If you’re thinking of buying or selling a business, the most common way to do it – assuming the business is run as a company – is via a sale of the company’s shares. And, unless we’re talking about a very basic, off-the-shelf purchase, the transaction will be documented by a contract in writing known as a share purchase, share transfer, share sale or sale and purchase agreement.
The reason that a share sale is the most usual way to transfer ownership of a business is that while the owners may change, the company stays the same. The day-to-day activities of the business continue as normal, with employees, contracts and property remaining in place.
When you sell a business, you may hope to achieve a clean break. However, since some company liabilities – particularly related to tax – only come to light after the transaction, sellers can’t step away completely. Hence the need for a detailed share purchase agreement or SPA.
While it’s possible to find model SPAs on the internet, we wouldn’t recommend using them. The benefit of engaging corporate solicitors to prepare a bespoke document is to reflect a fair and commercial distribution of the risks and rewards of the transaction. By using a lawyer, you can also safeguard yourself against painful post-sale discoveries and liabilities.
In this guide, we look at the main terms of SPAs, who is responsible for preparing the first draft, and what you need to look out for if you’re involved in the purchase of a company.
- What is a share purchase agreement?
- Who prepares the first draft?
- What's the share purchase agreement process?
- What are the main terms of a share purchase agreement?
- How do you execute a share purchase agreement?
- What are the tax implications of a share purchase agreement?
What is a share purchase agreement?
A share purchase agreement (SPA) is the main contract used in the private sale of shares. Its main purpose is to set out the deal terms in writing, specify any conditions to the sale (such as getting regulatory consents), allocate risk, and protect the buyer by limiting the seller’s ability to set up a competing business.
It will, therefore:
- Describe the main commercial terms of the transaction (what shares are being sold, the identity of the buyer and seller, and the sale price), and what each promises to do to carry out the sale
- Contain protections for the buyer, and contain key information about the business
- Set out a timetable for the sale process
- Contain confidentiality provisions to keep details of the transaction private
- Describe any conditions relating to the sale, such as the buyer obtaining licensing approvals or consents to carry on the business
Who prepares the first draft?
In a sale of shares between two parties, a draft SPA is normally drawn up by the buyer’s legal representatives, as it’s the buyer who is most concerned that the SPA protects them against post-sale liabilities.
Where a company is being sold at auction, the seller’s lawyers will usually prepare a draft SPA and make this available for inspection to interested bidders. Following negotiation of the terms of the SPA and the due diligence process, the parties each sign the SPA, the buyer pays the purchase price and the shares are formally transferred to the buyer using a stock transfer form. Usually, this takes place on the same day.
What's the share purchase agreement process?
The share purchase agreement process can be divided up into three main phases:
- The pre-contract phase, where the parties negotiate heads of terms, exchange certain legal documents such as confidentiality and exclusivity agreements, carry out due diligence and prepare the SPA
- The contract phase, where the share purchase agreement is negotiated and executed, the seller obtains any consents needed for the transaction to proceed and fulfils any other contract conditions
- The post-contract phase, where any formalities for the business transfer are completed, and the parties deal with any business costs that occur such as post-sale tax liabilities
As part of the due diligence phase, the seller will provide the buyer with information about the company such as:
- Financial information relating to the company’s activities, its customers and market for its products or services, as well as bank account details, loans and other financial commitments
- Accounts and financial projections
- Tax information
- The ownership structure, identity of shareholders and classes of shares
- Any existing or threatened litigation
- Property details, whether owned or leased
- IPR such as trademark or patents
- Employees and details of any pension schemes
- Management and company structure, including the makeup of the board and identity of any subsidiary companies
What are the main terms of a share purchase agreement?
Because certain words or phrases contained in an SPA are frequently used, ambiguous or have a precise legal implication, they are often listed in a ‘definitions’ section at the beginning or end of the agreement, or in a schedule. This simplifies the document as well as providing clarification, for example, what is meant by ‘intellectual property rights’ or ‘confidential information’.
Defining terms up-front in the document helps avoid future disputes.
The identity of the buyer and the seller appears at the beginning of the SPA, together with their addresses or registered offices (if they’re a company or other legal body). Where the business being sold has more than one shareholder, each seller should sign so that are each liable for the full amount of any liabilities (joint and several liability), or if this isn’t the case, how the distribution of liability between individual sellers will be divided.
Sometimes parties like a bank or group company that guarantees the seller’s obligations may also sign the SPA. The company being sold can also be made a party, for example where business property is part of the deal.
