A stock purchase agreement is the main transaction document for a stock acquisition. It governs the transfer of title and sale of shares of a corporation’s stock to the purchaser. The document sets forth the critical details of the transaction, such as the number of shares purchased, the purchase price and how the purchase price will be paid. While each deal has its unique set of facts and issues, almost all stock purchase agreements share some key provisions dealing with structure and allocation of risks in respect of the purchase and sale between the parties. Not surprisingly, it will be difficult to cover all the issues you will encounter when negotiating a purchase agreement in one article. The issues presented here are simplified in order to illuminate the essential elements of these issues. Obviously, there are important nuances and exceptions to any general rule, and consequently, this article should only be used as a general guide to navigating the issues explored here. Consult an experienced attorney to obtain specific advice concerning the transaction in which you are involved. Below we outline and offer negotiating tips on ten common sections found in purchase agreements.
Purchase and Sale
In this section the seller agrees to sell, and the buyer agrees to purchase shares of the company’s stock. The agreement will require the seller to deliver good title to the stock (often a share certificate evidencing ownership of the company’s stock, along with stock powers) and deliver it free of any third party claims (as a related matter, buyer will also request an explicit representation to this effect in the representations and warranties section). This section also states the purchase price for the stock, how and when the purchase price will be paid (wire transfer in immediately available funds is the standard). If there are multiple sellers then this section will also outline how the purchase price will be split among them. Consideration for the shares often takes the shape of cash, stock or some combination of the two. Seller should be aware that the decision to accept consideration in either cash or stock will have different tax implications in terms of how the purchase price will be treated. Consult a tax attorney for advice on the tax implications of your transaction.
Purchase Price adjustment
In acquisitions where the purchaser is buying the majority of the stock of the target company, the financial information of the target company is usually not ready until 30-90 days after the closing date. To mitigate the risk of negative information about the target company emerging after the closing date, the buyer will attempt to negotiate a provision that allows her to holdback a certain amount of the purchase price (the “holdback amount”) to adjust the purchase price downwards. Purchase price adjustments are most often tied to a working capital adjustment or incurrence of increased debt. For example, if the target company has outstanding credit facilities and borrows under those facilities during the negotiating period of the transaction the additional debt can affect the value of the company and that should therefore be reflected in the purchase price. Other adjustments are based on the profit and loss statements of the target company, valuation of specific assets or the target company’s equity to debt ratio.
Earn-outs stipulate additional consideration, other than the closing day purchase price paid to the seller, that buyer must pay if the target company meets certain performance targets in the future. If there is an earnout, the buyer pays part of the purchase price at closing and the rest is paid in one or more stages if the target company achieves certain earnings or operational targets.
Escrow is used to withhold that portion of the purchase price that will be used for purchase price adjustment or indemnification obligations. The key negotiating point here will be how seller receives the escrow amount: will it be paid in a lump sum or in multiple tranches at different stages. The escrow account is normally governed by a separate escrow agreement negotiated contemporaneously with the share purchase agreement.
Representations and Warranties
The representations and warranties are a heavily negotiated section in any share purchase agreement. While many of these are deemed as standard, the representations and warranties can cover a wide range of issues. International deals will sometimes include FCPA and OFAC representations and you may sometimes see employment issues covering ERISA matters. In most cases it is the seller’s representations to buyer that are the most important and often comprise the majority of representations and warranties provided in the agreement. Seller’s main concern is certainty of closing, and as a such, Seller will want to ensure that the buyer has the required financing to pay the purchase price and that the closing is not contingent upon the payment by buyer of any unknown fees to third parties. Standard seller representations will include representations that the seller: owns the shares without any encumbrances, is authorized to complete the transaction (i.e., transfer the shares), has (or will by closing) taken care of any regulatory or third party consents, and has provided buyer all the material information it has access to about the company and its shares.
The representations and warranties negotiations are an exercise in risk allocation and will, in most cases, serve as the basis for indemnification claims in the case of a breach. As a result, the following limitations on representations and warranties are heavily negotiated:
materiality, buyer will sometimes want a blanket representation stating that neither seller nor the target company is a party to any litigation but seller will want this limited to “any material litigation” or any litigation that may have a “material adverse effect” on the transactions contemplated by the agreement;
knowledge, a knowledge qualifier is often added to limit the scope of certain representations, e.g., “to the knowledge of seller there is no material legal action pending against the company.” The parties will also negotiate whose knowledge matters for the purposes of the representations, and this usually comes down to certain key employees of the target company; and
survival period, one of the key issues when negotiating the representations and warranties will be how long they survive after the closing of the transaction. Survival periods tend to range anywhere from six months to eighteen months. The seller would want the survival period to be as short as possible since that mitigates its exposure on the representations and warranties provided, and the buyer would want them to survive as long as possible. Certain core representations and warranties such as title to shares, due organization and existence of the entity selling the shares, and due authority to sell the shares, are typically evergreen and will have no survival limitation but others such as tax, employee benefit matters and environmental matters will fall within the previously given range. (Note, however, that applicable statutes of limitations on contracts under the laws of the jurisdiction governing the agreement may extinguish the ability of either party to launch a judicial proceeding after a certain amount of time in respect of anything in the agreement, including evergreen representations and warranties). The market range for these representations and warranties tend to be between 12 and 18 months (seller pushes for 12, buyer pushes for 18).
