Share Purchase Agreement Explained
Share Purchase Agreement or SPA is an agreement by which the seller sells all or some of his shares in the purchased company, and the purchaser purchases the same.
A Share Purchase Agreement is a legal contract outlining the terms between a buyer and a seller of shares in a company – usually a private limited company. It is used at the point of the purchase of the shares, and the buyer becomes legally obligated to purchase once the contract is signed.
Mainly there are three forms of SPA in UK.
Head Agreement – a formal agreement where the head of agreement is then signed by both parties and some conditions may be attached to that .
Conditional Agreement – when a condition is attached to the agreement, such as sales, the buyer may become bound to the agreement, and the seller may have a period of time to fulfil the condition.
Deferred Consideration – this is when the buyer pays part of the purchase price at the time the shares are purchased and the remaining balance at a later date.
SPA are very important under UK law and business dealings and are governed by the rules, regulations and principles of English Law, particularly contract law.
Components of a Share Purchase Agreement
A share purchase agreement typically comprises the following key elements: parties, purchase price, payment and completion mechanics and conditions precedent.
Parties
The first element of a share purchase agreement is the identity of the buyer and seller. The purchase agreement should identify the seller (usually the ‘shareholder’ of the target company) and the buyer (usually a corporate vehicle). The purchase agreement should also confirm the exact name of the selling company. The company may be the ‘target’, in which case it is the issuers of the shares (the shareholders) who are selling the company. Alternatively, the company may be a holding company and the subject matter of the share purchase agreement will be the shares of an intermediate company through which the holding company owns (at least 51% of) the shares of the target.
Purchase price
The share purchase agreement will set out how the purchase price has been calculated; the calculation may contain a number of mechanisms. For example, in the case of the buyer purchasing all the shares of the company it may be appropriate to achieve a multiple of EBITDA or net profit. Alternatively, if the buyer will acquire only a minority interest, it may be appropriate to place an enterprise value on the target (taking into account the purchase of a proportionate interest in the enterprise) and then value the shares based on the application of an appropriate discount rate to take into account factors such as the illiquid nature of the minority shareholding and the marketability of the shares. (We discussed these valuation mechanisms and methods in our earlier post).
Payment
The share purchase agreement will set out how and when the seller will be paid for the shares. In most cases, payment will be made in full either on exchange of contracts or on the completion date of the share sale. If the seller is being paid a fixed amount, it is possible that part of the sale proceeds would not be released to the seller until after the completion date (for example in an escrow account). The concept of an ‘earn-out’ may be familiar to the seller and buyer. This is where the seller qualifies his potential share of the price by share performance after the date of completion. This mechanism is aimed at alleviating the risk to the buyer that the target company may not perform post-completion. An earn-out clause will contain a formula or pricing mechanism for measuring the company performance. It may also specify the period for which the buyer warrants performance.
Conditions precedent
Certain conditions must be satisfied before the sale can be completed. These may include a shareholder vote, regulatory or other third party consent, or in the case of a data protection compliance issue, the approval of the Information Commissioner.
UK Legal Requirements for Share Purchase Agreements
In the United Kingdom, share purchase agreements (SPAs) are governed by a combination of longstanding principles developed by common law and regulatory requirements. Parties looking to enter into an SPA should ensure compliance with both sets of requirements to avoid any issues.
The general requirement for a share transfer is that a proper instrument of transfer is executed by the seller and the buyer of the shares. In the case of public companies, a share transfer is effected by a contract note in a prescribed form. No formalities apply to a private company other than to comply with the Companies Act 2006 that regulates the allotment and transfer of shares and the UK Stewardship Code 2010. The buyer of private company shares must also pay stamp duty at a rate of 0.5 per cent of the consideration payable. For example, for a £1million consideration, stamp duty will be payable on £5,000. It is important to note that there are limitations on the extent to which a seller can contract out of the Companies Act provisions.
SPAs of UK companies that are not traded on a regulated market must be registered with the UK’s Companies House registry following completion. This is a statutory obligation imposed on the purchaser. One of the consequences of failing to lodge a transfer for registration is that the ownership of the relevant shares effectively remains unchanged until the transfer is registered. Failure to comply can also result in the transfer being void or voidable. However, this will not affect the consideration paid for the shares, which will have presumably already been paid by the buyer to the seller.
In the case of listed companies, a different set of rules apply. These will differ according to the applicant’s venue of registration, but as an example, in Ghana the Ghana Stock Exchange (GSE) rules stipulate that the seller must send a notice of transfer to the company, stating its intention to sell. The company will then retain this notice on their register and not allow any transfer other than pursuant to the notice. The GSE has set policies that provide investors with rights over certain issues including the right to be treated equally and fairly, and the right to cast their votes. A total of 8 policies have been issued, all of which aim to protect the rights of investors.
In addition, the purchaser may be subject to City Code obligations that have been issued by the UK’s Panel on Takeovers and Mergers. More specifically, the City Code aims to regulate changes of control of public companies to ensure shareholders of such companies are afforded the same regulatory level of protection afforded to them in other major European jurisdictions. It applies to all corporations which have their registered office in the UK, an establishment in the UK and whose securities are admitted to trading on a regulated market in the UK.
These legal requirements are only an introductory note on the regulations that apply to SPAs in the UK. Consulting the relevant UK regulations and City Code is essential when a transaction concerns UK shares.
