M&A
The share purchase agreement - what you need to know about the structure, the legal protection for the seller and the buyer, and the risk allocation between them
One of the most important agreements you will ever sign as a business owner will be the share purchase agreement - either as a buyer or as a seller. The content of the agreement will govern the price you get for your company, the actions that the buyer and the seller need to perform before the deal goes through, what is at all included in the deal, what price mechanisms should be applied in relation to the agreed initial price, how the price should be paid and when, and the liabilities of the seller post closing. And more.
Therefore it is worth taking the time to understand the meaning, the risks and the expectations the agreement reflects. So here is an overview of the structure and key terms of a share purchase agreement that you need to know about in order to create a deal that you get as much possible out of, and where you reduce the risk for post closing claims and other problems.
1. Recitals
The parties are defined, the company is identified, and also a short background as regards the deal and the intent of the share purchase agreement is stated.
2. Definitions
Any comprehensive legal agreement will need to have specific definitions as regards central concepts and words that it uses in order to ensure that the parties are in agreement as regards what is actually meant - as far as this is possible. For example, a "Material Breach", the "Agreement" and the "Shares" will most typically be defined.
Gathering the definitions in the beginning of an agreement will also make the rest of the agreement easier to read since repeating lengthy definitions is not needed. Instead the defined terms are written with a capital letter in the beginning, as to show that they are a defined term through out the agreement.
3. Sale and Purchase
Often, in the beginning of the agreement, there is a dedicated section stating that the overall aim with the agreement is that the seller wishes to sell, and the buyer wishes to buy, the company under the terms and conditions set forth in the agreement.
4. Purchase price
The price of the company and the purchase price mechanism is clearly stated. If the price is to be paid in tranches this is also addressed including the timing and the size of each of the tranches, whether any escrow is to be used etc. In cases were more than one seller is involved the portions of the price that each is to get will be outlined.
Earn-out
In cases where the price is, in part, structured as an earn-out, this will often be addressed under its own section due to the complexity of the earn-out. How the earn-out is to be calculated, when it is to be calculated and paid out, and other practical issues will be agreed upon hereunder.
The earn-out can be based on any metric(s) that the parties choose, and the complexity will to a large part relate to how to calculate different components leading up to the metric(s). What accounting principles and methods and what other factors need to be addressed, such as for example cost allocation, spending needs, re-organisations that could affect if the earn-out metric(s) is reached or not.
Any number of factors that the buyer could use to “manipulate” the underlying numbers, with the result that the decided metric(s) is not reached, and the seller is not entitled to the earn-out payment, need to be identified and regulated already in the share purchase agreement.
If the earn-out runs for multiple years then the complexity and the risks for the seller will increase.
Often the earn-out is described as an agreement to "fight over the price later" due to the high frequency of the disputes that occur. So keep that in mind - and you will be in a better position to negotiate a good earn-out structure in the agreement that does mitigate such risks for future disputes.
Conditions to closing
The bigger the deal the more likely there will be things that need to happen before the deal can be completed. That is called "conditions to closing" and may entail anything from employees and customers signing new contracts to getting required permits and needed authorizations from competent authorities.
If the conditions are not met, the deal does not go through (unless waived where possible), and in order to ensure that the deal is not held up in the air for an unreasonable time period, you will also be advised to have a long-stop date.
Such long-stop date will entail that if all conditions to closing have not been met at e.g. 6 months after signing, then the deal will not be completed, and the buyer and the seller have no obligations towards each under the share purchase agreement (save as for e.g. breakup fees, non-disclousure and the likes).
Completion
The share purchase agreement should detail the actions that the seller and buyer must do on the completion date. There is typically a vast number of actions that should all take place at the date of closing - the day when the buyer gets the keys to the company and the seller is entitled to the payment.
The shares will change owner, the share ledger is to be updated, the consideration (or at least the part that is to be paid at closing) is to be transferred to the seller, the current board of directors and CEO is to be replaced, the new board of directors and CEO (and auditor) must be registered with the companies registration office, a general power of attorney is issued to the buyer, potentially new employment contracts with the founder/management are signed, etc, etc.
The detailed list can be used as an agenda at closing or, in particular in larger deals, there will be a separate closing agenda prepared either in physical form or a digital one.
Post completion undertakings
In many cases there will be obligations for either or both parties to do, or not do, certain things after the completion of the transaction. A typical example will be that a founder commits to not conducting any form of competing business for a time period of e.g. 24 months after the deal (this needs to be checked in relation to applicable competition laws).
The buyer will often agree to grant discharge of liability for the former board of directors and CEO (at least unless the auditor does not advise otherwise) in jurisdictions where this issue is a mandatory matter on the annual general meeting.
Buyer reps & warranties
Even though the focus is on the sellers and their disclosure of correct and complete facts regarding the company, the seller will typically also want some warranties from the buyer. Not least when the seller is offered part of the price in the form of shares in the buyer.
