Summary
A Share Purchase Agreement (SPA) is an important document when buying or selling shares in a company.
- Meaning: a contract between the buyer and selling shareholders recording the terms on which the shares will be sold and purchased.
- Purpose: to set out the commercial terms of the deal and allocate risk between the parties.
- Key terms: the shares being sold, the purchase price and how it will be paid, warranties, indemnities, and restrictions on the sellers’ activities after completion.
- Buyer protection: due diligence helps identify risks and informs the warranties and indemnities negotiated in the SPA.
- Seller protection: effective disclosure qualifies the relevant warranties, while negotiated liability limits help manage the sellers’ exposure to claims after the sale.
Introduction
If you are buying or selling shares in a company, an SPA is one of the key documents involved in the transaction. Put simply, the SPA is a contract between the buyer(s) and the selling shareholders that sets out the terms on which the shares will be sold and purchased.
An SPA records the commercial terms of the deal, including which shares are being sold, the purchase price, and when payment is due. It also allocates risk between the parties. From the buyer’s perspective, this means securing protection if information about the company being acquired (the target) proves inaccurate. From the sellers’ perspective, it means identifying matters that need to be disclosed against the warranties in the SPA and negotiating appropriate limits on their potential liability after the sale.
In this blog, we explain what an SPA is, who the parties are, and the key terms that buyers and sellers should understand before proceeding with a transaction.
Who are the parties to an SPA?
An SPA is entered into between the buyer and the shareholders selling their shares. This is because the shareholders own the shares being sold, while the target owns the underlying business assets. The purchase price is therefore paid to the selling shareholders, rather than to the target. There may be a single seller or several, depending on how the target’s shares are held and whether the buyer is acquiring all of them or only a proportion.
Share purchase agreement vs asset purchase agreement
Before looking at SPAs in more detail, it is worth briefly distinguishing between the two main ways of acquiring a business: share purchases and asset purchases.
Share purchases
In a share purchase, the buyer acquires shares from the shareholders in order to take ownership of the target (or a stake in the target). The target remains the same legal entity after the sale and continues to own its assets, but with new ownership. The sellers will execute stock transfer forms to pass the shares to the buyer.
Existing customer and supplier contracts remain in place without needing to be separately transferred to the buyer. However, key contracts should still be checked for change of control clauses, which may require the customer or supplier’s consent to the sale or allow them to terminate the agreement as a result.
The target also retains its existing liabilities, and buyers will seek protection in the SPA in the form of warranties and indemnities to address this risk.
Asset purchases
In an asset purchase, the buyer acquires specific business assets identified in the agreement, rather than shares in the target. Those assets are acquired from their owner, which will usually be the target business rather than its shareholders. This gives the buyer greater flexibility to choose what it wishes to acquire, whether that is the majority of the business’ assets or an individual asset, such as a piece of intellectual property.
Each type of asset must be transferred using the appropriate mechanism. This differs from a share purchase, where ownership of the shares changes but the target continues to own its assets. Any contracts being transferred to the buyer will generally need to be assigned or novated.
An asset purchase is documented in an asset purchase agreement (APA) rather than an SPA. Although both address similar issues, SPAs are the focus of this blog.
Where does an SPA fit into the acquisition process?
At the start of a deal, the buyer and sellers will often agree heads of terms setting out the main commercial points of the proposed transaction. The buyer will then carry out due diligence on the target, investigating its business, finances, and legal affairs to better understand what it is acquiring.
This is particularly important because the principle of “buyer beware” applies under English law. The buyer is responsible for investigating the target and should not assume that the seller will volunteer information about every potential issue with the target. For this reason, the buyer will usually seek appropriate contractual protections in the SPA. These protections include warranties and indemnities, discussed further below, which offer protection for the buyer and also encourage disclosure of information about the target by the sellers.
The findings of the due diligence exercise inform the negotiation of the SPA, helping the buyer identify the contractual protections it needs. Drafting and negotiations often take place while due diligence is ongoing, with the SPA updated as issues emerge.
