What is a purchase agreement? (Components, types and FAQs)

By Indeed Editorial Team

Published 14 November 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

It's important for all organisations and individuals to keep records of their transactions and business agreements. This helps avoid an instance of misunderstanding or miscommunication, which can affect a business relationship. Purchase contracts are standard agreements that people use to record important information about finalising transactions. In this article, we explain what purchase agreements are, list their key components and answer a few frequently asked questions about these documents.

What is a purchase agreement?

A purchase agreement, also known as a purchase contract or purchase and sale agreement, is a legally binding document between a buyer and a seller that defines the terms and conditions of their transaction. Purchase contacts usually refer to the sales of goods, not services. They serve as proof of transaction when you're selling or buying goods within any industry and at any price, even for small transactions. One of the most common examples of purchase contracts are real estate agreements, which are an essential part of the property buying process.

Related: What are business documents? (With common examples)

Key components of a purchase contract

To make sure a purchase contract is a legally binding document, it's necessary to include specific elements, like the transaction date or signatures of both parties. Here are the key components of purchase contracts:

Identification of parties

A purchase contract clearly specifies who the two parties of the agreement are. This includes the names, addresses and contact details of both a buyer and a seller. In a real estate contract, this component also identifies the exact address of the property and mentions any additional information, like what type of property it is. It's also possible to have more than one buyer or seller appear on a purchase contract.

Deposit

To show that they're truly interested in finalising the transaction, some buyers choose to pay a deposit after making an offer. It's also possible that the seller requires that they pay it. It's important that the purchase contract specifies that, mentioning the exact sum and the deadline for deposit payment. To make the transaction transparent, it's helpful to mention if the deposit is an additional payment or goes towards the final purchase price.

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Items you include and exclude in sale

Then, the agreement specifies the items you're selling or buying. It's important to describe them detachedly. In some instances, it's possible to include attachments, like photographs, which help with identification. For instance, when selling a property, people usually exclude or include the following items:

  • light fixtures

  • heating equipment

  • kitchen appliances

  • bathroom fixtures

Contingencies

This component may not appear when you're finalising a small transaction, but it's a standard element of real estate or mergers and acquisitions (M&A) agreements. A contingency refers to a clause that specifies any actions either of the parties, or both, perform to make the contract legally binding. For example, this can refer to hiring a third party to do a home inspection, completing a property appraisal or providing additional documents that prove the seller's ownership title.

Related: What is contingency planning? (With steps and examples)

Disclosures

Disclosure schedules are a common element of M&A purchase contracts, which offer factual disclosures related to the transaction. This component protects the buyer, as it requires that the seller shares any information on the safety or value of the items. For example, when selling property, it's important that the seller discloses information about any lead hazards if they know about them. There are two main types of disclosures in agreements:

  • Affirmative disclosure: An affirmative disclosure, also known as a proactive disclosure, serves to provide the buyer with enough information to make a conscious purchasing decision. For instance, when buying a company, this can refer to information about employee benefit plans.

  • Negative disclosure: Negative disclosures provide exceptions to the seller's responsibilities and warranties. It makes the seller verify that the target company complies with any and all regulations, except those that the disclosure specifies.

Price and terms

Next, a purchase contract usually mentions the final purchase price. It's important that both the seller and the buyer accept it. A standard agreement also specifies terms of payment, such as what method the buyer wants to use to pay. Common payment methods include paying in cash or paying a cash down payment and covering the rest with a loan.

Related: How to negotiate price: negotiation tips for salespeople

Closing date and costs

Some purchase contracts also feature information about the date of the sale's closing and any additional closing costs. The date specifies when the ownership of the item, company or property transfers to the buyer. Depending on what they're buying, closing costs can affect either the buyer, the seller or both parties. For example, the closing cost of selling a property is usually between two and five per cent of the final purchase price. It often includes an agent's or salesperson's fee.

Related: What are commissions? (With different types and steps)

Default

The term default refers to a situation in which one party fails to meet the transaction's requirements on time. For example, this can happen when the seller fails to provide formal proof of ownership, which makes them in default of the contract. In case something like this happens, it's important that the agreement specifies what steps the other party can take to protect their rights or cancel the purchase.

Signatures

The last component of purchase contracts are usually the signatures of both parties. It's important that these are handwritten signatures. In most instances, signing occurs during a final meeting when all parties and their representatives, like lawyers or accountants, are present.

Related: How to make a signature in 6 steps (with extra tips)

Purchase contracts FAQ

To better understand purchase and sale agreements, it's helpful to review answers to frequently asked questions about them. These include:

1. Why is signing a purchase contract important?

Purchase and sale agreements are important documents that companies and many individuals use when finalising transactions. These agreements serve as proof of what both parties agreed on and help make the transaction as clear and concise as possible. Key benefits of purchase contracts include:

  • The agreements use clear and concise language, which helps avoid misunderstandings.

  • By providing detailed information about the item, purchase price, requirements and closing date, purchase contracts protect the rights of both buyers and sellers.

  • Purchase contracts make it easier to leverage legal proceedings in case of a dispute.

2. Who prepares purchase contracts?

Either the buyer or the seller can prepare a purchase contract. If you want to sell something and have a proof of the transaction, you may consider looking for a free agreement template online. For larger transactions, like when you're selling a flat or car, it's beneficial to consult the agreement with a lawyer or contract manager.

Related: What is a contract manager? (Plus tips on becoming one)

3. What types of purchase agreements are there?

There are four standard types of purchase contracts. Choosing which one's best for you depends on the type of transaction and how much information you have. The four types are:

  • Standard purchase order: A standard purchase order (PO) are useful for when you know all the details about the goods you're about to sell or buy. Businesses use them for one-time transactions.

  • Planned purchase order: A planned purchase order (PPO) features detailed information about the item, but provides little or no information about the delivery date and location. Companies can use this type of purchase contract to improve their efficiency, as they can quickly approve PPOs as needed.

  • Blanket purchase order: A blanket purchase order (BPO), also known as a standing order, is an agreement for future transactions that doesn't mention the quantity of the goods. Businesses may use BPOs for ordering office supplies.

  • Contract purchase order: A contract purchase order (CPO) is an agreement you can use when you have the least details about a transaction. It only specifies the terms and conditions between the buyer and the seller and mentions that the parties plan to provide more information when an opportunity to finalise a transaction occurs.

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