Share purchase agreement

The purchase of shares constitutes the purchase of a company’s operating business. None of the existing contracts with the company change. If a shareholder sells his shares in a company, then he achieves a complete break in the relationship between him and the target business. The buyer however, will insist upon some contractual promises about the company (warranties) which will continue to bind the shareholder after the sale.

A typical share purchase agreement will deal with the following matters:

Selling the shares

Once the shares in the target business have been transferred, ownership will pass to the buyer. It is likely that the buyer will want to appoint new directors, auditors, etc. The buyer may also want to remove the current officers.

Warranties

Warranties are contractual statements made by the seller on completion relating to the target business. They have two purposes:

• To "flush out" any information which the buyer ought to know and which could affect the value of the company, or even the buyer’s decision to buy the business.
• To give the buyer some comfort in the event that the business is not as the seller represented to him, eg the company may have some hidden problem or litigation.

While warranties are beneficial, the party giving them must be able to stand by them. When a buyer purchases shares, any warranties given by the seller are given by them personally.

Restrictive covenants

Restrictive covenants prevent the seller from competing with the buyer for a limited time once the sale is finalised. They may include:

• A non-competition clause that prevents the seller from setting up a business in competition with the buyer.
• A non-solicitation clause that prohibits the seller from soliciting the buyer’s’ customers or suppliers.

On their face, restrictive covenants are particularly important for the buying party, as immediate competition by the seller could harm the new business or significantly impair it. The covenant in question must be no more than adequate to protect the business interest, the reasonableness of the duration or scope of any restraint being tied to the nature of the interest in question.

No third party involvement

The buyer will step into the seller’s shoes as shareholder or director, however, the company’s employee’s, contracts, properties, etc will remain in the company’s ownership. There is therefore, no need for the assets of the company to be transferred, thus a share sale can often be completed without any third party involvement. A share purchase therefore, is often a lot more discreet than an asset purchase.

No liability for debts

At completion, the seller of shares will have no liability for the debts of the business, which become the responsibility of the new owners. This is because a company has a separate legal personality from its directors and shareholders. By comparison, if there is an asset sale, then, with a few exceptions (eg employees), the seller will keep all the current liabilities of the business, unless he can negotiate with the buyer to take them over with the business.

Inheriting outstanding problems

The buyer will inherit the seller’s company, which means they will also inherit any problems (such as outstanding tax bills) that exist at the date of the sale.

Risk

Because the buyer inherits a company, the share purchase generally involves far greater risk than an asset purchase. This justifies the inclusion of warranties, which are necessary to protect the buyer.