Purchase agreement in a business transfer

Buying or selling a business is one of the most complex transactions you can undertake. It is not just a question of price. It is about mapping everything attached to the business: its assets, debt, contracts, employees, rights and obligations. And it is about making sure that the agreement you sign precisely reflects what you are buying or selling.

This guide explains the two basic structures for a business sale, what a business purchase agreement should contain, and which pitfalls to watch out for.

Two basic structures: share deal vs. asset deal

Before you can draft a business purchase agreement, you must decide the legal structure of the transaction. The two main models are:

Share deal

In a share deal you buy the shares in the company that runs the business. The company continues as an unbroken legal entity. You take over the company with all its assets, contracts, employees and, importantly, all its debt and potential obligations.

Advantage for the seller: If the shares are sold by a holding company that owns at least 10% (subsidiary shares), the gain is as a rule tax-free under the Capital Gains Tax Act (aktieavancebeskatningsloven), regardless of how long the shares have been held. If the seller is an individual, the gain is instead taxed as share income. That is why many sell via a holding company.

Risk for the buyer: You take over all existing and latent risk in the company, including any tax claims, liability cases or hidden obligations that do not appear in the accounts.

Asset deal

In an asset deal you buy specific assets from the business (inventory, machinery, goodwill, customer lists, intellectual property), but not the company as such. The company remains with the seller and is typically liquidated afterwards.

Advantage for the buyer: You can select the assets you want and leave debt and risks with the seller.

Disadvantage: Contracts with customers and suppliers typically have to be transferred with the counterparty's consent. Employees have special rights on a business transfer (under the Business Transfer Act).

For the seller: The gain is realised in the company and taxed as corporate income (22%), or as personal income if the seller runs a sole proprietorship. If the proceeds then have to be extracted to the owner of a company, that triggers further taxation (dividend or liquidation). An asset sale is therefore typically heavier for the seller in tax terms than a share sale via a holding company.

Due diligence: investigate what you are buying

Before you sign, you must carry out due diligence: a systematic review of the business's legal, financial and operational circumstances. The purpose is to uncover risks and hidden obligations you cannot see from the accounts alone.

Typical due diligence areas:

Legal due diligence:

• Existing contracts (customers, suppliers, leases, employees)
• Pending or threatened court cases
• Ownership of assets and intellectual property
• Licences and permits

Financial due diligence:

• A review of the accounts and tax returns for recent years
• A cash-flow analysis
• A check of debt and obligations

Operational due diligence:

• Dependence on key people
• Customer concentration
• The state of technology and systems

The results of due diligence should be reflected in the warranties in the business purchase agreement.

What should the business purchase agreement contain?

1. The parties and the subject of the agreement

State the seller and buyer precisely, and what is being traded: either a description of the assets being transferred, or the shares being sold.

2. The purchase price and payment terms

Describe:

• The total purchase price and any allocation across assets
• The payment plan: cash at takeover, instalments or an earn-out?
• An earn-out clause: part of the price conditional on future turnover or earnings
• An adjustment mechanism: adjusting the price depending on the company's net assets at the takeover date (a locked box or completion accounts)

3. The takeover date

State the date for the transfer of risk and ownership. Set out precisely what happens on the takeover date: handing over keys, access to systems, and introduction meetings with customers and employees.

4. Warranties

Warranties are the seller's statements about the state of the business. They are decisive in protecting the buyer against hidden problems not revealed by due diligence.

Typical warranties from the seller:

• That the accounts give a true and fair view
• That all disclosed contracts are fully valid and in force
• That there are no pending court cases
• That the company's IP rights are fully owned by the company
• That tax obligations have been met

The seller will typically try to limit the warranties with knowledge qualifications (to the extent the seller is aware), while the buyer will insist on absolute warranties.

5. Indemnities

Unlike warranties, indemnities are specific promises to keep the buyer harmless for concrete known risks, for example a pending tax case or a particular customer claim.

6. Limitation of liability

The seller will almost always try to include:

• A time limit: claims based on breach of warranty must be raised within typically 18 to 36 months
• A minimum threshold (basket): claims below a certain amount (for example DKK 100,000) cannot be raised
• A maximum liability (cap): the seller's total liability is limited to a maximum amount, typically a share of the purchase price depending on the negotiations

7. The seller's restraint period and non-compete clause

It is standard for the seller to undertake not to start a competing business within a certain period and geographic area after the sale. A non-compete agreed as part of a business sale is assessed more leniently than a clause towards an employee and can therefore apply for longer.

Restraint period: typically 2 to 5 years depending on the industry and geographic market.

8. Confidentiality and disclosure

Describe what may be disclosed about the transaction; the sale price is typically confidential. Set out whether and when communication takes place to employees, customers and suppliers.

9. Conditions precedent

The transaction can be conditional on:

• Regulatory approval (for example competition-authority approval for large transactions)
• Financing (the buyer's ability to obtain financing)
• Consent from key customers or suppliers
• Key people continuing for a transitional period

10. Seller guarantee and holdback

In some transactions part of the purchase price is withheld (escrow) for an agreed period as security for warranty claims. In other structures the seller personally guarantees the company's obligations for a transitional period.

The Business Transfer Act and employees

On the transfer of a business or part of a business, the Act on the legal position of employees on a business transfer (the Business Transfer Act) applies.

The Act means that employees as a rule pass automatically to the new owner on unchanged terms. It is not possible to dismiss employees solely on the grounds that the business is changing owner.

Important obligations:

• Information and consultation of employees and staff representatives before the transfer
• Maintaining existing pay terms, holiday accrual rules and seniority
• Taking over obligations towards pension schemes and holiday funds

Frequently asked questions about business purchase agreements

Do we need a lawyer for a business sale?

For smaller transactions with simple asset structures, it is possible to manage with a professional template and accountant assistance. For larger transactions, transactions with employees, or transactions with complex contracts and IP rights, commercial legal advice is recommended.

What is a letter of intent (LOI)?

An LOI describes the overall terms of the transaction while due diligence is ongoing. The transaction itself is as a rule non-binding, but an LOI can contain binding elements, for example an exclusivity period and confidentiality.

What happens to customer contracts in a share deal?

In a share deal the customer contracts are already entered into with the company. They follow the company automatically and do not require separate consent, unless the contract contains a change-of-control clause.

What is an earn-out?

An earn-out is a payment that depends on the business's future results. Example: in addition to a fixed amount, the buyer pays an amount that depends on the turnover or earnings over the next couple of years. Earn-outs are used to bridge disagreement about the business's future potential.

Can the sale price be adjusted after takeover?

Yes, via adjustment mechanisms (completion accounts). The sale price is set provisionally and adjusted up or down depending on the company's actual net assets or working capital at the takeover date. Alternatively the locked box method is used, where the price is fixed on the basis of a specific "locked" balance date.

Conclusion

A business sale is a complex transaction that requires careful legal and financial preparation. The choice between a share deal and an asset deal, thorough due diligence and clear warranties are decisive in ensuring both parties know what they are trading.

A professional business purchase agreement protects you, whether you are buying or selling.

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The content of this article is for guidance only and does not constitute legal advice. Business transfers should always be carried out with professional advice from a commercial lawyer and an accountant.