This is a multi-part blog post that describes the various sections of a typical business purchase agreement. This post covers Covenants and Conditions to Closing.
2. Price and structure of the acquisition / purchase
3. Representations and warranties of the buyer and seller
4. Covenants of the buyer and seller
5. Conditions to closing
7. Termination clauses and remedies
9. Representations and warranties of the buyer and seller
Covenants within the purchase agreement are promises, or agreements between the buyer and seller. Conditions to Closing typically provide an escape hatch for a buyer to legally walk away from the deal at the last minute if certain conditions are not meet.
Covenants, usually a seller’s obligation to a buyer, may be a promise to conduct the business in an ordinary course between the time of signing and closing, or it may be an agreement to cooperate with the buyer on an outstanding tax issue in future after the close. Here are some other common covenants:
– The seller agrees to pay their taxes
– The seller agrees to settle outstanding liens
– The seller agrees to cooperate on future employee issues
It can be important to pay attention to the conditions of closing in the purchase agreement. It may be boilerplate text about the buyer being able to walk away should he find out any of the seller representations are false, but the covenants may also contain financing contingencies or other conditions that would be critical to know about.
For example, a financing contingency means that the seller could expend significant time and expense in working through due diligence and signing an agreement, yet the buyer could fail to get financing. In that case, with a financing contingency in place, there would be no consequence for the buyer. You can’t always get rid of financing contingencies, but you can work to minimize the risk, and you should at least be very aware of the contingency and an idea of what the odds are for financing success.
I always identify financing contingencies at the letter-of-intent stage, and ideally you should force the buyer to have financing commitments in place before the definitive agreement stage, but of course it is possible for a lender to back out at the last minute.
Financing contingencies are very common for smaller deals as they often relying on an SBA loan. For larger deals it is on a case by case basis.
For us, I’ve had two financing contingencies in the last year. In one, the private equity fund that our seller had signed with put in a condition on financing. When I asked about where they expected to raise the debt from, they said it was actually from their own fund, they just called it debt instead of equity. No problem. The other deal was also a private equity fund, and they failed in the due diligence phase to produce financing. Unfortunately that killed the deal with that buyer.