Essentials of a Stock Purchase Agreement
Stock Purchase Agreements are a form of purchase agreements used when an investor buys equity in a business, rather than purchasing assets or shares of a business. By entering into a Stock Purchase Agreement, the investor is buying a percentage of the value of the Company. The Company agrees to issue shares to the investor, and the investor agrees to pay the Company the purchase price in exchange.
A Stock Purchase Agreement will explain the capitalization of the Company, the purchase price for the stock and the method by which the buyer will pay it. In many cases, escrow is used so that the Company does not get the money until after the buyer has received the shares. This is a very common use of a Stock Purchase Agreement, because it protects both parties; the investor does not have to pay until they receive the certificate, and the Company does not have to make the shares out until they know they are going to be paid . However, this could slow down the process, as escrows can take time to set up.
The Stock Purchase Agreement will also spell out the closing date and other details about what will happen in the future. For example, if you are entering into a large deal where you are purchasing a controlling interest in the company (51% or more), you may require that there be additional procedures followed for selling of stock in the future, such as having a right of first refusal agreement signed beforehand. If the Company gets sold, the investor may want a right of first refusal in the event that they want to sell their shares.
As with all purchase agreements, you should have a lawyer look over the Stock Purchase Agreement because it may cover subjects that are not familiar to you and it can be very easy to misinterpret clauses.
Components of a Stock Purchase Agreement
Covering the fundamental key components that a stock purchase agreement must have will make sure that both the seller and buyer have certainty as to exactly what it is that they are contracting to do. Again, you do not want to have any ambiguity as to what you are requiring from the counterparty or what you are required to perform. As mentioned in the preceding paragraph, a good stock purchase agreement will outline exactly what it is that is being purchased, the purchase price for the stock, representations and warranties of both the parties, governing law, default provisions, and closing conditions.
The stock purchase agreement will contain the precise identification of the stock being bought so as to avoid any dispute later as to what was being purchased pursuant to the agreement. On the purchase price, the stock purchase agreement will address the exact price that was paid for the stock, any shares incentives provided to the buyer, any debt securities or convertible securities to be assumed by the buyer, any additional payments to be made to the seller post-closing, and whether there will be any escrow arrangements.
Representations and warranties usually included in a stock purchase agreement include: (a) the name of the target company; (b) its business, assets and liabilities; (c) its shareholders; (d) any assets not in the target company’s name; (e) any liens on its property or other restrictions; (f) the target company’s organizational structure and tax status; (g) the target company’s compliance with law; (h) the validity of any security interest in the target company’s assets; (i) the target company’s agreements and any liabilities to third parties; (j) the target company’s financial condition and prior financial statements; (k) the target company’s disclosure and warranty obligations; and (l) the target company’s employee benefit plans and employees.
Default provisions refer to what will happen to the parties should a failure to perform occur. The default provisions in a stock purchase agreement frequently require one of the parties to initiate an action in equity for a decree of specific performance. Closing conditions constitute any conditions that must be satisfied by the seller or buyer prior to the closing. The closing conditions in a stock purchase agreement usually include the buyer obtaining all necessary approvals to close the transaction.
Legal Implications and Considerations Under a Stock Purchase Agreement
The legal implications of entering into a stock purchase agreement can be substantial. Buyers must perform appropriate due diligence prior to closing the transaction and in many cases those obligations will continue for a certain period of time after closing. A buyer can assume onerous contingent liabilities of the target, often without much recourse to the seller for indemnification. Sellers may be required to make representations and warranties covering a wide range of topics, and can be left on the hook long after the sale closes for all manner of unknown liabilities, including employee benefit plan obligations and environmental problems. If the stock purchase transaction is in any way regulated, the parties will have to consider compliance with all of applicable federal and state securities laws and, in most cases, the Hart-Scott-Rodino Antitrust Improvement Act of 1976.
An inadequate stock purchase agreement can create significant legal risks, such as:
Minimizing some risk can be achieved through indemnity provisions of the stock purchase agreement, sometimes a real bargain for the benefit of a financially motivated seller. In addition, a buyer typically would want to reserve the right to perform its own review of the target’s financial condition, and it may well be entitled to demand access to the target’s finances, including bank, accounting and tax records.
Stock Purchase Agreement and Its Distinction with an Asset Purchase Agreement
While both a stock purchase agreement and an asset purchase agreement are commonly used when purchasing a business from someone else, each has benefits and drawbacks that should be carefully considered. The following defines each type of agreement, discusses the differences between the two, and gives a brief overview of each, including when it may be appropriate to use one over the other.
