This article is a continuation of the article titled Transitioning “Tails:” A Veterinarian’s Journey that was published in Issue Number 9, 2024, regarding a veterinarian’s exit strategy, and is the third in a continuing series that guide the reader through the sale process. This installment will briefly address the components of a purchase agreement.
Regardless of who purchases your practice, a purchase agreement will always be involved. It is the most important “deal document,” as it outlines the terms of the transaction and serves as the final, binding authority for the parties involved. Typically, the purchase agreement is drafted by the buyer’s attorney, who will incorporate the terms of the letter of intent (“LOI”) alongside additional customary provisions.
A purchase agreement will always address key aspects of the transaction, including what is being sold by the seller and what is being purchased by the buyer (i.e., all or substantially all of the business’s assets or the seller’s equity interests), the total consideration to be paid (including any earn-out or deferred payments) and how it will be paid (cash, promissory note, rollover equity, etc.), excluded liabilities (if any), and the representations and warranties, covenants, and indemnification obligations of each party.
Below is a brief overview of what is being sold, “reps and warranties,” covenants, and indemnification.
What is Being Sold?
The LOI generally specifies whether the transaction will be structured as an “asset deal” or a “stock deal.” In an asset deal, only the business’s assets are sold, whereas in a stock deal, the equity interests of the seller are sold to the buyer. The effect of a stock deal is that the buyer essentially steps into the seller’s shoes, acquiring all the business’s assets as well as its liabilities—whether or not those liabilities arose before the sale date. To mitigate this risk, the buyer will generally seek indemnification from the seller for any pre-closing liabilities. In contrast, an asset deal excludes all pre-closing liabilities.
During due diligence, the buyer will conduct lien and litigation searches to identify known risks and address them. Regardless of the deal structure, the assets must be delivered to the buyer “free and clear of any encumbrances.” For example, if there is a lien on an X-ray machine, the seller must pay off the lien prior to closing, or the parties may agree that part of the sale proceeds will be sent directly to the third-party lienholder at closing.
Representations and Warranties (Reps and Warranties)
A representation is a statement about a fact or condition that is true at the time the statement is made. Common representations include the seller’s ownership of the assets or the absence of litigation. A warranty, on the other hand, is a promise or guarantee that certain facts or conditions will remain true in the future. For instance, the seller may warrant that the assets are being sold free and clear of any encumbrances.
Together, representations and warranties allocate risk between the parties. If any representation or warranty is found to be false, the affected party may be entitled to claim damages. Exceptions to reps and warranties are “scheduled” on the “disclosure schedule.”
Covenants
Covenants are promises or commitments made by one or both parties to take (or refrain from taking) specific actions during the agreement or after its execution. These provisions help set expectations for future conduct. Covenants can address operational issues (i.e., seller maintaining inventory at levels consistent with past practice), financial matters (i.e., seller avoiding new debt), or post-closing activities (i.e., the seller agreeing to assist with the
transition or integrations).
If a party breaches a covenant, the other party may have the right to terminate the agreement or seek damages.
Indemnification
Indemnification refers to a provision where one party agrees to compensate or protect the other party from certain specified losses, liabilities, damages, or costs arising from events or circumstances related to the transaction. Indemnification serves as a risk allocation tool, ensuring that if something goes wrong after the deal is completed, one party will bear the financial responsibility, rather than both parties.
Indemnification typically arises when a party breaches a representation and warranty or a covenant. Indemnification claims are usually subject to a specific time frame, during which claims must be made, and may be limited by a deductible or cap (i.e., the maximum amount one party will be required to indemnify the other). However, there are exceptions to these limits in certain cases (such as fraud).
The next article will briefly discuss the ancillary transaction documents.