Sale and purchase of shares
At the heart of the SPA is the agreement that the seller will sell and the buyer will purchase the shares of the target company. Normally, the seller agrees to sell the shares ‘with full title guarantee’ – this special term means the seller owns the shares outright, is allowed to sell them, will do everything needed to carry out the transfer, and that the shares are not subject to any third-party rights or restrictions.
A SPA should specify the sale price for the shares, specify the currency and timescale for the sale, and list any other conditions like staged payments. Usually, payment is made in cash, although sometimes the buyer may offer the seller some of its shares, or issue loan notes to the seller. This will need the involvement of a lawyer.
The purchase price may be fixed or could be variable and adjusted when the transaction completes. This can occur when the price has been worked out with reference to the value of the company’s assets or earnings.
Usually, SPAs are signed, the purchase price paid, and the shares transferred on the same day. Occasionally there may be a delay between contact exchange and the completion of the deal, particularly when there are conditions to be met before the sale can take place.
In these cases, it’s important to get a legal professional to describe the conditions and handle the gap in the transaction between signature and completion. A long-stop date by which the conditions must be fulfilled is essential, as well as a provision that states what will happen if any of the conditions aren’t met by that date.
Here are some typical conditions precedent in a SPA:
- Where the buyer or seller is a public company, listing rules may require that they get the consent of their shareholders to the transaction
- HMRC clearance. In certain cases, a party to the deal might ask that HMRC give clearance to the transaction to make sure that taxes such as capital gains tax are not payable
- If the business is operating in a competitive sector, either in the UK or globally, you might need clearance from the relevant competition authorities
- The buyer may need regulatory or licensing consent to the purchase, for example if the business operates in a highly-regulated sector such as banking or insurance
- Third-party consents. Although selling shares is generally more straightforward than selling business assets, for key business contracts to remain in place after the sale like leases, the consent of landlords and other third parties may be needed
- Consent of the seller’s shareholders and waiver of their pre-emption rights if part of the purchase price involves seller shares
One of the reasons it’s so important to get a legal professional involved in drafting a SPA is that you need to be completely sure who is responsible for meeting the conditions, how to measure when they’ve been satisfied, and what to do if the long-stop date isn’t met.
Another reason to involve a lawyer is that there can be a long time between the date the contract is signed and the date that the conditions are met, during which the business might suffer losses or there be other occurrences that could cause the buyer to wish to withdraw. Careful drafting of the SPA can help protect the buyer against such unforeseen occurrences.
Best and reasonable endeavours
‘Best endeavours’, although it appears an innocuous form of words, has a precise legal meaning. A buyer or a seller agreeing to use best endeavours to achieve a particular goal can find themselves considerably out-of-pocket, as this obliges someone to achieve a particular goal no matter the cost. After ‘best endeavours’, the next most strict requirement is ‘all reasonable endeavours’ followed by ‘reasonable endeavours’.
Flexible and deferred payments, and earn-out clauses
The final sale price for the shares may be flexible, depending on the performance of the target company’s business following the sale. If that’s the case, a set of completion accounts will be prepared that show the true value of the company at the point of sale. This way, the price for the shares can be adjusted if the business doesn’t perform as expected.
This involves complicated drafting and the involvement of finance professionals so that a fair price is achieved, and the document reflects the parties’ expectations.
It’s also possible that the sale price of the company is paid over a period and by instalments, depending on how the company performs after completion. It may be calculated with reference to profits earned post-sale for example, or the meeting of performance targets set by the buyer. Make sure you get this clause professionally drafted so that it includes the amount and timing of payments, interest, and payment protections in case of default.
If you are considering an earn-out clause, bear in mind:
- How long you want the earn-out period to last
- When payments will be made
- What measures will be used to track performance and how they will be calculated
- What to do in the event of a dispute
- What involvement, if any, the seller will have after the sale has taken place
- How the seller can make sure the buyer doesn’t adversely affect the company’s results and thus artificially skew the performance figures
If part of the purchase price will be held back by the buyer following completion, for example to meet potential claims under the seller’s warranties and indemnities, this can be put into an escrow account with a third party such as a bank or lawyer, with a mechanism put in place that describes the escrow arrangements and makes provision for when and how monies will be released.