What are the key terms contained in a SPA?
The terms of an SPA will always depend on the target and the risks identified. However, certain provisions commonly appear, which we discuss below, although this is not designed to be an exhaustive list.
Agreement to sell and purchase
After the definitions section, a clause in the SPA will record the parties’ agreement to buy and sell the shares in the target. This is usually one of the simpler clauses in the SPA, with the buyer interested in acquiring the shares free from any charges or third-party rights.
Purchase price and payment
The purchase price is one of the key sections in the SPA. There should be a section that clearly sets out how much the buyer will pay for the shares in the target business, as well as when and how that payment should be made.
The price, also often referred to as consideration, may consist of cash, shares in the buyer or a new holding company, or a combination of both. However, the headline price agreed by the parties will not necessarily be the amount paid at completion, and the SPA may set out an arrangement for determining the final price to be paid by the buyer. Please see a brief discussion of some of these mechanisms below:
Earn-Out: this makes part of the purchase price dependent on the target’s performance. It may be used where the sellers remain involved in managing the target after the sale to incentivise them to contribute to the strong performance of the target, although in this situation a balance must be struck between the sellers’ interests in the short-term performance of the company against the buyer’s wish for the target to be a long-term success.
Completion Accounts: this adjusts the purchase price by reference to the target’s financial position at completion. The buyer pays a provisional amount, with the figure adjusted up or down once the completion accounts have been prepared. The SPA will need to specify the rules for the preparation of the accounts, how the price change will be calculated, and how any disagreement regarding the adjustment should be resolved.
Deferred Consideration: this mechanism sees part of the purchase price paid upon completion, with the remainder paid later. In this situation, the SPA is likely to set out whether a guarantee or security is needed to protect the sellers against non-payment and whether the buyer can deduct amounts from the deferred payment if it has claims against the sellers.
In relation to where the payment should be made, the SPA will usually state that this should be via bank transfer to a nominated account. This could include multiple accounts for each seller, or one account for all of the sellers so that the consideration can then be distributed. The SPA will state that payment to that nominated account will discharge the buyer’s payment obligation, ensuring the buyer is protected should the recipient fail to pay the sellers.
Completion and Conditions Precedent
At exchange, the parties enter into the binding SPA. At completion, the parties carry out the agreed steps to implement the sale, such as transferring the payment and completing the stock transfer forms.
In many transactions, exchange and completion occur simultaneously. In other scenarios, there may be a gap between exchange and completion. This gap is usually to allow certain requirements to be satisfied before completion takes place. These requirements are called conditions precedent. The SPA will need to set out what these conditions precedent are, whether there are any deadlines for their completion, and what the consequences are if they are not satisfied. Common examples of conditions precedent include approaching a key customer with a change of control clause in their contract to ensure they consent to the transaction, obtaining competition clearance from regulators (particularly for larger transactions), or waiting for approval from the UK government if the transaction requires national security review.
Regardless of whether exchange and completion occur at the same time, the SPA will set out the completion mechanics. This includes the timing of completion, the completion location, and any completion actions and deliverables. These actions include (i) each party providing the other with the signed transaction documents, (ii) the buyer paying the purchase price, and (iii) a board meeting of the target being held to approve the registration of the transferred shares on the target’s register of members.
Warranties
Warranties are one of the most important elements of the SPA. Essentially, they are contractual promises about the state of affairs of the business at a particular point in time. This point in time is usually at exchange, and if there is a gap between exchange and completion, the buyer will usually want the warranties to be repeated at completion.
If a warranty proves to be untrue, the buyer may be able to bring a claim against the sellers for breach of warranty. The buyer would then need to establish its loss under normal contractual principles, demonstrating that the breach has caused the buyer loss, namely the shares being worth less than they would have been if the warranty had been true.
Who gives the warranties in the SPA?
Those giving warranties are liable to the buyer after the sale completes for any breach of those warranties. For this reason, the buyer will want as many of the selling shareholders as possible to be giving the warranties, as this gives the buyer the greatest possible chance of recovering their losses. Conversely, some sellers may not want to give warranties.
