LBO sale and purchase agreement: asset and liability warranties, conditions precedent, earn-out, price adjustment and negotiation tactics.
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At the end of a merger and acquisition process, the buyer and seller formalize the sale in a share purchase agreement, often referred to as an SPA (“Share Purchase Agreement”). The SPA does more than just set a price: it outlines who assumes which risks, under what conditions, and with what protective mechanisms (price, adjustments, warranties, conditions precedent, etc.).
Negotiating an SPA effectively helps minimize unpleasant surprises after the sale (disputes, unidentified liabilities, disagreements over price) and ensures the security of the transaction for both the seller and the buyer.
The SPA sets out the different stages of the transaction: the pre-contract phase (negotiations and due diligence), the contractual phase (closing), and post-closing follow-up (formalities, warranties/indemnities, and potential adjustments).
The price is often negotiated using either closing accounts (post-closing price adjustment) or a locked box mechanism (price fixed based on reference accounts). An earn-out may also be included (additional consideration).
Key negotiation topics typically include: financial definitions (cash/debt/NWC), anti-leakage clauses, governance between signing and closing, warranties and indemnities (cap, deductible/basket, duration, process), conditions precedent, and specific clauses (non-compete, real estate, shareholder loans/current accounts, etc.).
The thresholds, caps, baskets, or time periods commonly seen in practice are never absolute standards. They depend on the specifics of each transaction and must be negotiated, tailored, and validated on a case-by-case basis.
In a sale, it is generally the buyer who drafts a SPA with the assistance of their legal representatives. The process of concluding a SPA consists of three main phases:
To draft the SPA and negotiate its terms, the buyer relies on the information provided by the seller during due diligence (financial and tax data, ownership structure, litigation, assets and liabilities, employees, governance, etc.).
Negotiation is a balancing act: an SPA that is too onerous for the seller may cause the transaction to shift to another buyer; an SPA that is too “lenient” may lead the buyer to revise their offer or withdraw. Understanding the key terms and anticipating potential sticking points is therefore essential to ensuring the success of the transaction.
There are two main methods for determining the sale price when negotiating a SPA:
Each of these methods has specific advantages and disadvantages, some of which are more favorable to the buyer and others to the seller.
In a standard process, the transaction price is determined in two steps:
The provisional price is based on the value of the target company, determined usingthe most recent approved financial statements or interim financial statements.
It is common to use a“debt-free, cash-free”basis: the business is valued, then adjusted for cash and debt (definitions to be finalized in the SPA).
The preliminary price is set at the time of signing. A closing date is set: it serves as the basis for preparing closing financial statements (often prepared by the buyer), based on which the price will be adjusted.
The final price is adjusted based on the financial statements prepared as of the closing date, as well as the target’s cash position, debt, and working capital requirements, to determine its actual value.
The key issue is defining these aggregates (what is included/excluded, calculation methods, accounting standards, restatements): they must be defined in advance to minimize discrepancies. It is common to include an expert appraisal clause in the event of a disagreement over the adjustment (involving a third-party expert following a defined process).
It is essential to include clauses in SPAs involving a price adjustment that address the seller’s management of the target company between signing and closing. These clauses must stipulate that the seller isobligated to manage the company prudently, in the ordinary course of business, to avoid any reduction in cash flow or detrimental commitments that could affect the target’s value.
It is also advisable to require the buyer’s prior consent for certain significant management decisions, such as investments or borrowings exceeding a certain threshold, or the sale of key assets. The purpose of these clauses is to minimize price adjustments after closing.
The closing accounts mechanism offers significant advantages to the buyer, notably greater certainty regarding the final price and the value of the acquired company, since the buyer will pay the exact value at the time of acquisition. However, it also has drawbacks, such as post-closing disputes regarding price determination and the associated costs. For the seller, this mechanism can also lead to disputes over the final price, although the security provided by this system may reduce the guarantees required by the buyer.
The locked-box mechanism sets the sale price based on financial statements prior to the execution of the sale agreement, without any subsequent adjustments for changes occurring after that date. This mechanism provides price certainty as of the signing date; however, it does not preclude adjustments for any inaccuracies in the financial statements that would violate the representations and warranties in the contract.
