extensive documents. Lawyers will be reviewing them line by line and going through them thoroughly. The process is often tedious, exhausting, and stressful, especially as the seller. You may be anxious or stressed, just wanting the deal to be done.
Make sure to stay strong during this time. At this point, you’ve managed to find a buyer and work through much of the valuation gap, something that often kills business deals before they get off the ground. Essentially, you’re at the homestretch. Make sure you don’t let emotions get in the way of the sale as your trusted legal counsel negotiates on your behalf.
Your advisors — namely your legal counsel and business broker or M&A advisor — will be helping you through this process. Rely on their knowledge and experience to get through your own sale. Patience is a virtue, and one that often pays off for sellers during the DA negotiation phase.
Understand the Definitive Agreement to Successfully Execute Your Business Sale
As a business owner, selling the company you have built can be a daunting task. Perhaps one of the most exhaustive (and exhausting!) endeavors is navigating the Definitive Agreement process.
The Definitive Agreement is a binding document that completes the sale from the seller to the buyer. It contains everything from the financial figures of the sale to Non-Disclosure Agreements and non-competes. Signing the Definitive Agreement is the last step in the sales process. Once signed, the transition process begins.
When you’re looking to sell your business, hire highly qualified, specialized legal counsel to negotiate the agreement on your behalf. The financial consequences of signing a bad deal can far outweigh the cost associated with an attorney who’s an expert in the field of mergers and acquisitions. The Definitive Agreement process is when owners most need to trust the experts they’ve put in place around them to help push the deal across the finish line.
Keep in mind that if you’re not quite ready to sell your business yet, you can start working to build value now. Doing so increases the likelihood of closing the valuation gap, negotiating the Definitive Agreement, and getting your business sold.