The warranties will focus on the buyer having the fundamental capacity to go ahead with the deal etc.
Seller reps & warranties
The seller's warranties will be a lengthy schedule that is scrutinised and negotiated in detail between the parties before signing. It is a central part of the deal and the risk sharing between the parties in case the company does not meet the buyer's expectations and some issue arises post closing. The seller must be mindful and ensure that all has been disclosed in a fair and transparent manner during the buyer's due diligence of the company.
The reps and warranties will then reflect the result of the due diligence, and effectively mean that the seller warrants certain stated facts about the company as being true and correct.
The warranties will relate to what has been disclosed, and basically stipulate that save as has been disclosed during the due diligence, all aspects of the business – from taxes, to intellectual property, to employment issues and customer contracts – are "ok". That means that taxes have been paid in time, that the company owns necessary intellectual property that it uses, no litigation is ongoing, pending or threatened towards the company, all employment matters have been handled correctly, insurances are adquate and premiums have been paid on time, etc. So it is serious sign-off that the seller must give.
Specific indemnifications
In instances where it is not possible to give a “clean” warranty on an issue because there is in fact a known risk that there will be some form of damage/cost incurred by the company, the buyer can demand to have that potential future cost covered by the seller if it does materialize. For instance, if there is a pending law suit against the company that will be ongoing when the buyer takes over the company, the “your watch – my watch” principle could entail that the seller provides the buyer a specific indemnification promising to cover the costs if the company ends up losing the dispute and needing to pay damages.
Liability and limitation of liability
An important part of any agreement is the limitation of liability where the maximum liability of each party – and in this case first and foremost relevant for the seller – will be set.
In an SPA it could be 100 % of the price, it could be 75 % of the price, it can be higher for certain warranties and lower for others, and so on. The liability can also be limited in time as to only last of certain time periods, often different for different types of warranties. The fundamental warranties such as the seller actually owning the shares and having the capacity to sell them to the buyer would be a much longer, compared to the time period for e.g. operational warranties.
Miscellaneous
The agreement must also cover all of the basics such as confidentiality, no assignment, entire agreement, amendments and waivers, notifications, invalidity, choice of law and dispute mechanism.
End note
If there is ever an agreement to take seriously and to read carefully - and to take time to negotiate in detail - it is the share purchase agreement. Because the implications of buying or selling a company are significant - and so are the chances that issues and disputes actually do arise.
If all goes well and the seller and buyer have engaged in careful negotiations that do set the expectations of the deal, together with a thorough due diligence leading up to the agreement – then selling and buying a company can result in a really great deal for both parties.
Stockholm, 2024-07-29
Author: Kat Strandberg
Contact: kat@stgcommerciallaw.com
1. Recitals
The parties are defined, the company is identified, and also a short background as regards the deal and the intent of the share purchase agreement is stated.
2. Definitions
Any comprehensive legal agreement will need to have specific definitions as regards central concepts and words that it uses in order to ensure that the parties are in agreement as regards what is actually meant - as far as this is possible. For example, a "Material Breach", the "Agreement" and the "Shares" will most typically be defined.
Gathering the definitions in the beginning of an agreement will also make the rest of the agreement easier to read since repeating lengthy definitions is not needed. Instead the defined terms are written with a capital letter in the beginning, as to show that they are a defined term through out the agreement.
3. Sale and Purchase
Often, in the beginning of the agreement, there is a dedicated section stating that the overall aim with the agreement is that the seller wishes to sell, and the buyer wishes to buy, the company under the terms and conditions set forth in the agreement.
4. Purchase price
The price of the company and the purchase price mechanism is clearly stated. If the price is to be paid in tranches this is also addressed including the timing and the size of each of the tranches, whether any escrow is to be used etc. In cases were more than one seller is involved the portions of the price that each is to get will be outlined.
Earn-out
In cases where the price is, in part, structured as an earn-out, this will often be addressed under its own section due to the complexity of the earn-out. How the earn-out is to be calculated, when it is to be calculated and paid out, and other practical issues will be agreed upon hereunder.
The earn-out can be based on any metric(s) that the parties choose, and the complexity will to a large part relate to how to calculate different components leading up to the metric(s). What accounting principles and methods and what other factors need to be addressed, such as for example cost allocation, spending needs, re-organisations that could affect if the earn-out metric(s) is reached or not.
Any number of factors that the buyer could use to “manipulate” the underlying numbers, with the result that the decided metric(s) is not reached, and the seller is not entitled to the earn-out payment, need to be identified and regulated already in the share purchase agreement.
If the earn-out runs for multiple years then the complexity and the risks for the seller will increase.