Where there are several sellers, the parties will need to agree whether they all give the same warranties and accept the same liabilities. Each seller will generally be expected to give warranties about ownership of their shares in the target and their authority to sell them.
However, the position may differ for warranties concerning the business affairs of the target. While the buyer will still want as many sellers as possible to give these warranties, they may accept that only the sellers with knowledge of the day-to-day affairs of the business provide these warranties. For example, the buyer is likely to want the founder and director of the target to give these business warranties. However, the buyer may accept that a family member who invested when the business started that has not been involved since does not. This will be a matter for negotiation between the parties, with the agreed position reflected in the SPA.
Warranties and the Disclosure Letter
The buyers will want warranties to be drafted as widely as possible to catch any breaches by the sellers, while the sellers will want them drafted more narrowly. This will be a key point of negotiation between the parties.
However, it is important to view the warranties in context of the wider transaction, namely the Disclosure Letter. This letter is prepared by the sellers’ solicitors, identifying matters that currently exist that would breach the warranties as drafted in order to qualify them.
As discussed above, the SPA may contain a warranty that the target is not involved in any litigation. If there is an ongoing claim, the sellers can disclose that claim in the disclosure letter. The SPA will set a particular standard for disclosure. Where the disclosure meets this agreed standard, it will prevent the buyer from bringing a claim for breach of warranty.
For this reason, warranties have the effect of encouraging disclosure by the sellers about the target business to ensure they are not in breach of any of the warranties. This information enables the buyer to assess whether they need further details, wish to negotiate a price reduction, or require an indemnity for a specific risk. In extreme situations, the disclosure could also prompt the buyer not to proceed with the transaction.
Key warranties contained in the SPA
The main body of the SPA usually sets out how the warranties are given and the limits on the sellers’ liability as discussed below. The detailed warranties themselves are then contained in a schedule that forms part of the SPA. While the warranties will need to reflect the nature of the target, some common warranties are discussed below.
Ownership of Shares
These warranties address whether the sellers own the shares being sold and have the necessary authority to transfer them to the buyer. As discussed above, all sellers will be expected to give this warranty.
Customers, Suppliers and Contracts
These warranties cover the target’s key trading relationships with both customers and suppliers. The warranties will cover whether there have been any breaches of these agreements and whether any parties have indicated that they intend to stop or reduce their business with the target. They may also address change of control clauses that would require the consent of the counterparty before the transaction can take place or allow them to terminate.
If a major customer has threatened to stop doing business with the target, the buyer will need to consider the effect this could have on the target’s revenue and the price they are willing to pay. In Equitix EEEF Biomass 2 Ltd v Fox & Ors [2021] EWHC 2531 (TCC), the target supplied steam to a single customer, making the continuation of that relationship key to the business. The customer terminated its contract shortly after the buyers acquired the target. Although the buyers were aware of an earlier threat by the customer to terminate, the sellers failed to inform the buyers that the intention to terminate had been repeated and was something they were seriously contemplating. The court found that this went beyond what the buyer already knew and therefore the sellers were liable for breaching the warranty that no party had indicated an intention to terminate a material contract. The case highlights why buyers seek warranties covering threats to key contracts, and why sellers should ensure their disclosure letter meets the agreed level in the SPA.
Separately, identifying change of control clauses allows the buyer to establish whether counterparties are prepared to continue doing business with the target and obtain any necessary consents.
Accounts and Financial Information
Financial warranties address whether the target’s accounts give a fair and accurate view of the target’s financial position and have been prepared in accordance with applicable accounting requirements. The buyer will want protection from a scenario where the target appears more valuable than it is based on the accounts provided to them.
Disputes and Investigations
These warranties cover existing or threatened litigation, regulatory investigations and other disputes involving the target. For example, the buyer will want to know if a customer or supplier has threatened a substantial claim against the target, even if court proceedings have not yet started. This allows the buyer to investigate the potential liability further if it is disclosed by the sellers and consider whether indemnity protection may be needed. Alternatively, if an undisclosed issue makes a relevant warranty untrue, the buyer may have a claim, subject to establishing a recoverable loss and any agreed liability limits.
