Forms and Deposits
Forms and Deposits
Most small business sellers engage brokers to help them value and market their businesses. Yet beyond that role, some brokers also provide standardized legal documents, like form Letters of Intent (LOIs) and form purchase agreements. The purpose of these forms is (ostensibly) to reduce the need for lawyers and, therefore, legal fees.
There is nothing per se wrong with a broker offering form documents. Brokers can provide standardized legal documents for the same reason as Legal Zoom. Somewhere, sometime, a lawyer has approved those forms. So long as the broker passes them on without offering additional legal advice, it is permitted.
Yet buyer beware.
Spending less on lawyers is an attractive proposition. But forms can do more harm than good.
They are unlikely to capture your deal accurately.
They may constrain negotiations.
They could commit you to paying a nonrefundable deposit.
You should generally avoid signing forms, if at all possible.
Reasons to avoid signing forms.
Unless the transaction is incredibly simple, a form purchase agreement is unlikely to capture the deal you want to do.
A form purchase agreement uses broad, generally applicable language. Broad language doesn’t always hurt—for example, you want the seller to give broad representations—but broad can also damage. A form purchase agreement won’t capture any nuances.
Forms are often a false economy.
If you sign a form purchase agreement you have two options. First, you can use the form as is. But for the reasons just stated, this may not capture the deal you want to do. Alternatively, you can hire a lawyer to amend the purchase agreement. Yet here, beware diminishing returns, as the supposed benefit—lower legal fees—will erode.
Forms constrain negotiations.
A purchase agreement should reflect the negotiated positions of the parties. But by agreeing to use a form purchase agreement, the parties are framing the basis for negotiations still to come. You lose negotiating leverage because conceptually you’ve agreed to the terms in advance.
The arguments against signing a form purchase agreement also apply to form LOIs. To some extent, they apply with less force, as an LOI is largely nonbinding and is written in more general terms. But signing a form LOI is also harder to justify. There are countless LOI templates for buyers to review and use to prepare a tailored letter. And a growing cadre of SMB focused M&A lawyers are willing to discuss LOI drafts pre-engagement in the hopes of winning your trust and taking on the more lucrative role of M&A counsel.
What to look for when using a form is unavoidable.
Sometimes, using a form is unavoidable.
Searchers often spend months looking for the right business to buy. Having done so, they approach the seller’s broker and get told that the seller will only entertain bids if the buyer agrees to proceed using a form.
Push back. But depending on the level of interest in the seller’s business, you may have little choice if you want to do the deal.
This form or bust scenario normally plays out in one of two ways.
The seller demands that the buyer sign a form purchase agreement upfront in lieu of an LOI. Sometimes, this is because the seller’s broker is predominantly a real estate broker and is used to having the parties sign a purchase agreement upfront (this is common in real estate transactions). Alternatively, it is because the seller has been burned by buyers walking away from a sale and wants to lock a prospective buyer into a contract.
The seller insists that the parties use a form LOI or form purchase agreement to save on legal fees yet otherwise intends to follow the normal deal roadmap. This scenario is preferable to the first, as the buyer is not forced to sign a binding purchase agreement pre-diligence. But it still raises the same general concerns outlined above.
Consider the following before agreeing to use a form.
Make sure that the form is legitimate—i.e., the work product of a competent lawyer, not ChatGPT.
A form purchase agreement, for instance, should broadly cover all major areas of a transaction including what’s being sold and for how much; what needs to happen in order for the parties to close; and the parties’ various sale-related factual statements (representations and warranties), obligations to one another (covenants), and promises in the event of something going wrong (indemnifications).
Make sure that the form contains sufficient offramps.
This is particularly true in the case where a seller is demanding that you sign a form purchase agreement before conducting diligence. What happens if you discover a material problem later in the process? What happens if your lender will not fund the deal? You need the form to provide sufficient contingencies so that you are not forced to go through with the transaction.
Make sure that the seller is okay with you amending the form.
If something go wrong, you want the form to capture the contours of the deal accurately and to provide adequate protections.
What about deposits?
Forms sometimes commit the buyer to paying a good faith deposit. So-called earnest money deposits are common in real estate transactions. Yet they are the exception in small business transactions.
Your first response should always be to reject the idea of a deposit outright. But, if left with no alternative, you must ensure that the deposit is refundable if the deal does not go forward.
There are many reasons why a deal won’t close, and many of them—issues that arise during diligence, a lender’s refusal to fund the transaction, etc.—are out of your hands. If the seller insists on a nonrefundable deposit, this is a red flag. Walk away.