To protect the buyer against a loss in value until the effective takeover, a period is defined between the date of the financial statements and closing, during which certain cash outflows (leakage), such as dividends or management fees, are prohibited. Under this mechanism, it is generally the seller who prepares the reference financial statements, requiring increased vigilance on the part of the buyer during due diligence and in the warranties required.
To protect the buyer from any loss in the target’s value between signing and closing, it is always recommended to include “anti-leakage” clauses. These clauses are intended toprevent any transaction that could result in a loss of value of the target company (increased dividends, billing of management fees, payment of exceptional compensation, etc.). Carefully and comprehensively determining the list of these transactions is essential. However, certain cash outflows are necessary to ensure the continued sound management of the company. These cash flows—such as the payment of salaries or suppliers—must be designated as “permitted leakages.” It is advisable to include in the SPA a mechanismrequiring the buyer’sprior authorization for certain transactions, depending on their nature or amount, or to stipulate that such“permitted leakages” result in a price reduction.
The locked-box mechanism has the advantage of providing both the seller and the buyer with simplicity and certainty regarding the sale price. However, it presents a risk for both parties, particularly for the buyer:
In short, the main drawback lies in the interim period between signing and closing, during which the buyer bears the economic risk while the seller continues to manage the company.
The main difference between the two pricing methods lies in the timing of the risk transfer. Under the locked-box mechanism , risk is transferred when the financial statements are prepared prior to the execution of the agreement. In contrast, under the closing accounts method , risk is transferred at the time of closing. The choice between these mechanisms will depend on the specifics of the transaction and the interests of the parties involved. To avoid disputes and delays in the transaction, it is crucial that the SPA be drafted clearly and precisely.
The price supplement, or earn-out clause, often arises due to differing objectives between the seller—who anticipates the company’s future growth—and the buyer, who is cautious in the face of uncertainty. This clause allowsthe sale price to be adjusted based on the company’s future performance. Generally, the earn-out does not exceed 15% of the sale price and spans a period of 1 to 3 years. To prevent abuse, it is essential to establish simple and transparent calculation rules. This supplement may be based on future profits or the achievement of specific performance targets.
When negotiating an earn-out clause, the advantages and disadvantages differ depending on whether one is looking at it from the seller’s or the buyer’s perspective:
The earn-out isparticularly relevant for a seller who remains involved in the company after the sale, as they can directly influence future performance. By deferring part of the payment, it reassures the buyer of the company’s potential. On the other hand, a seller wishing to withdraw completely from the company’s management should opt for a fixed sale price to close the transaction immediately.
To effectively draft an earn-out clause, it is essential to clearly define the duration of the period, the payment schedule, the performance criteria, and the steps to be taken in the event of a dispute. The complexity of the earn-out stems from several key factors:
Finally, it is recommended to include protective mechanisms such as escrow clauses to safeguard the interests of both parties and minimize the risk of disputes. These elements ensure that the earn-out is fair and accurately reflects the company’s future performance.
The seller may offer a payment facility for a portion of the sale price—whether or not it bears interest at market rates—thereby reducing the need for bank loans and bolstering the confidence of financial institutions. This amount often represents between 5% and 20% of the sale price and is repaid over a period generally ranging from 1 to 5 years, with or without interest depending on the agreements between the parties.
In the context of buyout financing, lenders may require death and disability insurance when the buyer becomes the future CEO of the company.
A seller’s credit, or deferred payment, allows the seller to grant the buyer a payment extension, consisting of a partial or total deferral of the purchase price. The seller’s credit constitutes a claim by the seller against the buyer, with repayment terms set forth in the contract. To limit the risk of non-payment, the seller may request collateral such as a surety bond, a pledge, or a bank guarantee.
This method is advantageous for the buyer because itinvolves the seller in the acquisition process. If the transaction fails and the company cannot repay its loans, the buyer would be unable to repay the loan granted by the seller.
For the seller, deferred payment allows fora higher asking price by offering financing terms to the buyer. The longer the loan term, the greater the risk to the seller. It is also a way to negotiate the purchase price and financing terms. Experienced lenders often require that the seller’s loan be subordinated to senior debt.
The Good Asset-Bad Asset (GAP) clause is a crucial component of the SPA, which generally covers undisclosed liabilities and, depending on its wording, certain asset shortfalls or asset overvaluations discovered after the sale.
