How to sell a company - Part 3: The SPA and Ancillary Documents

This is the third part of a series of seven blogs that outlines the process of the sale of a company – before, during and after the negotiation and signing of the share sale and purchase agreement.

In this Part 3 of the series, we focus on the preparation of the transaction documentation – the share sale and purchase agreement ("SPA") and the accompanying ancillary documentation. Follow the links to read Part 2: Data Rooms and Due Diligence and Part 4: The Consideration.

The SPA

Although there is no legal requirement to have a SPA, it is usually recommended that parties do enter into a written contractual agreement for the sale and purchase of shares in a company, for several reasons, including:

• Documenting the terms of the transaction: the SPA provides a legal framework that details the sale process, setting out what is being sold, by whom and to whom and for how much and specifies the parties' respective obligations and liabilities in relation to the transaction.

• Transparency: by setting out the agreed terms of the transaction, the SPA aims to ensure that both parties understand their respective rights and obligations - helping to reduce the risk of any misunderstandings and the possibility of post-completion claims.

• Risk allocation and mitigation: warranties, indemnities and other provisions contained in the SPA help manage and allocate the risks associated with the sale of a company between the parties.

The SPA provisions

Although share sale and purchase transactions differ in size and complexity a SPA is often extensive and detailed. Some of the key provisions typically covered include:

1. Conditions precedent: For some share acquisitions it may be necessary for completion of the transaction to be made conditional on certain matters occurring first. For example, obtaining regulatory approval for the sale of the shares or receiving landlord's consent to the change of control of the company or the target company not being involved in any litigation. The terms of the conditionality of the sale will be detailed in the SPA.

2. Price: Various issues may need to be negotiated in relation to the price to be paid for the shares, including: (i) how the price will be satisfied. For example, in cash or by the issue of shares in the buyer to the seller; (ii) when the price is to be paid; (iii) the method of payment. For example, by bank transfer to a nominated account; and (iv) whether the price is a fixed sum or subject to a price adjustment mechanism - such as completion accounts, or, an earnout based on the future financial performance of the company.

3. Warranties: The laws of the UK provide little statutory or common law protection for a buyer of shares in a company in relation to the nature and extent of the assets and liabilities it is acquiring, and so the principle of "caveat emptor" - buyer beware - applies. Therefore, to protect itself against undisclosed risks or unexpected liabilities, the buyer will usually insist the seller gives extensive contractual assurances, known as warranties, about the target company, its legal, financial and business affairs and assets. As an example, the seller might be required to warrant that it is not aware of any current or pending litigation against the target company. If that warranty is untrue when given at completion of the transaction and the seller has not formally "disclosed" the existence of an ongoing court action to the buyer as part of the sale process, the buyer may have grounds to claim damages from the seller if it can show that the breach of warranty has caused a reduction in the value of the target company.

4. Warranty limitations: To try and mitigate the risk of a claim against it, a seller will seek to negotiate limitations on a buyer's ability to make claims for breach for warranty. This will normally include: (i) issuing a disclosure letter to the buyer detailing any exceptions to the warranties (see below); (ii) imposing a financial cap on the seller's aggregate liability for breach of warranties (usually capped at the purchase price); and (iii) requiring that any claims must be made within an agreed time period after completion (typically the claim period lasts for around two years after completion).

5. Indemnities: An indemnity is a contractual promise, usually made by a seller to a buyer that the former will reimburse the buyer, typically on a pound for pound basis, should a specified known liability arise. For example, if during the sale process a seller discloses a litigation against the target company, the buyer may negotiate an indemnity from the seller to pay to the buyer the sum of all liabilities, losses and costs that arise from that litigation. Such an indemnity allocates all the financial risk of the litigation to the seller.

6. Tax covenant: A tax covenant deals with the allocation of tax liabilities between the seller and the buyer as at completion and ensures that any tax-related issues are addressed and clearly defined. Under the terms of the tax covenant the seller usually promises to indemnify the buyer for any pre-completion tax liabilities in the target company which do not arise in the ordinary course of business, or, which were not provided for in the target company's last accounts.

7. Restrictive covenants: The buyer will usually wish to protect its investment in the target company by requiring the seller to undertake that it will not set up a competitive business, work for a competitor or try to poach the target company's customers, suppliers or employees for an agreed period of time after completion.  As restrictive covenants are essentially a restraint on trade they must be reasonable and proportionate otherwise it may be that the restrictions specified will be deemed invalid if a buyer tries to rely on them and raise an action against the seller in connection with them post-completion.

8. Completion: The specifics of completion of the transaction will be detailed within the SPA. These will include the date of completion, any steps to be taken in order to complete (such as the resignation of the target company's existing directors) and any documentation required to be delivered to the buyer and the seller at completion.

Ancillary documentation

The SPA will also invariably require a number of other documents to be entered into and delivered at completion. These will generally include:

1. Board approvals: The seller and buyer (if corporate entities) should each hold a board meeting to approve the transaction and execution of the transaction documents, including the SPA and ancillary documents. The target company directors should also hold a board meeting approving the transfer of the shares to the buyer. Minutes of the meetings should be prepared and copies delivered to the other parties at completion.

2. Stock transfer form: This is the document required to formally transfer legal title in the shares of the target company from the seller to the buyer.

3. Share certificates: The seller will be expected to surrender its share certificates for the shares in the target company being sold at completion. If any of the certificates have been lost, the buyer may require an indemnity for the lost share certificates, signed by the seller.

5. Resignation letters: It is common for the buyer to require some or all of directors (and the secretary and auditors, if any) of the target company to resign at completion and appoint its own new directors in their place. Any directors that are required to resign will usually sign a letter confirming that they are resigning from their position and that they have no claim against the target company.

5. Disclosure letter: It is usual practice for the seller to record in a disclosure letter any matter or circumstance that will render any of the warranties it is required to give to the buyer in the SPA untrue or inaccurate. The disclosure letter is negotiated alongside the SPA and is delivered to the buyer at completion of the transaction. The buyer usually agrees in the SPA that the seller will have no liability under the warranties in respect of any matter that has been adequately disclosed in this way. If, during the course of negotiations, the seller discloses material issues of concern about the company, the buyer will usually address such matters by seeking an indemnity from the seller in respect of the issue, or, by negotiating a reduction in the purchase price.

How Brodies can help

If you would like any advice on the issues raised in this blog, please get in touch with one of Brodies Corporate Team below or your usual Brodies contact who will be happy to assist.

View our downloadable guide, "Taking the blinkers off when selling your business", by Neil Ritchie, Director of Personal Tax, on what to watch out for from a personal perspective when selling your business.