Common Pitfalls in Business Purchase Agreements & How to Avoid Them

When buying or selling a business, the purchase agreement is a pivotal document that can shape the future success or failure of the transaction. A well-drafted agreement not only clarifies the terms of the deal but also safeguards the interests of both parties.

However, many business owners and entrepreneurs often overlook critical components in these agreements, which may lead to costly disputes, regulatory complications, or even failed acquisitions. In this guide, we will explore five common pitfalls in business purchase agreements and provide practical tips on how to avoid them.

Are you drafting or signing a business purchase agreement? Let our lawyers at By Design Law provide you with the help you need to ensure nothing is overlooked. Call us at (206) 593-1519 or use our online scheduling tool.

1. Inadequate Due Diligence

One of the most common mistakes that buyers make is not conducting thorough due diligence before signing a purchase agreement. Due diligence is the process of investigating every facet of the target business, including its financial health, legal obligations, intellectual property, employee matters, customer relationships, and potential liabilities.

Why it’s bad:

• Undiscovered liabilities: Hidden debts, pending litigation, or regulatory issues can emerge after the deal closes, leaving the new owner responsible.
• Inaccurate valuation: An incomplete financial review can lead to overpaying or underestimating the capital injections needed post-purchase.
• Reputational damage: If the business being acquired has a history of misconduct, the new owner may inherit negative public perception.

How to avoid it:

1. Work with a lawyer: Lawyers can help uncover critical issues that might otherwise go unnoticed.
2. Request comprehensive documentation: Review tax returns, audited financials, key contracts, and any outstanding litigation documents.
3. Conduct on-site visits: Speaking directly to managers, employees, and key clients can help validate or challenge information found in documents.
4. Create a checklist: A standardized due diligence checklist ensures no key area is overlooked—from intellectual property rights to environmental liabilities.

2. Fuzzy or Inaccurate Representations & Warranties

Representations and warranties are statements of fact that each party makes about the business. In many agreements, these statements are too vague, overly broad, or altogether missing key details.

Why it’s bad:

• Breaches lead to disputes: If the seller’s representations are inaccurate (e.g., misstating financial performance or legal compliance), the buyer could have grounds for a lawsuit or renegotiation.
• Lack of clarity: If the agreement doesn’t explicitly define the scope and limits of each party’s representations, disagreements about who is responsible for misstatements can arise.

How to avoid it:

1. Detail is key: Make sure the representations and warranties are specific, addressing everything from financial records to regulatory compliance.
2. Customize to the deal: Avoid boilerplate clauses that may not fit the particular industry or deal structure. Tailor your representations and warranties to reflect the unique aspects of the target business.
3. Include timelines: Where applicable, specify when certain facts must be true (e.g., as of the closing date or throughout a defined period leading up to closing).
4. Add “materiality” thresholds: Incorporate language that covers only significant issues (“material” misstatements or omissions) to avoid trivial disputes.

3. Overlooking Restrictive Covenants (Non-Competes, Non-Solicitation)

Often, the buyer’s primary motivation for purchasing a business is to capitalize on the seller’s existing goodwill, proprietary knowledge, and customer base. However, if the purchase agreement does not include robust restrictive covenants—such as non-compete and non-solicitation clauses—the seller could start a competing venture and quickly erode the value of the business just sold.

Why it’s bad:

• Loss of customers and key employees: Sellers, if unrestricted, may lure customers or employees away to a new or existing competitor.
• Erosion of goodwill: The core value of the acquired business (reputation, market share, and brand loyalty) can be diluted overnight.

How to avoid it:

1. Define scope and duration: A non-compete clause must be reasonable in terms of geographical area, type of business, and duration to be legally enforceable.
2. Include non-solicitation clauses: Prevent the seller from poaching employees or clients for a defined period.
3. Check local laws: Enforceability of non-compete agreements varies by jurisdiction. Work with a lawyer to ensure the clauses comply with state and federal regulations.
4. Ensure fair consideration: Courts are more likely to uphold restrictive covenants if the seller received fair compensation, such as a specific payment for agreeing to the clause.

4. Unclear Payment Terms & Financing Provisions

Whether the purchase is financed by a bank, seller-financed, or paid for in cash, unclear payment terms often lead to serious conflicts. Issues might include ambiguous repayment schedules, poorly defined interest rates, or confusion over what happens if the buyer defaults.

Why it’s bad:

• Cash flow problems: If the buyer is unclear on the payment schedule or hidden costs, they might run out of operating capital shortly after taking over the business.
• Litigation risks: A misunderstanding about interest rates or collateral can spark lawsuits and stall the deal’s progress.
• Damaged relationships: Complex or poorly communicated financing terms can sour the relationship between the buyer and seller, undermining the success of the transition period.

How to avoid it:

1. Spell out the payment structure: Clearly define down payments, installment schedules, interest rates, and other relevant terms.
2. Address contingencies: Include provisions for what happens in case of default or if certain performance metrics aren’t met.
3. Use escrow services: If there is a holdback or earnout portion of the purchase price, an escrow service can protect both parties.
4. Get professional assistance: An accountant or financial advisor can help structure the deal to align with the buyer’s capacity and the seller’s expectations.

5. Neglecting Post-Closing Obligations & Transition

Even after the documents are signed and the deal is technically “closed,” there can be ongoing responsibilities for both parties. These obligations might include training, transfer of licenses, finalizing regulatory approvals, or continuing to support certain clients for a defined period.

Why it’s bad:

• Operational disruption: If the seller doesn’t train the buyer on key systems or processes, the buyer may struggle to maintain business operations.
• Regulatory hurdles: Transferring licenses, permits, and certifications can be complicated, and failing to do it promptly can lead to non-compliance.
• Relationship breakdown: If the parties are unclear about their ongoing roles, conflicts can arise, stalling or sabotaging a seamless transition.

How to avoid it:

1. Detail transition services: The purchase agreement should specify the scope, duration, and compensation (if any) for post-closing support.
2. Set clear deadlines: Agree on timelines for transferring licenses, updating registrations, and notifying customers or suppliers.
3. Establish communication protocols: Decide in advance how often and through what channels the seller will be available for consultation.
4. Obtain regulatory approvals early: Anticipate the lead time for licensing or other regulatory matters, and address these before closing when possible.

Need Help With a Business Purchase Agreement?

If you’re in the process of drafting or signing a business purchase agreement—or if you simply have questions about how to protect yourself in a transaction—our team at By Design Law is here to help. We offer tailored, strategic advice designed to facilitate smooth transactions and long-term success. Reach out today by calling us at (206) 593-1519 or using our online scheduling tool.