If you’re selling your business by way of a transfer of shares, you will invariably have to sign up to a share purchase agreement or “SPA”. This is a very detailed agreement and is often over 50 pages long, sometimes even as long as 100 pages or more. At first glance, SPAs can be very daunting but they usually follow a similar structure and the key operative provisions are actually (relatively) short.
The first part of the SPA usually deals with the two points that most buyers and sellers really care about, namely that the sellers agree to sell their shares to the buyer, and the buyer agrees to pay a sum of money to the sellers.
If it has been agreed that the purchase price is to be paid in instalments then this will also be set out, usually with some provision for interest on late payments.
In most share transactions, the share transfer takes place (“completes”) on the date the SPA is exchanged. At completion, each party will be required to deliver various documents to the other (usually done by exchange of emails between solicitors) and the sellers required to hold a board meeting of the target company to confirm the changes of directors, transfers of shares and various other administrative changes. All of the requirements will be set out in detail in the SPA – usually with a general section in the main body, and a schedule listing the documents to be provided and the matters to be approved at the board meeting.
If the purchase price is based, in part, on the value of some or all of the company’s assets and liabilities at completion, there will usually be a completion accounts mechanism. It’s very difficult to calculate and agree a company’s asset and liability position prior to completion, so the SPA will set out a mechanism for this to be agreed and any additional payment to be made in the months following completion. This usually involves the sellers’ accountant providing its version of the accounts, these then being scrutinised and queries raised by the buyer’s accountant, often a little negotiation over some of the figures (with the ability to go to an independent expert if matters can’t be agreed) and finally a figure being determined/agreed and paid.
If the purchase price is based, in part, on the future performance of the company (e.g. a percentage of future turnover or profit) then there will usually be a schedule to the SPA setting out how this will be calculated, how the figures will be produced and agreed (or determined by an independent expert) and when the earn-out will be paid.
The warranty mechanism is the buyer’s key protection to ensure that it knows everything it should about the company before buying it and that there are no skeletons lurking in the closet. There will be a lengthy and detailed warranty schedule containing many statements about the company, relating to employees, customers/clients, suppliers, property, IT, intellectual property, environmental matters, health and safety, accounts, tax, record keeping etc. If any of the statements or “warranties” are not true, then the sellers must provide written details of any inconsistencies.
Where a warranty is untrue and the sellers haven’t given fair disclosure of the facts relating to it, then any loss suffered by the buyer could be passed onto the sellers in the form of a warranty claim.
The SPA will contain both a warranty schedule and a warranty clause, setting out how the warranty/claim mechanism works.
While the buyer will want to ensure it can bring a claim where a warranty is untrue and it suffers a loss because of it, the sellers will want to ensure that the scope of any such claim is limited as far as possible and most SPAs contain a range of limitation provisions. The principal limitations will be:
- The buyer should never be able to claim back more than the purchase price.
- There should be a sensible time limit beyond which the buyer cannot bring a claim (usually between 1 and 3 years, with 7 years for any tax-related claims).
- The buyer shouldn’t be able to bring claims for any warranty breach resulting in a relatively modest loss.
- The buyer shouldn’t be able to bring claims unless the total of its claims exceeds a sensible minimum threshold (often set at between 1% and 3% of the purchase price).
The sellers will also often want to ensure that the buyer takes reasonable steps to reduce its losses, claims off insurance where it can, and consults the sellers in relation to any third-party actions that could lead to warranty claims.
If the buyer discovers anything troubling in relation to the target company, either as part of its due diligence or as a result of warranty disclosures, it might decide that some matters are too risky for it to proceed without the benefit of an indemnity from the sellers. An indemnity sits outside the warranty mechanism and is a promise by the sellers that they will reimburse the buyer pound for pound for any loss it or the target company suffers as a result of certain facts or circumstances that have already taken place, or if certain events happen in the future.
Post Completion Restrictions
It’s a usual expectation that in return for being paid a considerable sum to sell your company, you should agree that you won’t immediately set up in competition or attempt to poach customers, clients and staff. It’s therefore normal to include a set of post-completion restrictions, with varying time limits (though 3 years is the usual maximum).
The tax covenant is a detailed and often lengthy schedule to the SPA, but can be reduced to the following: if any tax that should have been paid hasn’t been paid then the buyer will be able to recover it from the sellers.
If you would like to discuss any aspect of buying or selling a business then please contact Matt Worsnop by email at email@example.com or by phone on 0116 281 6235.