Perhaps the most heavily negotiated definition in any purchase agreement will be the definition of “material adverse effect” or “material adverse change”, also referred to as “MAE” or “MAC” clauses. MAE clauses offer the buyer an “out” in the event that the business, operations or prospects of the target company is adversely affected in a material way before the transaction closes. The seller will want the application of the MAE clause to be as narrow as possible. In general, buyer proposes a broad MAE clause that allows her to exit the deal if the target company’s results of operations deteriorate before closing. Seller will attempt to qualify this to say the exit is only available if the cause of the deterioration uniquely affects the seller and not the whole industry, or that the poor results are not unusual when viewed in the context of historical results of the seller or its competitors in the industry.
If the signing and closing of the deal are not on the same day, each party will require the fulfillment of certain conditions for closing to occur. Common closing conditions include obtaining necessary government approvals (for example, early termination of the waiting period under the Hart Scott Rodino anti-trust act), obtaining stockholder approvals, and no material adverse change in the company. In connection with the closing conditions buyer will generally negotiate to include a “bring down” of the seller’s representations and warranties. The bring down is usually included when signing and closing do not occur on the same day, thus leaving a possibility that all the representations and warranties will not be accurate through the closing date. With a “bring down”, the buyer does not have to close if the representations are not true on the closing day or if they were not true on the signing date. Seller typically negotiates to have this limited by materiality or material adverse change. The “bring down” is a mechanism that mostly benefits the buyer but it also benefits the seller since the buyer’s financing representations and warranties would be brought down at closing as well.
Covenants normally take the form of pre-closing and post-closing covenants. Common pre-closing covenants include the seller operating the business as usual until closing (the standard language is “in the ordinary course, consistent with past practice”), not entering into any material contracts (sometimes a dollar value threshold is used to specifically determine materiality here), not incurring any indebtedness, not issuing shares, not declaring or paying any dividends, not disposing of any assets or making any acquisitions, and not making any capital expenditures beyond a certain amount. Post-closing covenants govern the behavior of the parties after the deal is done, and depending on the industry, the seller agreeing not to compete with the target company for a certain period of time and not soliciting any employees of the target company. Seller will typically require the buyer to maintain director and officer indemnification insurance to outgoing directors and officers of the target company, on a basis no worse than what they had prior to the acquisition.
Termination and Break-up Fees
Termination provisions allow the parties to walk away from the deal under certain circumstances. Some common reasons for termination include failure to obtain regulatory approvals, breaching a no-shop clause, failure of one party to satisfy closing conditions or, in some cases, if the seller has a fiduciary duty to accept a better offer from another buyer. Associated with the termination provision is what is referred to as a “break-up fee,” used to compensate the party who is not in breach if the deal is terminated. The break-up fee is typically a percentage of the deal value. While there is no bright-line rule the market standard is generally somewhere between 3% and 4% of the deal value.
Indemnification is a post-closing remedy that covers a non-breaching party in the event of a breach by another party of a covenant or representation made in the purchase agreement or other deal documents. The agreement will normally include procedures for notifying a party of an indemnification claim and other requirements associated with indemnification such as any requirements to cooperate in settling a third party claim. Indemnification claims are limited to a cap (the maximum amount a party can recover on any indemnification claim and a basket or deductible (the indemnifying party does not have to pay for a party’s losses until they exceed a certain amount, at which point the indemnifying party is liable for all losses). This is sometimes referred to as a “tipping” or “dollar one” basket. Certain breaches will have no limitation in terms of a cap on recovery. These include: (i) legal authority to complete the transaction; (ii) title to shares; (iii) capitalization of the target company; and (iv) certain matters that are set out in disclosure schedules.
Like most legal agreements, the stock purchase agreement will include its share of boilerplate clauses. While these provisions are standard they can sometimes have significant impact on deals. For example, if the stock purchase agreement is not assignable, the seller may run into administrative problems if it wants to move the target company under control of another subsidiary before the closing. Common boilerplate clauses include choice of law, dispute resolution, whether the agreement has any third party beneficiaries, allocation of expenses, etc.
As stated at the outset, the foregoing is a summary of key provisions and negotiating points associated with share purchase agreements. When negotiating your agreements it is best to do so with the assistance of legal counsel who can apply these general principles to your specific set of facts. We hope this article provides a solid foundation for understanding some key issues associated with stock purchase agreements.
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 References herein to the “company’s stock” mean the shares of the company’s common stock. A stock purchase that will effect a change of control will likely include the redemption or purchase of any other existing equity in the capital structure, such as shares of preferred stock.