Execution of the SPA and completion (when the shares are transferred) often, but not always, takes place simultaneously. The SPA will need to describe in detail what happens at completion, for example:
- When and where completion will take place
- The exact procedure at completion (handing over signed documents, transfer of funds, holding of necessary board meetings, etc)
- Execution of the stock transfer form and handing over of share certificates
- Director and officer resignations
- Handing over of company’s legal records such as the PSC register
- What happens if completion fails to take place
Warranties and indemnities
Because the general rule of ‘buyer beware’ applies to the sale of shares, the law doesn’t provide the buyer with much protection if unexpected liabilities or problems come to light after the company is sold. To protect the buyer against such unexpected costs, a SPA will contain extensive warranties in which the seller makes statements and promises regarding the state of the company’s affairs and assets. The seller may also give indemnities to the buyer – this means that the buyer is on the hook for any losses the buyer incurs if the warranty is breached.
So, the warranties have two main purposes:
- They encourage the seller to disclose information so that the buyer can investigate the issue and adjust the purchase price if necessary
- They act as insurance against any unknown problem that emerges post-sale, giving the buyer the right to adjust the price they paid retrospectively
If a warranty turns out to be untrue, then the buyer will bring a breach of contract claim against the seller to recoup a portion of the purchase price. A buyer won’t be able to bring a claim for breach of warranty if the seller has already told them about the issue. For this reason, the seller will make ‘disclosures’ to the buyer in the course of the sale so that the buyer can evaluate the nature of the risk and change the purchase price to reflect this.
These disclosures are made in a ‘disclosure letter’ negotiated and handed over at completion that will help flush out any issues not known to the buyer and that could affect the purchase price or decision to buy.
The wording of warranties and indemnities must be extremely precise and should be drafted by an expert.
An SPA usually covers:
- What the warranties relate to in detail, for example they may cover:
- Who owns the shares
- That the accounts and financial records of the company are accurate and up to date
- That the company is compliant with the law and there are no disputes or litigation likely
- Details about employees and pensions
- Assets of the company including property and IPR
- The company’s systems and websites
- Relationships with suppliers
- Insurance claims and tax matters
- Who will be giving the warranties
- What will the buyer be entitled to if there’s a breach of warranty, and whether the seller’s liability will be capped or otherwise limited, for example:
- Liability for minor problems may be excluded
- There may be an upper limit for claims
- There may be a time limit by which claims must be brought
Restrictive covenants stop a seller from competing with the buyer after the sale. They may include wording that prevents the buyer from operating in the same sector or geographical area, or stop the seller from approaching the buyer’s employees, customers or suppliers to do business with them.
Some restrictive covenants are implied by law, for example, to prevent the seller from using the company’s trade secrets or pretending to be acting on behalf of the company, post-sale. However, these are limited in scope, so the advice of a professional is essential.
Although restrictive covenants are important insurance for the buyer, they must be very carefully worded as if they are too wide, they can be set aside in law for being unreasonable.
Communications and confidentiality
Because a SPA is a private transaction, it usually contains provisions restricting the flow of confidential information and preventing the buyer and seller communicating details of the deal to third parties. Similarly, the SPA may contain a clause that describes how, where and when announcements about the transaction may be made public.
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How do you execute a share purchase agreement?
The execution requirements of a SPA depend on the legal status of the parties, for example, whether they are individuals, limited companies, partnerships and so on. In most cases, a SPA will be signed as a simple contract and not as a deed (executing a contract as a deed requires the signatures to be witnessed and sealed).
It’s becoming more common for parties to use electronic signatures to execute an SPA, and this can include using a web-based e-signature platform, pasting a signature into a document, or using a touchscreen to write a signature manually.
What are the tax implications of a share purchase agreement?
Despite tax affairs being disclosed by the seller in the disclosure letter and the buyer having inspected the company’s records, sometimes unforeseen tax liabilities can arise. For this reason, SPAs usually contain tax warranties and a tax covenant (or tax indemnity) that covers the buyer should such expenses come to light.
A tax covenant aims to cover the buyer completely for the whole amount of the tax payable. If the tax liability arose because of pre-completion activities, the seller will pay. If it arose because of post-completion business, then this will be the buyer’s responsibility.
The reason for tax warranties (in addition to the tax covenant) is so that the buyer can additionally get protection for tax liabilities after completion that are greater than they anticipated following their inspection of the seller’s records (for example, the way that tax allowances and reliefs have been calculated).
For more answers to commonly asked questions and advice on share purchase agreements, mergers and acquisitions and tax covenants, consult our corporate solicitors. Get in touch on 0800 689 1700 email us at firstname.lastname@example.org, or fill out the short form below with your enquiry.