The Sale and Purchase Agreement, or “SPA” as it is more commonly known, is the main legal document in any sale process. In essence it sets out the agreed elements of the deal, includes a number of important protections to all the parties involved, and provides the legal framework to complete the sale of the company. The SPA is therefore of critical importance to both sellers and buyers.
The SPA is also a rather lengthy document and is almost always subject to detailed negotiations between seller and buyer and their respective lawyers.
Common features and provisions of an SPA include:
Parties to the agreement
In the simplest form of a sale where the company being sold is wholly owned by a single person or parent company and is being bought by a single buyer, there are only two parties to the agreement. However, additional parties will be involved where, for example, there are multiple shareholders in the company being sold. In these cases, each of the shareholders will need to enter into the SPA agreement to sell their shares.
Agreement to sell and purchase
This is often the shortest and simplest provision in the SPA. However, it is one of the most important as it ensures that full legal ownership to the shares (also known as “title”) is properly transferred together with all the relevant rights that attach to the shares (e.g. rights to dividends). The provision will also normally state that the shares are free from any encumbrances, giving the buyer comfort that the seller has not pledged any of the shares to a bank or other lender.
Consideration, retentions and earn-outs
Consideration for an acquired company is paid by buyers to a seller in the form of cash, debt (such as a loan note issued by the buyer), shares in the buyer, or a combination of these. Whilst the seller’s preference is normally to receive consideration in cash and upon completion, often a portion of the consideration will be:
- Retained for 12-24 months in a joint escrow account to give the buyer the comfort that there is money available in the event of any warranty claim it may bring in that period against the seller (this is known as a “retention”)
- Contingent upon the business achieving agreed financial targets following completion, common in deals involving Human Capital & Recruitment businesses where the value resides in the people (this is known as an “earn-out”).
More about earn-outs
The main benefit of an earn-out for a seller is that it allows them to achieve additional consideration if the business increases its earnings over a defined time period. Equally, having an earn-out in a deal means that a buyer only pays for growth only when this has been achieved by the business (instead of relying on forecasts at the time of deal completion).
Whilst earn-outs are a simple concept, they add potential complications to an agreement that need to be carefully addressed in the SPA. For example, there is often a tension that a seller will want autonomy to run the business during the earn-out period and maximise growth whereas the new owner will often be reluctant to concede too much freedom. Sellers often seek contractual assurances from buyers in the SPA that buyers will not do anything to reduce the profits of the business, nor sell any material assets, nor voluntarily liquidate the business etc. The SPA should also contain precise terms regarding the preparation of earn-out accounts, the definition of “profits” and mechanisms to resolve disputes.
The vendor’s tax position in relation to the earn-out (specifically whether the earnout proceeds are taxed under capital gains tax and as the proceeds are received rather than being taxed in advance at completion of a deal) should also be carefully considered and appropriate expert advice sought at an early stage to ensure tax compliance. The seller should also consider whether any security is needed over the buyer’s obligations to make the earn-out payments (e.g. guarantees, payments into escrow etc).
The buyer will want to prevent the seller from establishing any new competitive business that will impair the value of the company being sold. The SPA will therefore contain restrictive covenants that prevent the seller (for a specified period and within specified geographic regions) from soliciting existing customers, suppliers or employees and from competing generally with the company being sold. These restrictive covenants must be reasonable in geography, scope and duration otherwise they may contravene competition law.
Warranties and indemnities
When a company is sold in a share deal the buyer will automatically inherit all of its liabilities and obligations. To mitigate the risks involved in this, the buyer will ask the seller to give certain warranties as to the liabilities and condition of the company and, if any specific risks have been identified, provide specific indemnities.
Warranties are statements of facts made by a seller in the SPA relating to the condition of the company being sold. If a warranty subsequently proves to be untrue and the value of the company is reduced, the buyer may have a claim for breach of warranty. Warranties will cover all areas of the company including its assets, accounts, material contracts, litigation, employees, property, insolvency, intellectual property and debt.
If more specific risks are identified during due diligence, it is likely that these will be covered by an appropriate indemnity in the SPA under which the seller promises to reimburse the buyer on a pound for pound basis for the indemnified liability.
For further information, see the Reading Room’s article “Warranties and Indemnities Explained”.
Simultaneous signing and completion of a deal (where the parties sign the SPA and complete the sale on the same day) is the preferred and simplest way of concluding a deal. Sometimes however there is a need for a time gap between signing and completion in order to satisfy certain final outstanding conditions. These are known as “conditions precedent” and commonly include tax authority clearances, merger approval by competition authorities, and consent from third parties (for example,
where a change of control provision exists in a material contract of the company being sold). Unless the parties agree otherwise, the sale agreement falls away if all of the conditions precedent are not satisfied by an agreed date (the “longstop date”). It is therefore critical that the SPA sets out how to determine when the conditions precedent have been satisfied, and when they are no longer capable of being satisfied. It should also specify which of the parties is responsible for satisfying each particular condition precedent. The relevant party will be obliged to use its reasonable endeavours to satisfy the relevant conditions precedent by the longstop date.
Completion is when legal ownership of the shares transfers to the buyer, resulting in the buyer owning the target company. A completion schedule in the SPA will normally list all of the documents to be signed and other actions necessary at completion to effect the deal. Often negotiations carry on until the last minute and as a result finalising all completion matters can be a fairly fraught affair, with technical completion often happening in the early hours of the morning!
Following completion the SPA continues to be an important document for reference as it covers how any earn-out is to work and contains restrictive covenants, confidentially obligations, warranties and indemnities, all of which will remain very relevant.
The sale and purchase agreement is possibly the most important document in an owner’s business life. For this reason, it should be approached carefully and rigorously, with legal and other M&A experts guiding both the seller and the buyer. The traditional glass of champagne at completion always tastes that much better if this has been done and, as a result, there is a strong and comprehensive SPA in place.
Written by Charles Russell LLP for Boxington
This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions.
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