This note provides a basic overview of the process of the sale and purchase of the shares in a company from the shareholder(s). Unlike an asset purchase where the buyer can cherry pick and buy only certain assets of the business from the company, a share sale involves the buyer purchasing all of the business from the seller. The key point to understand for any buyer is that upon acquiring the shares of the company he takes the company “warts and all”. The buyer takes not just all the assets but also any liabilities and obligations of the company both known and unknown.

The buyer’s two key methods of protection and limiting risk comes in the form of:-

• a due diligence investigation into the state of the company; and
• warranties and indemnities.

The seller on the other hand will also seek to limit his exposure to risk in two key ways:-

• a thorough disclosure to the buyer of the company information and to qualify or seek to limit and indemnity and warranties; and
• carefully drafted limitation of liability provisions in the share purchase agreement.

1. Heads of Terms

The parties to a sale and purchase will usually agree the key terms of the deal in a “Heads of Terms” document. The document will not only set out the key agreed terms and structure of the deal but will also frequently contain:-

• confidentiality provisions: to protect misuse of any commercially sensitive information of the business.
• lock out (or exclusivity) provisions: which may seek to restrict the seller from approaching or dealing with other potential buyers for a period of time.

2. Due Diligence

Once the parties have agreed the key terms of the deal the buyer will usually instruct his professional advisers to carry out a “due diligence” exercise. This is an information gathering process carried out by the buyer and his advisers to find out as much as possible about the company early on in the negotiations. Through this process the buyer aims to gain a full picture of the company and its success factors, strengths, weaknesses and is also an essential preliminary to contractual protection (in the form of warranties and indemnities). This can help the buyer identify the level and areas of protection needed and any risks that the buyer should try to avoid or mitigate.

This process usually involves the buyer’s advisers requesting information by way of replies to the Due Diligence Questionnaire which sets out standard enquiries about the company ranging from the seller’s legal status to looking at the financial and commercial aspects of the company. It is for the seller and his advisers to provide a reply and supply the information requested to the buyer and his advisers to assess. In small acquisitions this process can be carried out by emails or hard copy documents in the post. On larger deals it will be necessary to set up an online data room where documents can be viewed.

3. Share Purchase Agreement (SPA)

The SPA is the key document in the acquisition process and is traditionally prepared by the buyer’s lawyers in the first instance. It is the contractual agreement between the seller and the buyer relating to the purchase of the seller’s shares for a specified price and sets out the other terms governing the acquisition. One of the most important elements of the SPA are the warranties and indemnities.

Warranties: these are contractual statements made by the seller about the condition of the company. They are usually contained in a schedule at the back of the SPA and may run to many pages. A typical warranty would include things like confirmation that the company is not being sued by a third party. Warranties serve two main purposes:

• to provide the buyer with a remedy (a claim for breach of warranty) if the statements made about the company later prove to be incorrect and the value of the company is reduced. Warranties therefore, at least on paper, provide a form of retrospective price adjustment;
• and to encourage the seller to disclose known problems to the buyer. Because the seller’s liability under the warranties is invariably limited to the extent that proper disclosure is made against them, the effect of the warranties should be to flush out potential problems.A breach of warranty will only give rise to a successful claim in damages if the buyer can show that the warranty was breached and that the effect of the breach is to reduce the value of the company or business acquired. The onus is therefore on the buyer to show breach and quantifiable loss.

Indemnities: this is a promise to reimburse the buyer in respect of a particular type of liability, should it arise. The purpose of an indemnity in an acquisition context is to move the risk of a particular event or matter to the indemnifying party and to allow the indemnified party to recover on a pound-for-pound basis in respect of that matter or event. Indemnities are often used where a warranty may not allow a buyer to recover. For example, because it had knowledge of the matter before signing the acquisition agreement or because a damages claim may not be available.

Another key element of the SPA for a properly advised seller will be the seller protection provisions. These provisions seek to limit the seller’s risk by, amongst other things, capping the amount the buyer can claim against the seller and limiting the time period to make any claim.

4. The Disclosure Letter

The Disclosure Letter is document in the form of a letter from the seller to the buyer and usually consists of two sections:

• General disclosures: which cover matters such as the documents that have been given to the buyer (often these will form what is called the “disclosure bundle”) and publicly available information such as that held at Companies House, the Land Registry or the Intellectual Property Office.
• Specific disclosures: which take the form of qualifications to the warranties. For example, where a warranty states that the company is not being sued, the disclosure letter may qualify this statement with a disclosure stating that the company is being sued for non-payment of a debt. This disclosure then enables the parties to agree how to deal with this risk.

For the seller, each disclosure stated in a disclosure letter reduces the buyer’s rights under the warranties, but at the same time it effectively increase the buyer’s risk. Therefore, if the buyer accepts the disclosure then the seller is no longer liable in relation to those disputes. For this reason, the buyer may not accept all disclosures which the seller would like to make in the disclosure letter.

5. Tax

Tax is a key part of any share purchase and is often the main driver in the structure of the deal. Both the buyer and seller should ensure they appoint tax advisers at an early stage as this may affect the direction and documentation of any deal and avoid wasted costs at a later date.

As mentioned above the buyer will buy the company warts and all, this will include any tax liabities, so any buyer will need to ensure that he has appropriate protection against potential tax risks. This protection comes in the form of both tax warranties, but also a tax covenant.

The tax covenant can be included in the share purchase agreement itself as a schedule at the back of the document, or it can take the form of a separate document which is executed as a deed.

The main practical differences between a deed and a simple contract are the execution formalities and different limitation periods to make a claim (six years in the case of a simple contract and 12 years for a deed).

Tax indemnities are commonly drafted in the form of a covenant by the seller to pay the buyer an amount equal to the tax liability that has arisen in the target. Strictly, the buyer cannot be indemnified for a loss suffered by another (that is, the target) and neither does it follow that the loss suffered by the buyer equates to the tax liability arising in the target.

6. Ancillaries and Completion

Completion is when the parties sign the documentation and the shares in the company actually change hands. In addition to the SPA, Disclosure Letter and The Tax Deed the parties will need to deal with:-

• the stock transfer form
• share certificates
• board minutes
• resignation letters of directors
• persons of significant control notifications

7. Post Completion

Following completion the buyer will need to attend to various post completion formalities including:-

• Paying stamp duty of 0.5% of the consideration paid for the shares within 30 days
• Issuing new share certificates
• Making various notification to Companies House
• Updating the company books.

For more information please contact James Oxley Partner, Corporate & Commercial on james.oxley@haroldbenjamin.com