Particulars regarding private acquisitions of companies
Key terms and explanations:
A share purchase agreement (“SPA”) is typically entered into by and between a buyer and seller(s) of a target company’s shares whereby the seller(s) agrees to sell a specific number of shares to the buyer for a specified price. The SPA serves to manifest mutual written agreement of the terms and conditions of the sale of some or all of the shares of a target company. In this article, assume a target company includes its subsidiaries. SPAs fall within the domain of mergers and acquisitions (“M&A”) and typically arise where an investor wholly or partially acquires a company. This article addresses the key terms associated with the private acquisition of a target company’s shares.
When a company acquires all, or a significant portion, of the shares of a target company that investor also acquires its liabilities. Consequently, an M&A transaction is typically accompanied by extensive due diligence (“DD”), not just to understand to what, if any, liabilities the acquirer will be exposed, but also clarify key information about the seller, such as its actual asset base (fixed assets, contracts, finances, human resources and customers, among others). DD is the fundamental audit or investigation of a target company conducted by a purchaser to compile and assess information that will directly impact the decision to make the acquisition. From a legal perspective, DD is typically conducted as to corporate records, general legal claims and litigation involving the target company, intellectual property (“IP”) and trade secrets, labour, anti-money laundering, anti-corruption, data privacy, environmental and other regulatory compliance that may be relevant to the specific industry of the target company. DD is also conducted in relation to the target company’s financials by accountants and auditors. In cross-border M&A, where the target has assets and operations in different countries, DD must be conducted in multiple jurisdictions and carefully co-ordinated to verify the target’s actual assets and liabilities in relation to the laws and customs of each location.
The consummation of an M&A transaction typically makes a successful DD investigation and the underlying provision of complete and accurate documents a critical condition of the closing of the acquisition. The completion of a robust DD investigation cannot be stressed enough in the case of most M&A transactions. Target companies typically have a heavy burden to provide an investor with all materials requested in this respect. Even a seemingly straightforward M&A involving a small company with limited assets and operations can be accompanied by significant hidden liabilities. In the past, data rooms were the norm and set-up at the premises of the target company or its lawyers, where all categories of requested documents would be deposited for inspection by the purchaser. Now, data rooms tend to be digital and law firms and other third parties provide in-house server-based or cloud-based platforms where all DD documents are uploaded by the seller and its advisers for collation and inspection by a purchaser and its professional advisers (typically lawyers and accountants) to the greatest extent possible. Access to such information is typically subject to strict non-disclosure requirements, therefore it should be clearly determined who will have access to such information to avoid a possible breach of those restrictions.
A key distinction should be made between a share purchase and an asset purchase. An asset transaction involves the purchase or sale of some or all of a company’s assets, such as equipment, inventory, real property, contracts or lease agreements. An asset purchase can be advantageous because it allows a purchaser to be selective about the assets it purchases. Moreover, an asset purchase allows a purchaser to acquire the property of a company without the liabilities that would accompany the assets in a share purchase. Extensive DD is still required in the case of an asset purchase, particularly with respect to ownership of, and liens on, those assets. Whether to conclude a share or an asset acquisition is dependent upon numerous considerations and the objectives of the acquirer.
Though not the focus of this article, mergers are also relevant in this context and generally consist of:
1. forward (or direct) mergers - the target merges into the purchaser, taking all the target’s assets, rights and liabilities (the target ceases to exist as a separate entity thereafter);
2. forward triangular (or indirect) mergers - the target merges into a subsidiary of the purchaser, which takes all the target’s assets, rights and liabilities (the target ceases to exist as a separate entity thereafter); and
3. reverse triangular mergers - the purchaser’s subsidiary merges into the target (the target survives and the purchaser’s subsidiary ceases to exist).
Prior to expending time to draft an SPA, the parties should negotiate and execute a term sheet, which addresses all the key and principal terms of the transaction, which can then be incorporated into an SPA. Term sheets should be formatted in simple rows and columns making key terms easy to enter and review with space for each of the counterparties to make entries and comments. Term sheets relieve the parties of separating key terms from the remaining language found in a contract allowing for greater clarity, comprehension and organisation. Once principal terms are agreed and drafted into an SPA, material changes to the terms of the SPA will be more onerous and time consuming to achieve than if revised at the term sheet stage.
A well negotiated and agreed term sheet:
- Helps counterparties to more clearly distil key issues before they are embedded in a lengthy legal document;
- Mitigates the possibility of later disputes;
- Typically is binding and contains non-disclosure, no-shop and other protective restrictions with respect to its terms and related negotiations; and
- Can mitigate legal fees because revising a term sheet is easier and faster than revising an agreement that has been drafted without a term sheet on the basis of multiple conference calls, meetings and emails from the client and counterparty’s lawyers, particularly once the terms have been already been incorporated into an SPA (this is an ill-advised approach).
Sometimes it is necessary to revise an SPA, even after a term sheet has been agreed, because the situations of the parties may require it. However, the investment in a well-crafted term sheet should not be considered optional and will almost certainly be less costly and time-consuming than revising an SPA because it was sloppily drafted on the basis of piecemeal input from the parties.
This article addresses common terms and variations of an SPA but is in no way exhaustive. Specific transactions, and companies in different industries, will require different terms and will often be subject to extensive negotiations between the parties. This article does not consider the laws of any specific jurisdiction nor does it address anti-trust or anti-competition considerations that may be relevant in certain M&A transactions. Additionally, SPAs may also be controlled or affected by existing shareholders’ agreements between the shareholders of a target company.