Although it is possible to acquire the shares in a company by way of a simple Stock Transfer Form, this does not offer much protection to a buyer of a company, due to the principle of "caveat emptor" (buyer beware).
Therefore, it is common for a buyer to seek additional protections in relation to the acquisition in a share purchase agreement.
It is standard practice for the buyer's solicitors to produce the first draft of the agreement and the topics covered may include the following:
The purchase price payable by the buyer (also known as the consideration) for the target company, including the form it is to take and when it is to be paid, will be specified in the agreement.
Where the purchase price has been calculated by reference to a set of annual accounts, or management accounts, completion accounts may be required. This is a mechanism whereby an adjustment can be made to the purchase price to allow for any changes in the net asset position (or other financial basis) of the target company to be made.
A key element of the share purchase agreement is the warranties.
Warranties are statements given by the seller (or, in the case of multiple sellers, either all the sellers or only those involved in the day-to-day management of the company) in relation to the target and its business. They are included in a share purchase agreement to reduce the risk of a buyer on an acquisition.
A key aim of the warranties is to provide the buyer with a potential remedy if a statement made about the target or its business proves to be untrue post-completion - effectively a post-completion price adjustment. They also act as an information-gathering mechanism for the buyer and assist in uncovering any potential problems with the business prior to completion.
A breach of warranty claim can result in a successful claim for damages, provided that the buyer can show that the warranty was breached and that it has a suffered a loss as a result of this, ie a reduction in the value of the company.
As the warranties are often heavily negotiated, a buyer may seek to reduce its legal costs by asking for just a few key warranties, such as ownership of the shares of the company. This may particularly be the case if the buyer knows the target company relatively well or the value of the transaction is low.
However, if the business is complex and/or the buyer wishes to minimise its exposure to risk, warranties will usually be sought in relation to all aspects of the business. These will include, for example, the accounts, financial matters, trading matters, assets, property, environmental, employees and pensions, insurance and intellectual property.
The buyer is likely to seek to qualify the warranties by disclosing any issues that make the warranties untrue - see A Buyer's Guide to Disclosure.
If there are certain potential liabilities that the buyer discovers during the negotiation phase of the transaction that are of concern to the buyer, an indemnity can be sought from the seller in relation to this risk.
An indemnity in the context of the acquisition of a company is the promise by the seller to pay to the buyer, on a pound for pound basis, the loss it incurs as a result of a specific issue that has been identified as a source of potential liability prior to completion.
A tax covenant is often included in the agreement to protect the buyer.
The purpose of a tax covenant is to allocate the risks in relation to taxation between the buyer and the seller.
Although subject to negotiation, this is generally done by making the seller responsible for liabilities arising pre-completion and the buyer responsible for those arising post-completion.
Having spent a considerable amount of time and money acquiring a company, a buyer will want to ensure that the seller of the company does not set up a competing business the day after completion. It will also want to ensure that the seller does not attempt to entice customers, suppliers and key employees away from the target company.
In order to prevent this from happening, restrictive covenants can be included in the share purchase agreement, which restrict the seller from doing this and from being involved in a competing business post-completion.
However, it is very important to ensure that the restrictions are reasonable and do not constitute a restraint of trade, in order for them to be enforceable. Consequently, the restrictions should be limited in terms of scope (both geographically and functionally) and time.
Limitation of the Seller's Liability
It is generally accepted that the seller's liability arising in relation to the warranties should be limited to some extent. Whilst this is subject to negotiation, it is usual for a seller's liability to be limited both financially and in terms of time.
There may be reasons why a simultaneous exchange and completion is not possible and completion is made conditional, for example if the buyer is listed on a public stock exchange.
Alternatively, a buyer may want to ensure that material contracts will not be affected by reason of a change in control of the company and so requires time to seek assurances from the third parties involved that they will continue to work with the target company following completion.
In such circumstances, the buyer will want to ensure that the seller continues to run the company in the same way as it had prior to exchange of contracts to mitigate the risk of the value of the company diminishing prior to completion of the acquisition.
The buyer may also require the seller to seek the consent of the buyer before allowing the company to carry out certain actions, such as appointing additional directors, borrowing money other than in the ordinary course of business and entering into material contracts.
A contentious issue here is often whether the warranties are to be repeated on exchange and then again on completion and therefore whether the seller is able to disclose in relation to events occurring between exchange and completion.