Intellectual Property
These warranties address whether the target owns, or has the appropriate rights and licences to use, the intellectual property needed to operate the business. They may also cover infringement claims and disputes over ownership. For example, a buyer acquiring a software business will want to establish that the target owns the key piece of technology justifying the acquisition.
Limits on the sellers’ liability in the SPA
It is standard for the sellers to limit their liability for claims for breach of warranty in the SPA. Common limitations include:
- A de minimis threshold, ensuring the buyer cannot bring claims for small amounts below a particular amount
- Time limits for the buyer to notify the sellers of any potential claims under the warranties
- Provisions preventing the buyer from recovering twice for the same loss (under two or more different warranties), and
- Imposing a financial cap on the seller’s aggregate liability for all warranty claims, usually expressed as a proportion of the purchase price.
Indemnities
Indemnities are promises to reimburse the buyer for a particular type of liability that may arise in the future. They are often used to address risks identified during the due diligence process. An indemnity allows the buyer to recover the covered liability from the sellers more easily than would otherwise be the case in a warranty claim. In addition, indemnity claims usually permit the recovery of a wider range of losses beyond the diminution of the value of its shares and/or loss of any profits.
For example, if an ongoing customer dispute was identified, the buyer may wish to include an indemnity for the sellers to pay the damages and costs of the dispute should the counterparty litigate. The sellers will be keen to ensure the indemnities are capped at a certain liability.
Joint and several liability
Where several sellers give the warranties and indemnities, the buyer will often require that this is on a joint and several basis. Should there be a breach of a warranty, for example, this allows the buyer to pursue any one of the sellers that has given that warranty for the whole recoverable amount, subject to any agreed liability limits as discussed above. The seller who pays the buyer the damages may then seek a contribution from the other sellers to recover part of the money paid to the buyer.
Restrictive Covenants
In some transactions, the sellers may continue to work for the target after they sell their shares to the buyer. In other situations, the sellers may be selling their shares and then discontinuing their involvement. In this scenario, the buyer will be interested to protect the value in the business they have just acquired, wanting protection against the sellers immediately starting a competing business and taking the target’s customers. Conversely, the sellers will want to retain reasonable freedom to work and pursue other business interests.
Regardless of whether the sellers leave or remain at the target, restrictive covenants are likely to be included in the SPA. These restrict how the sellers may act following the completion of the sale. Key examples of restrictive covenants include:
- Non-compete obligations, restricting the seller’s ability to start or work for a competing business, and
- Non-solicit obligations, restricting approaches to the target’s customers or attempts to recruit its employees.
To be enforceable, restrictive covenants must go no further than is necessary to protect the target’s legitimate business interests. For this reason, the restrictive covenants included in the SPA should be tailored to the business activities of the target and have appropriate limits (most importantly, time).
Other provisions in the SPA
The SPA will contain confidentiality obligations, both preventing the seller from disclosing information about the target and in order to keep the provisions of the SPA itself confidential. The SPA may also contain an announcement clause, agreeing a format for the deal to be publicised.
Finally, the SPA will contain boilerplate clauses. These will include, for example:
- How the terms of the SPA may be varied, generally in writing and signed by the parties.
- That the SPA represents the entire agreement between the parties.
- The governing law and jurisdiction for SPA, which sets out which laws will be used to interpret the agreement and which court would be used to resolve any disputes surrounding the SPA, such as in relation to a breach of warranty.
You can read more about boilerplate and standard contractual provisions in our commercial contracts guide here.
How can EM Law help with a share purchase agreement?
EM Law advises on share purchase agreements and the legal aspects of buying and selling a business. The SPA should reflect the target being acquired, the commercial terms agreed, and the risks identified during the due diligence process.
If you require support negotiating an SPA or help navigating the sales process, please contact us here or visit our Corporate Law Firm page for further information.
