When it comes to buying and selling businesses, one of the most straightforward ways to transfer ownership is to sell the company’s shares. This is because while the ownership of the business may change, the day-to-day activities of the business continue, with employees, contracts and property staying with the company.
When someone sells their shares in a business, they often hope to achieve a clean break. However, since some company liabilities – particularly related to tax – only come to light after the transaction, buyers need to make sure that departing owners remain on the hook, and this is one of the main aims of the principal sales document, the share purchase agreement.
While it’s possible for you to modify a template SPA, the benefit of engaging corporate solicitors to draft and negotiate the share purchase agreement is that they can help make sure it reflects a fair and commercial distribution of the risk of the transaction between buyer and seller. By using a lawyer, you can also safeguard yourself against painful post-sale discoveries and liabilities.
What is a share purchase agreement?
A share purchase agreement (SPA) is the main contract used in a private sale of shares.
The SPA will:
- 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 the duties of the parties in relation to the sale.
- Contain protections for the buyer, including disclosure of key business details.
- Contain confidentiality provisions and protections for the buyer against post-sale competition from the seller.
- Describe any conditions relating to the sale, such as the buyer obtaining licensing approvals or consents to carry on the business.
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 solicitors will usually prepare a draft share purchase agreement 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 difference between a share purchase agreement and a share transfer agreement?
There is no difference between a share purchase agreement and a share transfer agreement.
Important clauses in share purchase agreement that need professional attention
A share purchase agreement is likely to be long and consists of a main document and various schedules or annexes containing disclosures and particular details of the transaction. While an SPA can be in any format, the following are the most important clauses, and the ones that should ideally be drafted by an experienced legal professional.
At the beginning of the SPA, the identity of the seller(s) and buyer(s) is described, including their addresses and registered offices if they’re a company or other legal body. Where the company is owned by more than one shareholder, it’s important for the buyer to make sure that each seller is 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 distributed.
Occasionally, there may be other parties to the document, such as a bank or group company that guarantees the seller’s obligations. The company being sold can also be made a party, for example where business property is being transferred in or out of the selling company as part of the deal.
Definitions and interpretation
Defined terms are used to simplify a document and clarify certain words, for example what is meant by ‘intellectual property rights’ or ‘confidential information’. Defining terms up-front in the document helps avoid future disputes about what these mean. The ‘interpretations’ are important, as they make clear how certain phrases should be interpreted in law.
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 has the effect in law of implying that the seller owns the shares outright, that they have the right to dispose of them, that they will do everything needed to carry out the transfer to the buyer, and that the shares are not subject to any third-party rights or restrictions.
An SPA should specify the sale price for the shares, what currency will be paid, over what timescale, and any other conditions like staged payment related to company performance. Usually payment is made in cash, although sometimes the buyer may offer the seller some of its own shares, or alternatively issue loan notes to the seller. This will need the involvement of a lawyer.
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.
Here are some typical conditions precedent in an SPA:
- Where the buyer or seller is a public company, listing rules may require that they get 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.
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 ideally a cut-off date so the parties can pull out if necessary.
Another reason to involve a lawyer is that there can be a long period of 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 – such as COVID-19 – 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
It’s possible that the final sale price for the shares is 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 the company’s performance. You should involve your solicitors so that the instalment schedule is properly drafted, and includes the amount of timing of payments, interest, and payment protections for the seller in case of default.
If you are considering an earn-out clause, bear in mind:
- How long do 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. This will have 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. In order to protect the buyer against such unexpected costs, a SPA will contain extensive warranties by the seller in which they make statements and promises regarding the state of the company’s affairs and assets, and possibly indemnities in the buyer’s favour by which they may recoup any losses from the seller.
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 a number of ‘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 finance 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 setting up a competing business with the buyer for a period of time 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.
Although these 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 share purchase agreement 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.
What are the execution requirements for 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, an 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).
What are the tax implications?
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.
The aim of a tax covenant is to cover the buyer completely for the whole amount of the tax payable. If the tax liability arose because of activities prior to completion, 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).