Typical Clauses in Share Purchase Agreements
Warranties and Indemnities
Share purchase agreements, or SPAs, will typically feature warranties, representations, and indemnities provided by the seller. Warranties are usually factual statements that the seller provides in relation to the company’s operations, legal interests, assets, policies, etc. For example, "all accounts with [a particular utility provider] have been settled." These statements may be qualified by what is known as a ‘disclosure letter’, which contains explanations of requirements or limitations set on the warranty. It is common for the seller to provide other statements, or representations, separate to the warranties, which are also usually business-related. Indemnities are promises that the buyer will be compensated should a particular event come to pass.
Confidentiality Clauses
A SPA confidentiality provision, sometimes known as a "confidential clause" or an "information clause", protects the parties: it allows for certain information to be shared with a limited group for a limited purpose without the risk of unauthorised publication or sharing. They may also exist in non-disclosure agreements, which may be needed as part of the due diligence process prior to the formal agreement being made.
Effective Share Purchase Agreement Due Diligence
Disclosure and due diligence are often used interchangeably, however this is not always the case. The key difference is that disclosure is more focused and relates specifically to adverse information concerning the company or assets being purchased (material adverse change or MAC). Due diligence in the context of the sale of shares in a UK company, typically requires the seller to produce specific areas of disclosure to the buyer in order for the lawyers acting for the buyer to review and make their own assessment of the risk, both in relation to disclosure and due diligence generally. For example, if the accounts that the company has produced over the past three years do not show the debtors have paid on time, the buyer’s lawyer will want to review the schedule of debtors before contracts are signed .
It is important for the buyer to have sufficient information available so that its lawyers can undertake due diligence because if the seller does not provide the information that the buyer’s lawyers require in order to assess risk, the buyer will not know what to look for and therefore it might miss something. It is possible that the seller has no working capital and therefore cannot give the usual representations and warranties that a buyer would look for regarding the company’s financial position. It could then be that the buyer can only obtain security from one of the shareholders for the purchase price. In such circumstances, the buyer should carefully consider whether to proceed.
The information that was disclosed about the company or assets sold to a buyer will have been provided in response to the buyer’s due diligence. Therefore a seller should carefully review the disclosure included in the share purchase agreement, as it may have to disclose the same or similar information in respect of the business in the future.
Navigating the Negotiation and Execution of a Share Purchase Agreement
The successful negotiation and execution of a share purchase agreement hinges on careful strategy and a clear understanding of common pitfalls. One of the first steps in this process is to identify the key issues that are likely to arise and address them in the early stages of negotiation. These may include the payment structure (whether in cash, stock, or other securities), potential warranties and indemnities, deferred payment arrangements, and any conditions to completion.
When entering negotiations, it is vital to have a clear idea of your objectives as a buyer or seller, and to be prepared to compromise on certain points while holding firm on others. Be prepared to support your negotiating position with legal and financial reasoning, as this can help persuade the other party to accept your terms.
One common pitfall is failing to appropriately safeguard the buyer’s interests through adequate due diligence and clearly defined warranties and indemnities. Thorough due diligence helps to ensure that you are aware of any potential issues with the target company before the sale, giving you an opportunity to address them in the share purchase agreement or to adjust the purchase price accordingly. Without proper due diligence, you may be left vulnerable to undisclosed risks.
Another potential issue is a lack of clarity around the post-closing arrangements. Ensure that all post-closing obligations are clearly delineated in the share purchase agreement, including the treatment of intellectual property rights, employee matters, and ongoing obligations of the seller.
It is also important to ensure that the share purchase agreement is subject to clear and fair conditions to completion, such as obtaining any necessary consents from third parties or regulatory authorities. If the conditions are overly onerous or impossible to meet, this could lead to delays or even potential disputes down the line.
Finally, the execution and closing process should be clearly outlined in the share purchase agreement, with specific attention paid to any closing documents that need to be exchanged. Make sure that all closing documents are drafted with sufficient detail to avoid any future ambiguity.
By following the above best practices, buyers and sellers can ensure a smooth negotiation and execution process for their share purchase agreement, reducing the risk of post-closing disputes and protecting their interests throughout the transaction process.
Post-Completion Considerations for Share Purchase Agreements
Post-completion obligations are a common feature of UK share purchase agreements and usually consist of the transfer of the shares into the purchasing company’s name, which is often granted some time after the completion date, with the seller retaining the legal title in the shares in the meantime. The completion accounts procedure may also be invoked at this stage to ensure the purchase price matches the agreed value of the shares. Any other actions the seller is obliged to take on the completion date to terminate the deal become ‘post-completion’ obligations, such as discharging the security it granted over the shares being transferred or terminating guarantees given on behalf of the target.
The seller may incur ongoing liability under the share purchase agreement, especially in the case of a deferred consideration (should the seller have provided a loan to the buyer or financing for the purchase of the shares), a warranty claim or an indemnity claim by the buyer . If there are any ongoing liabilities, a mechanism for calculating interest on any unpaid sum or overdue costs should be included in the share purchase agreement. The agreement may also include a buy-back obligation for any undistributed dividends amounting to the buyer’s liability under the share purchase agreement, which is more common in asset purchase agreements than in share purchase agreements.
Additionally, the share purchase agreement may be subject to restrictive covenants due to either the nature of the target’s business or because of the buyer’s non-compete obligations following a management buy-out.
As deal documentation is difficult to change after the fact, consider also whether there are any post-completion aspects that should be dealt with at completion.