A stock purchase agreement is a contract that is signed when a corporation is sold. It lays out the terms of the sale of the corporation itself. Through a stock purchase agreement, a buyer buys stock in a corporation from the seller. As a result, the buyer takes ownership of the entire corporation. This includes its assets, liabilities, and employees (although contracts may need to be amended with all employees after the purchase), though the buyer may avoid certain liabilities by making the corporation insolvent. Layoffs, sales of assets, or mergers are often necessary to make sure that liabilities are reduced enough to eliminate the debts of the corporation after purchase by the new owners. Stock purchase agreements need to be registered in the same place as the corporation to ensure that the land records don’t need to updated. If all parties are present and the amount of consideration and duty is paid, no other writing is required.
An asset purchase agreement is a contract to buy and sell the assets of a business. Between the date that the company goes up for sale and the date when the transaction is final, the business continues to operate. The stockholders do not directly own the assets. However, some of the seller’s liabilities may be attached to the assets. Those liabilities will not pass through to the buyer unless it is a successor corporation. The corporation may owe the buyer money after the sale closes. An asset purchase agreement describes the legal and accounting details of the sale of the assets. If there is a mortgage on the business property, the mortgage must be paid to the mortgagee. Then, the buyer can decide if it wants to keep the property held in the company’s name or if it would like the property transferred to the buyer. If the property is leased, it may stay in the name of the seller and be leased to the buyer. If the buyer does not want to keep the business in the name of the seller, the buyer may wish to form a corporation using funds from the sale of the business, and the assets may be transferred to the new corporation. However, if there are assets owned at the time of the sale, they could be forfeited because they are not included in the asset purchase agreement.
Negotiating Your Stock Purchase Agreement
When negotiating the terms of a stock purchase agreement, it is essential to engage in a collaborative process with the other party to arrive at a mutually beneficial outcome. Buyers and sellers have different perspectives and objectives, and those differences can be bridged by focusing on the bigger picture and the overall business impact of the decisions made. Parties should identify their respective concerns and then prioritize the most critical issues. By ranking the importance of issues from most to least critical, a party can determine which terms are worth a compromise and which are non-starters.
Effective negotiation of a stock purchase agreement often involves using creativity to generate solutions that achieve both parties’ interests or reduce conflict by substituting an objective measure , like the earnings of the target corporation post-closing, for subjective measures that could lead to a dispute down the road.
It can also be helpful to use neutral language that eliminates emotionally loaded words that can lead to misunderstanding or unnecessary conflict.
Most importantly, be willing to walk away if the other party is not willing to accept terms that preserve key protections or achieve the desired objectives. Allowing the other party to walk away can also be an effective tactic that shows that you are not afraid to pursue other options, and gives you leverage to reopen negotiations and pressure the other party to be more amenable to its initial offer.
Common Pitfalls in Stock Purchase Agreements
One of the most common errors made in stock purchase agreements is failing to include and define the various parties to the transaction. For companies who normally engage in these types of transactions, IP attorneys should already have the necessary language in their form agreements. However, when a company tries to structure its first stock purchase agreement, they may not consider if necessary words should be included to define all parties to the transaction. Inserting parties can be a real trap for parties that are dabbling with stock purchase agreements for the first time.
Another common error is not providing for how the stock will be issued. A well-written stock purchase agreement should specify whether the company has already registered the stock, or has filed an exemption, whether the company will issue "subscription rights" to the purchaser, or whether any exempt securities laws apply. The proper language can provide the purchaser with valuable protections and help avoid problems down the road.
Another common mistake I see is failing to properly handle the payment provisions. Specifically, how does the company want payments handled? Will payment be made in one large installment? Will payment be given in installments based on sales, per share, quarterly, annually, or some other periodic basis?
Also, many times, a company will forget to properly allocate expenses between the company and the purchaser such as a sale tax or state fees.
Whatever the case, as with any contract, it pays to read the stock purchase agreement a few times before signing to ensure that the terms are clear and consistent.
Closing and Executing the Stock Purchase Agreement
After negotiation and any necessary amendments, the stock purchase agreement must be finalized. Often, the U.S. attorney general and in some cases state attorneys general must approve such purchases. Once that hurdle is cleared, the purchase agreement can be executed by the purchasers and the sellers.
Early in the transaction, a term sheet will have been signed that outlines the principal terms and conditions of the transaction and lists the conditions precedent applicable to closing the transaction. If all matters are agreed to by the parties with the exception of certain financial, business or accounting details, the parties may enter into a letter of intent or agreement in principle that specifies that certain of the definitive agreements are to be finalized by a specified date.
At this stage in the process , the seller may be required by the purchaser to provide a statement as to its working capital, audited financial statements for its most recent fiscal year and the most recent interim period, initial and interim corporate actions, regulatory approvals, capital stock, ownership of subsidiaries, organizational charts, minute books and other records, material real and personal property and capital commitments, operating capital requirements, receivables and payables, pending litigation and non-competition agreements with respect to key employees and shareholders.
The purchaser may require a "public version" and a "confidential version" of the disclosure schedule, usually attached as a schedule to the agreement. The former may be traded and the latter may be delivered to advisers, accountants, other professionals and confidentiality committee members.