Often the earn-out is described as an agreement to "fight over the price later" due to the high frequency of the disputes that occur. So keep that in mind - and you will be in a better position to negotiate a good earn-out structure in the agreement that does mitigate such risks for future disputes.
Conditions to closing
The bigger the deal the more likely there will be things that need to happen before the deal can be completed. That is called "conditions to closing" and may entail anything from employees and customers signing new contracts to getting required permits and needed authorizations from competent authorities.
If the conditions are not met, the deal does not go through (unless waived where possible), and in order to ensure that the deal is not held up in the air for an unreasonable time period, you will also be advised to have a long-stop date.
Such long-stop date will entail that if all conditions to closing have not been met at e.g. 6 months after signing, then the deal will not be completed, and the buyer and the seller have no obligations towards each under the share purchase agreement (save as for e.g. breakup fees, non-disclousure and the likes).
Completion
The share purchase agreement should detail the actions that the seller and buyer must do on the completion date. There is typically a vast number of actions that should all take place at the date of closing - the day when the buyer gets the keys to the company and the seller is entitled to the payment.
The shares will change owner, the share ledger is to be updated, the consideration (or at least the part that is to be paid at closing) is to be transferred to the seller, the current board of directors and CEO is to be replaced, the new board of directors and CEO (and auditor) must be registered with the companies registration office, a general power of attorney is issued to the buyer, potentially new employment contracts with the founder/management are signed, etc, etc.
The detailed list can be used as an agenda at closing or, in particular in larger deals, there will be a separate closing agenda prepared either in physical form or a digital one.
Post completion undertakings
In many cases there will be obligations for either or both parties to do, or not do, certain things after the completion of the transaction. A typical example will be that a founder commits to not conducting any form of competing business for a time period of e.g. 24 months after the deal (this needs to be checked in relation to applicable competition laws).
The buyer will often agree to grant discharge of liability for the former board of directors and CEO (at least unless the auditor does not advise otherwise) in jurisdictions where this issue is a mandatory matter on the annual general meeting.
Buyer reps & warranties
Even though the focus is on the sellers and their disclosure of correct and complete facts regarding the company, the seller will typically also want some warranties from the buyer. Not least when the seller is offered part of the price in the form of shares in the buyer.
The warranties will focus on the buyer having the fundamental capacity to go ahead with the deal etc.
Seller reps & warranties
The seller's warranties will be a lengthy schedule that is scrutinised and negotiated in detail between the parties before signing. It is a central part of the deal and the risk sharing between the parties in case the company does not meet the buyer's expectations and some issue arises post closing. The seller must be mindful and ensure that all has been disclosed in a fair and transparent manner during the buyer's due diligence of the company.
The reps and warranties will then reflect the result of the due diligence, and effectively mean that the seller warrants certain stated facts about the company as being true and correct.
The warranties will relate to what has been disclosed, and basically stipulate that save as has been disclosed during the due diligence, all aspects of the business – from taxes, to intellectual property, to employment issues and customer contracts – are "ok". That means that taxes have been paid in time, that the company owns necessary intellectual property that it uses, no litigation is ongoing, pending or threatened towards the company, all employment matters have been handled correctly, insurances are adquate and premiums have been paid on time, etc. So it is serious sign-off that the seller must give.
Specific indemnifications
In instances where it is not possible to give a “clean” warranty on an issue because there is in fact a known risk that there will be some form of damage/cost incurred by the company, the buyer can demand to have that potential future cost covered by the seller if it does materialize. For instance, if there is a pending law suit against the company that will be ongoing when the buyer takes over the company, the “your watch – my watch” principle could entail that the seller provides the buyer a specific indemnification promising to cover the costs if the company ends up losing the dispute and needing to pay damages.
Liability and limitation of liability
An important part of any agreement is the limitation of liability where the maximum liability of each party – and in this case first and foremost relevant for the seller – will be set.
In an SPA it could be 100 % of the price, it could be 75 % of the price, it can be higher for certain warranties and lower for others, and so on. The liability can also be limited in time as to only last of certain time periods, often different for different types of warranties. The fundamental warranties such as the seller actually owning the shares and having the capacity to sell them to the buyer would be a much longer, compared to the time period for e.g. operational warranties.
Miscellaneous
The agreement must also cover all of the basics such as confidentiality, no assignment, entire agreement, amendments and waivers, notifications, invalidity, choice of law and dispute mechanism.
End note
If there is ever an agreement to take seriously and to read carefully - and to take time to negotiate in detail - it is the share purchase agreement. Because the implications of buying or selling a company are significant - and so are the chances that issues and disputes actually do arise.
If all goes well and the seller and buyer have engaged in careful negotiations that do set the expectations of the deal, together with a thorough due diligence leading up to the agreement – then selling and buying a company can result in a really great deal for both parties.
Stockholm, 2024-07-29
Author: Kat Strandberg
Contact: kat@stgcommerciallaw.com