It ensures that the purchase price accurately reflects the target company’s true value, taking into account necessary adjustments for any financial items not initially anticipated. The GAP clause helps identify and manage these risks by stipulating that the seller may be required to compensate the buyer in accordance with the terms set forth in the SPA for any financial loss resulting from liabilities or asset shortfalls that existed prior to the transaction.
To draft a GAP clause, the following key points must be addressed:
The GAP clause is essential for protecting the buyer’s interests in a merger and acquisition transaction. Negotiating it requires meticulous attention to detail and a thorough understanding of potential risks. Clear and precise drafting of this clause, combined with appropriate safeguards, can minimize post-closing disputes and ensure a smooth transition for both parties.
Conditions precedent are essential provisions in business sale agreements. They suspend the final completion of the sale until certain specified events occur. They provide legal protection to the buyer by ensuring that certain situations or events occur before the acquisition becomes final.
They may include conditions such as securing specific financing, the satisfactory completion of audits (accounting, financial, legal, etc.), or approval by the target company’s shareholders or governing bodies. These clauses must be drafted precisely to avoid any ambiguity and ensure that they cover all critical aspects of the transaction. A typical condition precedent clause in a SPA might stipulate that the acquisition will be finalized only if the acquirer secures bank financing for a certain amount of money by a specified date. Provided the purchaser has taken the necessary steps in good faith, the purchaser may be released from its obligation if the required financing is not obtained under the terms set forth in the agreement.
It is also crucial to specify the timeframe within which these conditions must be met and to clearly define the consequences of their non-fulfillment. If the conditions precedent are not met within the specified timeframe, the contract generally becomes void, unless otherwise stipulated.
For sellers, it is important to understand that including conditions precedent can prolong the sale process and create uncertainty until all conditions are met. However, these clauses are often necessary to ensure transparency and good faith in negotiations, allowing the buyer to complete due diligence and secure the necessary resources for the acquisition.
In addition to the general provisions discussed above, it is crucial to take certain specific provisions into account when drafting a SPA. These provisions can have a significant impact on the transaction and must be carefully negotiated and drafted. The following provisions are commonly included:
Negotiating and drafting a Share Purchase Agreement (SPA) are crucial steps in the business sale process. It is essential to fully understand the various clauses and mechanisms—such as the determination of the sale price, price adjustments, seller credit, asset and liability warranties, and conditions precedent—in order to best protect the interests of each party. Particular attention must be paid to drafting these clauses precisely and clearly to avoid post-sale disputes and ensure a smooth transition. Ultimately,a well-negotiated and well-drafted SPA contributes to the success of the transaction and the satisfaction of both parties involved. We recommend that you seek professional guidance during this key stage.
The LOI (letter of intent) comes upstream of the transaction. It sets out the main terms of the negotiation: indicative price, timeline, exclusivity, confidentiality, and key conditions. The SPA (Share Purchase Agreement) is the definitive share sale agreement that legally governs the transaction and binds the parties under detailed terms.
“Leakage” refers to any value transferred to the seller between the reference date of the accounts (the “locked box date”) and closing—dividends, exceptional compensation, repayment of advances, etc. The leakage amount is generally deducted euro-for-euro from the purchase price, unless the flows are expressly authorized (“permitted leakage”).
The seller can request:
the exact satisfaction criteria
the applicable deadlines
the steps expected from each party
the supporting evidence to provide
and the consequences if the condition is not satisfied
the method for calculating NWC and net debt;
the applicable accounting standards;
which line items are included or excluded;
the review procedure for the closing accounts;
and the potential use of an independent expert in case of disagreement.
A breach of a financial covenant (for example, if the debt-to-EBITDA ratio exceeds the contractual threshold) generally entitles the lenders to declare the debt immediately due and payable. In practice, however, lenders typically prefer to negotiate a waiver (a temporary suspension of the covenant breach) or a debt restructuring rather than trigger a default. Such negotiations rarely take place without shareholders injecting additional equity into the business.
The interest rate on senior debt is generally based on a floating benchmark rate (typically EURIBOR) plus a fixed margin (or spread), which usually ranges from 2% to 5%, depending on the target company's credit profile and prevailing market conditions. Negotiations focus on the level of the spread, the financial covenants, prepayment provisions, and the security package. During periods of higher interest rates, EURIBOR floors are also commonly included in financing agreements.
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