Reviewing a Purchase Agreement
When dealing with any sort of acquisition funding, the asset or stock purchase agreement plays a significant role in a bank lender’s underwriting process. Due to its significance, lenders request the purchase agreement and each associated exhibit noted in the agreement. A draft agreement enables the lender to avoid any delays associated with changing deal terms. If possible, a final agreement is preferable. This article will touch on a couple of elements that lenders look at as they are reviewing a purchase agreement.
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Within the purchase agreement, the borrower’s name should match the buyer’s name. In most instances when the buyer is an entity, the buyer’s name would refer to the entity. However, if the entity has not been formed, the purchase agreement will refer to the buyer as the individual owner of the entity to be formed. In addition, the right to purchase is assigned to the newly formed entity and documented within the purchase agreement. Lastly, the seller’s name, much like the buyer’s name, needs to match other entity documents provided to the lender.
The purchase price of the business is ultimately used by the lender to determine the proper loan amount for the borrower. There are two issues that typically arise as the lender considers the purchase price:
- Seller financing
- Seller financing is taken into consideration as part of the equity injection if the seller note is put on standby, meaning no principal or interest payments will be made during the life of the SBA loan to the seller. In addition, seller financing cannot exceed half of the required equity injection by the borrower. A copy of the seller note and standby agreement are sent to the lender as documentation.
- Adjustments in the agreement that impact the purchase price after closing
- Lenders should document whether or not there are provisions that may increase or decrease the purchase price after closing, such as an earn-out provision. Any post-closing adjustments in the purchase price will impact the lender’s underwriting. Typically, this arrangement is dealt with prior to closing on the loan or finalizing the purchase agreement.
Section H.2. on page 133 of SOP 50 10 5(J) states that the seller may not remain with the subject company as a key employee of any kind for more than twelve months from the date of closing. In these instances, the Small Business Administration needs the recipient to amass 100% of the ownership interest of the purchased business, which makes the transitioning of ownership a focal point. The documentation of a non-compete within the purchase agreement is deemed a sensible lending practice.
We at Peak Business Valuation, business appraiser, work with many companies on a weekly basis to discuss a purchase agreement. We welcome any questions you may have about reviewing a purchase agreement. Feel free to reach out by scheduling a free consultation.
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