In this, the latest in a series of articles about growing a business by acquisitive growth (previous subjects include selecting the right target business, negotiating the deal, and carrying out due diligence), I am focusing on the legal documents involved in share purchases.
The key document used in a share purchase is the
share purchase agreement
(SPA). The SPA is a legally binding contract between the buyer and seller, and is typically prepared by the buyer’s solicitors.
Solicitors have a more thorough understanding than accountants regarding the key details of an SPA, so I have asked Heidi Jones, Associate Solicitor at Birketts LLP, to describe the typical sections.*
The SPA sets out the terms on which the seller is to sell, and the buyer is to buy, shares in the target. There are four key sections in any SPA:
1. Definitions for the key terms used throughout the SPA. Setting these out at the beginning makes the SPA shorter.
2. The main body , including:
- The figure for the price, how that price is being paid (such as in cash, shares or loan notes), and when it is being paid.
- Restrictions prohibiting the sellers from setting up, or being involved in, a business competing with the target.
- Any promises (called indemnities) from the seller to the buyer to pay pound-for-pound for a particular liability of the target identified during due diligence (e.g. an environmental liability).
- Limitations on the seller’s liability.
- Boilerplate provisions which the solicitors will negotiate directly.
3. Warranty schedule , which is usually the longest section of any SPA. Warranties are statements of fact about the target which are given as contractual promises by the seller to the buyer. If a warranty is not true, the buyer may be entitled to bring a claim for breach of warranty against the seller.
There are two ways to protect a seller from a future breach of warranty claim:
- Where appropriate, limiting the scope of a warranty by reference to the seller’s awareness, materiality or a period of time. The seller’s solicitor will do this.
- Disclosing against warranties which are not true. The seller’s solicitor will work with the seller to prepare a disclosure letter (explained in more detail below).
4. Tax Covenant – this allocates responsibility for the target’s tax liabilities arising from pre-completion events to the seller, and responsibility for the target’s tax liabilities arising from post-completion events to the buyer.
Depending on the deal, there may be additional key terms incorporated in the SPA. Common examples include:
- On a ‘completion accounts’ deal , where the price is based on the cash, debt and working capital, or the net assets, of the target at completion. Here, there will be a schedule on completion accounts. This sets out who will prepare the completion accounts, what accounting policies apply, when to deliver, review and agree the completion accounts, and when to pay any balance owing.
- On a ‘last accounts’ deal , where the price is a fixed amount based on the last annual accounts, or management accounts, of the target. Here, there will be details on the payments the target is permitted to make to the seller between the date of the last annual accounts or management accounts and completion (e.g. salaries and bonuses in the ordinary course of business).
- On an
, where the price is dependent on the future performance of the target. Here, there will be a schedule setting out how the earn-out is to be calculated (e.g. if a percentage of the profits of the target), when to deliver, review and agree the earn-out statement, when to pay the earn-out, and what the buyer must, and must not, do during the earn-out period, which could otherwise affect the earn-out achieved.
The purpose of the warranties is to ‘flush out’ information about the target. However, there will be a number of warranties that will not be true. For example, a warranty may state, "there are no claims pending against the target" when, in actual fact, the target may have recently received a claim.
Rather than delete the warranty or amend it to refer to the recent claim, full details of the claim should be set out in the disclosure letter .
The seller’s solicitor will hold a disclosure meeting with the seller and key members of staff to go through each of the warranties, line by line, and prepare disclosures against them. The disclosures should cross refer to relevant documents, copies of which should be uploaded to a data room shared with the buyer and its solicitor.
To qualify a warranty, a disclosure must meet the agreed standard of disclosure – this requires the disclosure to be fair and to give sufficient details about the matter disclosed, to enable the buyer to identify its nature and scope.
Time for something a little more light-hearted?
In writing this blog, Heidi and I discussed some of the more humorous moments we’ve seen in disclosure meetings:
- I had a disclosure meeting with a target company’s sales manager, who, true to his job, brought samples of the company's products to the meeting. It was a food company so the samples were much appreciated!
- One disclosure revealed a home office had to be reviewed by a health and safety officer. After some measurements of potential fire exits through patio doors were taken, the home office was approved for use!
The reality is that a properly negotiated SPA is most valuable when something goes wrong; if a transaction completes and the acquisition is a success, the SPA will likely never to be looked at again (other than by the accountants, to account for the various transactions and tax implications).
So, it is where the SPA is breached or where a dispute arises, that the SPA is vital.
An overly buyer or seller-friendly SPA can lead the other party unnecessarily exposed to risk, while a poorly worded SPA can lead to arguments between the buyer and seller about areas each thought they had agreed.
It is therefore vital that you take appropriate advice to negotiate an SPA, and that you appoint solicitors and accountants who work effectively with you, and each other, to ensure its terms will provide sufficient protection and clarity to all concerned.
If you have any questions relating to SPAs, or any aspect of business growth through acquisition, please contact our friendly team at Rickard Luckin, or alternatively Heidi’s legal team at Birketts LLP.
(*The content of this article is for general information only. It is not, and should not be taken as, legal or accountancy advice. Law covered as at March 2020)
If you have any questions about the above, or would like more information specific to your circumstances, please enter your email address below and we will get in touch: