What is a share purchase agreement? A detailed insight article from the Alston Asquith team with frequently asked questions.
The transfer of shares in companies to a new shareholder (also known as a member) whether by sale or gift is very common in UK private companies.
Before agreeing to buy shares in a private company, the prospective buyer will generally seek to obtain a professional valuation and draw up a detailed contract for the purchase. This insight will advise on the general process of concluding a share sale and what is expected from the buyer and seller at each stage.
As a matter of principle, share transfers in UK private limited companies will generally involve a two-step process. In the first instance, the buyer and the seller will conclude a sales contract, often referred to as a share purchase agreement, where they agree on the price for which the shares are sold and the other terms of the transfer.
The second step is the transfer of the share(s). At the end of the second step, the buyer becomes the owner of the shares that formed part of the sales transaction. This second step is frequently referred to as “settlement”.
It should be observed that unless the contrary is provided, the term ‘transfer’ in the company’s articles of association refers only to the transfer of the legal title to the shares and not to transfer any equitable interest. This can have important consequences with respect to the restrictions on the transfer of shares.
A shareholder has the prima facie right to transfer his shares when and to whom he pleases. This freedom however may be significantly curtailed by provisions in the articles. Two common forms of restriction found in the articles of private companies are: (a) provisions that the board of directors should have a power, general or limited in scope, to refuse to register transfers as they see fit; and (b) pre-emption clauses, which are provisions that oblige a member to first offer his shares to other specified persons, such as the directors or other members.
It is common practice that before any share purchase agreement is drafted, the parties to the transaction will disclose all of the relevant materials relating to the assets and liabilities of the target company, this is known as due diligence.
In essence, due diligence is the process whereby the buyer of the target shares will investigate the company’s business, its key people, documentary records and assets. The process is designed to make the buyer aware of the inherent risks that may come with purchasing the target shares but also to justify the value placed on the investment or acquisition price. A third and equally important value of the due diligence exercise is to identify any necessary consents that may be required before the shares can be transferred (i.e. banks, landlords or business contracts).
It is common practice for buyers to carry out as a very minimum, legal, commercial, tax and financial due diligence prior to engaging in the sale transaction.
Although this insight will not attempt to deal with every item to be found in a due diligence checklist some of the more common enquiries are as follows:
Aside from questions relating to why the shares are being sold and any prior sale efforts that have been made, basic enquires should be raised on the statutory books and the organisational legal structure of the company.
Enquiries should be made to address the authorised and issued share capital, including details of classes of share and the number of shares in each class together with the names and addresses of all registered shareholders showing the number of shares held, whether beneficially or otherwise.
If it is a group company, you would expect an organisational chart showing the group structure. It is also common to request particulars of all subsidiaries of the company and the company’s interests in other companies, partnerships or businesses.
Names and addresses of all directors and the secretary of the company also copy of all of the contracts of employment with officers of the company. You would also expect details of the arrangements between the company and its officers or former officers which relate to or affect the capital, business, property, assets or liabilities of the company and its group undertakings.
Names and addresses of all employees together with all contracts of employment, including handbooks, policies and procedures. It is crucial that a prospective buyer before going into the company understands, amongst other matters, the types of employees, the customer linkages and the total compensation packages.
Details of all pension schemes, share schemes, insurance schemes and other employee benefit arrangements.
Details of all bank accounts, financial facilities, legal charges, debentures, mortgages and other financial or security documents affecting the company. You would also expect details and copies of all guarantees, indemnities, loans (including inter-company loans), off-balance sheet commitments, copies of debt facilities (including loan notes) and dividends and other distributions made since the last audited accounts.
Particulars of all properties owned by, leased to, licensed to or otherwise used by the company (or in which the company has an interest), property transactions in the course of negotiation/ to be completed before completion, all planning permissions, planning restrictions and existing uses for properties (lawful or otherwise). It is also important to request details of all notices relating to the properties which have been served upon or received by the company and all major works of repair in the last 3 years.
All existing, pending or threatened litigation, arbitration claims or judgments with the amounts involved. All litigation claims in the last five years and the amounts involved. Details of all accidents in the workplace, material breaches that have occurred under any agreement or arrangements to which the company is a party, all formal insolvency proceedings, including bankruptcy, liquidation, receivership, administration or scheme with the creditors affecting the company.
