The Definition of a Share Purchase Agreement
A share purchase agreement is a legal contract between a buyer and a seller — sometimes stated in the contract as a “purchaser” and “vendor” — in which the seller sells a stated number of shares at a stated price. The agreement is proof that the sale and its terms were mutually agreed upon.
A share purchase agreement is a business contract. A contract lawyer draws up the agreement, and both buyer and seller sign and date the agreement in the presence of two witnesses. By signing the share purchase agreement, both parties acknowledge that the sale will take place in such a way at such a price and under stated conditions
The purpose of a share purchase agreement is to ensure that the deal occurs as both parties expect it to. If either party attempts to change the price or number of shares or impose new or unexpected conditions, the other party can produce the contract, which both parties are legally required to abide by after signing.
The National Venture Capital Association states that the main items in a share purchase agreement are
– the names of the buyer and seller as well as
– the price and number of shares.
Pages of legalese often accompany these items,
– specifying how the price is determined,
– how the shares will be paid for and delivered,
-the transfer of ownership and explicitly removing buyer and seller from any other responsibility toward each other.
Share purchase agreements can be used in any instance in which one person or entity sells shares to another. The agreements are most commonly used when the shares in question are being transferred to entities in two different countries under two different legal systems or when the shares are being sold outside of a standard trading platform or off an exchange.
The stock purchase agreement covers the following sections:
- Interpretation – provides the definitions for all the major terms used in the overall body of the agreement;
- Purchase and sale of stock – itemizes the purchase price, any purchase price adjustments, the purchase price allocation for tax purposes between the seller and the buyer, and dispute resolution mechanisms;
- Representations and warranties of the seller and buyer – provides all the statements that the seller and buyer are signing off to be true;
- Matters related to employees – provides terms on how employee benefits and any accrued bonuses are to be handled post transaction;
- Indemnifications – provides details on all indemnifications to be provided by either the seller or buyer to each other for any costs that may arise post transaction resulting from conditions that existed prior to the deal closing;
- and Tax matters – specifies any special tax treatment that either the seller or the buyer may be entitled to.
Purchase and Sale
In this section the seller agrees to sell, and the buyer agrees to purchase shares of the company’s stock. The agreement will require the seller to deliver good title to the stock (often a share certificate evidencing ownership of the company’s stock, along with stock powers) and deliver it free of any third party claims (as a related matter, buyer will also request an explicit representation to this effect in the representations and warranties section). This section also states the purchase price for the stock, how and when the purchase price will be paid (wire transfer in immediately available funds is the standard). If there are multiple sellers then this section will also outline how the purchase price will be split among them. Consideration for the shares often takes the shape of cash, stock or some combination of the two. Seller should be aware that the decision to accept consideration in either cash or stock will have different tax implications in terms of how the purchase price will be treated. Consult a tax attorney for advice on the tax implications of your transaction
Completion accounts are a very common form of purchase price adjustment mechanism used in M&A transactions. The intention is to verify that the actual financial position of the target company at completion is in fact what the parties expected when, on the basis of historic financial information, they signed the deal.
The focus (whether it be working capital, net assets or another metric) varies from transaction to transaction, but the concept is that the parties agree at signing what they expect the financial position of the target to be at completion and then after completion use the completion accounts mechanism to establish retrospectively what the actual position was. The completion accounts are normally prepared on behalf of the buyer within an agreed period after completion and, once finalised, may cause an adjustment of the purchase price – whether by a repayment of part of the purchase price by the seller to the buyer or a top-up payment by the buyer to the seller
Purchase Price Adjustment
In acquisitions where the purchaser is buying the majority of the stock of the target company, the financial information of the target company is usually not ready until 30-90 days after the closing date. To mitigate the risk of negative information about the target company emerging after the closing date, the buyer will attempt to negotiate a provision that allows her to holdback a certain amount of the purchase price (the “holdback amount”) to adjust the purchase price downwards. Purchase price adjustments are most often tied to a working capital adjustment or incurrence of increased debt. For example, if the target company has outstanding credit facilities and borrows under those facilities during the negotiating period of the transaction the additional debt can affect the value of the company and that should therefore be reflected in the purchase price. Other adjustments are based on the profit and loss statements of the target company, valuation of specific assets or the target company’s equity to debt ratio.
Earn-outs stipulate additional consideration, other than the closing day purchase price paid to the seller, that buyer must pay if the target company meets certain performance targets in the future. If there is an earnout, the buyer pays part of the purchase price at closing and the rest is paid in one or more stages if the target company achieves certain earnings or operational targets
Escrow is used to withhold that portion of the purchase price that will be used for purchase price adjustment or indemnification obligations. The key negotiating point here will be how seller receives the escrow amount: will it be paid in a lump sum or in multiple tranches at different stages. The escrow account is normally governed by a separate escrow agreement negotiated contemporaneously with the share purchase agreement.
Representations and Warranties
–Seller’s main concern is certainty of closing, and as a such, Seller will want to ensure that
- the buyer has the required financing to pay the purchase price and
- that the closing is not contingent upon the payment by buyer of any unknown fees to third parties.
– Standard seller representations will include representations that the seller:
- owns the shares without any encumbrances,
- is authorized to complete the transaction (i.e., transfer the shares),
- has (or will by closing) taken care of any regulatory or third party consents,
- and has provided buyer all the material information it has access to about the company and its shares.
Termination and Break-up Fees
Termination provisions allow the parties to walk away from the deal under certain circumstances. Some common reasons for termination include failure to obtain regulatory approvals, breaching a no-shop clause, failure of one party to satisfy closing conditions or, in some cases, if the seller has a fiduciary duty to accept a better offer from another buyer. Associated with the termination provision is what is referred to as a “break-up fee,” used to compensate the party who is not in breach if the deal is terminated. The break-up fee is typically a percentage of the deal value. While there is no bright-line rule the market standard is generally somewhere between 3% and 4% of the deal value.
Indemnification is a post-closing remedy that covers a non-breaching party in the event of a breach by another party of a covenant or representation made in the purchase agreement or other deal documents. The agreement will normally include procedures for notifying a party of an indemnification claim and other requirements associated with indemnification such as any requirements to cooperate in settling a third party claim.
Indemnification claims are limited to a cap (the maximum amount a party can recover on any indemnification claim and a basket or deductible (the indemnifying party does not have to pay for a party’s losses until they exceed a certain amount, at which point the indemnifying party is liable for all losses). This is sometimes referred to as a “tipping” or “dollar one” basket.
Certain breaches will have no limitation in terms of a cap on recovery. These include: (i) legal authority to complete the transaction; (ii) title to shares; (iii) capitalization of the target company; and (iv) certain matters that are set out in disclosure schedules.
Like most legal agreements, the stock purchase agreement will include its share of boilerplate clauses. While these provisions are standard they can sometimes have significant impact on deals. For example, if the stock purchase agreement is not assignable, the seller may run into administrative problems if it wants to move the target company under control of another subsidiary before the closing. Common boilerplate clauses include choice of law, dispute resolution, whether the agreement has any third party beneficiaries, allocation of expenses, etc.
As stated at the outset, the foregoing is a summary of key provisions and negotiating points associated with share purchase agreements.