Selling a business – share sales

Heads of Agreement

It is usually good practice for parties to begin any transaction by recording the principal terms of their deal. The document is usually called the ‘heads of agreement’ and will often include details such as the purchase price or means of calculating it, the terms of payment, the basic terms of any consultancy or service agreements, details of any security for payment and the terms of any post completion restraint of trade on the seller.

The heads of agreement is not usually legally enforceable except for a few specific terms. Nevertheless, any party wanting to depart from them will find it difficult to do so without good reason.

Principal Documents

The basic components of most share sale transactions is the share purchase agreement, a tax covenant (or ‘tax deed’) and a disclosure letter.

Due Diligence

A prudent buyer should always conduct a detailed investigation of the company they propose to buy. This is the due diligence and is often in two parts – the commercial due diligence which looks at the target’s finances and is undertaken by accountants, and the legal due diligence which looks at the company’s legal compliance and at potential legal and commercial issues.

If the due diligence uncovers significant problems, the buyer has the opportunity to withdraw from the transaction and avoid making a bad investment, or instead seek to re-negotiate the terms of the sale, such as a reduction or restructuring of the price or indemnity protection for possible future liabilities.

Share Sale Agreement and the Disclosure Letter

The sale and purchase agreement (or ‘SPA’) is the main document in any sale and purchase transaction and usually the one which is the most heavily negotiated.

The share sale agreement will normally have two key parts – the so called ‘front end’ which sets out the legal framework for the purchase, and the schedules which will contain a number of things including the all important warranties.

The front end agreement will include details of the purchase price, which can include complex rules for calculating payments based on completion accounts or based on the company’s future performance or both. These can be coupled with ‘overage’ or ‘non-embarrassment’ clauses entitling the seller to further purchase monies if the company is sold on for a profit within a period of time following completion.

The warranties are very important and should be carefully reviewed. The warranties are statements about the target company which the buyer will rely upon in deciding to purchase the company at the agreed price. If a buyer subsequently discovers that a warranty is untrue or inaccurate, they will have (subject to certain limitations) the right to claim damages for breach of warranty.

The warranties are usually subject to the matters ‘disclosed’ by the sellers. The disclosures usually comprise a ‘disclosure letter’ and the documents submitted by the seller to the buyer during the due diligence process (referred to as the ‘disclosure bundle’).

Tax covenant

The tax covenant is sometimes a separate document but more often is included as a schedule in the sale and purchase agreement. The general idea of the tax covenant is that the seller should be responsible for any unexpected tax liabilities of the target company which relate to the period up to the completion date. Under the tax covenant the buyer has the right to recover any such tax on a £1 for £1 basis.

Ancillaries

In addition to the principal documents, a share sale will often include the execution of other ‘ancillary’ documents.

Security – Any seller who has agreed to accept payment over a period of time, often over a number of years, will often demand security for payment such as guarantees and legal charges.

Compromise agreement and resignation letter – If a seller is also an employee of the company, they may have employment related rights. The buyer will expect the seller/employee to waive all accrued employment rights and the way to ensure this is for the seller to sign an employment ‘settlement agreement’. In addition, the seller may also be a statutory director and may need to resign their position using a suitably worded resignation letter.

Service or consultancy agreement – A buyer will sometimes want the seller to stay on with the company for a period of time following completion. Typically this is to ensure a smooth hand over of the business including the making of introductions between the buyer and the company’s customers and suppliers. Such arrangements should be documented in either a service agreement or a consultancy agreement.

Exchange and Completion

Exchange is the point where the parties enter a binding contract to buy and sell the shares in the company. Completion will often take place straight away when the shares will be transferred and other documents are entered into. Occasionally a time gap will exist between exchange of contracts and completion. This can sometimes add complication to the sale agreement and is best avoided if possible. It can however be necessary. Reasons can be varied including regulatory considerations.

Post-Completion

The SPA will detail any further steps that need to be taken by the parties such as the preparation of completion accounts. Invariably a buyer will need to deal with certain housekeeping matters such as the filing of company forms, the payment of stamp duty on the stock transfer forms, and the updating of the company’s statutory books.