All intellectual property rights vested in, or used by, the company (whether registered or not and including, all trademarks, trade names, brand names, patents, design rights, registered designs, copyright and service marks). It is also important to gather details of all software owned or used by the company, including nature, description, version, number of copies licensed, author and details of any source code escrow arrangements for software under licence) and all licences.
All insurance policies currently in effect and owned by or providing coverage to the company, its directors, officers and employees, in each case giving details of the renewal date, annual premium, risk covered, name of the insurance company and policy number.
The last three audited accounts of the company, most recent management accounts of the company. Operating projections (including profit and loss and cash flow forecasts) for at least the next 12 months including all planned or required capital expenditure. Details of the current debtors, the period of debt and amount of current creditors, the period of credit and amount.
All agreements with HMRC. Details of taxes outstanding (including corporation tax, VAT, SDLT and/or PAYE) deferred taxation provisions, all tax clearances and tax indemnities taken, the last six tax computations and returns for the company and any correspondence with HMRC, dates of which tax returns have been settled and confirmation of any tax losses (if any).
All consents the shareholders must obtain before completion, all consents the company must obtain prior to completion. All consents the company must obtain, or permits or licences that will expire consequent upon change of ownership of the company. All agreements to which the Company is a party which contain change of control provisions. All brokers and/or finders agreements.
A share purchase agreement is a formal contract or an agreement that sets out the terms and conditions relating to the sale and purchase of shares in a company.
The share purchase agreement should very clearly set out what is being sold, to whom and for how much, as well as any other obligations and liabilities.
The share purchase agreement is normally a very detailed document that will normally be prepared on the basis of the detailed information obtained from either an accountant’s long-form report (if one is available), or, more usually, from the legal due diligence which should have been exchanged between the solicitors on either side of the transaction before the drafting starts.
Normally there will be two parties however if the shares are owned by several persons then it will usually be required to have each shareholder a party to the agreement. Although occasionally, where there are multiple parties, solicitors will include their details in a separate schedule to the agreement.
In certain situations, it may be necessary for the completion of the share purchase agreement to be conditional on certain matters, such as obtaining tax clearances or regulatory approval hence in such a case a conditions precedent would normally be inserted into the agreement.
This clause is normally very short however it protects the purchaser’s interests, namely that he is to receive good and proper title to the shares that he is buying.
The purchase price provisions should also address several auxiliary issues, including (i) how the price will be satisfied (ii) when the price must be paid and (iii) whether the price is a fixed sum, or subject to a price adjustment mechanism.
The completion mechanics can be difficult as the parties will need to agree upon timings, place of completion, the actions and what is to be delivered at completion. The latter normally include all of the post-completion formalities (i.e. stock transfer forms, share certificates, board approvals and the company’s statutory books).
This element is discussed in further detail in the following section however the seller’s warranties are normally set out in a separate schedule to the share purchase agreement.
This is frequently referred to as a tax covenant, tax indemnity or a tax deed however its purpose is always the same, it offers the purchaser protection for any tax liabilities that may not have been revealed by the due diligence.
In most transactions, confidential information will be disclosed by both parties therefore it is common practice that the share purchase agreement will include confidentiality provisions addressing these matters.
In English law the purchaser of shares is provided with little statutory or common law protection, concerning the nature and extent of the assets and liabilities it is purchasing and the principle of caveat emptor (buyer beware) applies.
To mitigate its risk, it is customary for the purchaser of a private company to receive some form of assurances from the seller, relating to the assets and liabilities of the company. It is generally considered that the major purpose of warranties in a normal share purchase agreement is to bring the attention of the sellers, the point which is likely to be of concern to the purchaser. The process of checking against the warranties is designed to bring out all of the potential problems; the parties will then begin to negotiate, before the sale, as to what impact these should make on the sale transaction. In this way, the possibility of disputes arising after completion is reduced.
Over the years there has been a steady expansion in the scope of the warranties that purchasers require and modern share purchase agreements tend to be very extensive, with a large part being in the nature of the warranties.
It should never be overlooked that the main purpose of the warranty is to impose legal liability upon the seller and to provide the purchaser with a remedy if statements made about the target company prove to be incorrect.
Please do not hesitate to contact a member of our team to discuss any matters relating to your business. We look forward to speaking to you.
Sources and further reading
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