Share Purchase Agreements: what you need to know

There are a number of ways to buy a company, but the two most common ways are by way of a share purchase, where a buyer acquires some or all of the shares in a company, or by way of an asset purchase, which enables a buyer to buy certain elements of a business, such as some of the IP. A share purchase agreement (“SPA”) is a document that is often entered into between a buyer and a seller of shares in a company, and we have explained some of its key features below. 

Whilst the only document you really need to transfer shares is a stock transfer form, most buyers and sellers of shares prefer to enter into an SPA setting out the terms and conditions of the sale and purchase. Specifically, as well as identifying the shares being sought and sold, an SPA can provide protection for the buyer and limit the seller’s liability if anything goes wrong.

What is paid for selling the shares is also referred to as the ‘consideration’. Shares can be paid for in different ways, but cash is the most common. There will usually be a specific cash price that has been negotiated between the parties, and which the buyer will pay to the seller for the sale shares. This amount is usually determined in accordance with the target company’s most recent financial statements, but it may be subject to certain price adjustment mechanisms included in the SPA which protect the buyer from changes in the company’s financial position since the last accounts date up to the date of sale. The most common price adjustment mechanisms are ‘completion accounts’ and a ‘locked box mechanism’, which I will discuss in further detail in Part 2.

The purchase price may also be split into multiple payments, which could be made at completion and then certain deferred payments on a subsequent date or dates.

Consideration for shares may also include ‘earn-out’ payments which are paid following completion, and are linked to the future profits or non-financial performance of the company. These are common where key individuals from the target company are staying on after the sale.  

The consideration may also be made up of loan notes or shares. Loan notes usually entitle the holder to interest as well as capital repayment, and sometimes sellers are offered shares in the buyer instead of cash, which might also entitle them to dividends. 

Warranties

On a share purchase, a buyer is assumed to have carried out sufficient investigations into the target company (known as ‘due diligence’) to understand the nature and value of the assets and liabilities it is acquiring, and so there is very limited common law or statutory protection for this. As a result, a buyer will usually ask the sellers to confirm a number of factual statements about the company, known as warranties. The warranties will cover topics such as who owns the shares, the fact that the company’s accounts have been properly prepared, the state of and fitness for purpose of any assets used by the business, customer/supplier contracts and intellectual property rights, amongst others.

Indemnities

Indemnities are a promise given by a seller to a buyer to compensate the buyer for a defined loss or damage arising from a specific, quantifiable circumstance. For example if the target company is being sued by a customer for a certain amount, the buyer will likely ask the seller to indemnify them for that amount in the event the company is required to pay-out the customer.

Share purchase agreements contain tax indemnities as standard (but, these are sometimes set out in a separate document), but other specific indemnities can also be included to cover matters such as employment issues, environmental problems or if the company is in litigation at the point of sale.

Restrictive Covenants

Buyers will often want to ensure that a seller is prevented from doing anything after completion that harms the new business they have just purchased. As a result, it is common to include restrictive covenants in a share purchase agreement. These typically include restrictions around the following:

1. Restrictions on setting up or working for a competing company;
2. Restrictions on poaching customers/clients;
3. Restrictions on interfering with the company’s relationships with its suppliers; and
4. Restrictions on poaching staff.

Restrictive covenants are often limited to a specific geographical area, and they will only be active for a specific amount of time after completion. The amount of time will vary, and usually be a point of significant negotiation during the transaction, but generally speaking they must be a reasonable length to protect the business interests of the company. 

Introduction to disclosures

The seller is given the opportunity to set out the extent to which a given warranty may not be true by disclosing certain information, usually in a ‘disclosure letter’. To the extent that matters about a company have properly been disclosed, any warranties will be qualified and a buyer won’t be able to make a claim against the sellers at a later date about that particular matter. For example, a warranty might say that the target company does not have any overseas employees. The seller will then be able to set out a list of any overseas employees in the disclosure letter, and the buyer will not be able to later claim that it wasn’t aware of the overseas employees.

Limitations on liability

It is also standard practice in an SPA to include both financial and time limitations on a seller’s liability for claims made by a buyer as a result of a breach of the warranties.

The financial limitations are typically broken down into three strands:

1. The aggregate total liability – this is usually limited to the total transaction value or less
2. A minimum limit which a claim must reach before it can be made against a seller (sometimes called a ‘de minimis limit’)
3. An aggregate limit connected to the ‘de minimis’ limit, where a number of claims are in effect placed into one ‘basket’ - once that ‘basket’ limit is reached, a claim can be brought by the buyer

It is also standard practice to include a maximum time limit, within which the buyer must notify the seller of a claim. Generally, parties will allow at least one full accounting period of the target company (plus a little more to allow for a claim to be made). This is usually the case for all warranties except warranties relating to tax, which have a fairly standard limitation period of 7 years to notify a claim. 

Yes, it is becoming increasingly common for parties to take out warranty and indemnity insurance. This is a specialist type of insurance which is designed to cover against any financial loss that might arise as a result of a breach of warranty in an SPA. This type of insurance can be taken out by either a buyer or a seller, but in each case should limit the scope for a buyer to sue a seller for a breach of warranty. 

Finalising the transfer of shares usually involves a two-stage process. First, the parties ‘exchange’ contracts, which means making a legally binding commitment to proceed with the transaction by signing and dating the SPA. If there is a disclosure letter, this will also be signed and dated at the same time, along with various other documents depending on precisely what is required for a particular transaction.

The second stage is completion, which involves the seller delivering an executed stock transfer form for the sale shares, and the buyer paying the purchase price to the seller.

It is relatively common on a share transfer for these processes to be simultaneous, however there are situations where there can be a gap between exchange and completion (for example, where regulatory approval for the transfer is needed or where consent is required from a third party).

If there is an SPA, it will set out the process for completion, including the timing, location, exchange of certain documents (for example board minutes and stock transfer forms) and any required director resignations. Completion tends to be managed by the buyer’s solicitors and the seller’s solicitors, but the buyer and seller themselves will need to sign a number of documents and transfer any cash consideration. 

After completion of a share purchase, there are various administrative matters which are to be dealt with. The parties will send each other dated copies of their signed documents, the buyer will be required to pay stamp duty on the purchase price, and any relevant Companies House filings will be made by the buyer’s solicitor, among other matters.

Where there is a purchase price adjustment mechanism, there will also be a process of agreeing the final price to be paid for the shares, which we will discuss further in Part 2.