Buying or Selling Shares of a Company.

The first stage that the parties will go through involves the negotiation of the basic terms of the deal. Sometimes the parties will negotiate direct with each other; sometimes they will go through an agent or broker.

Once the parties have come to a basic agreement, they sometimes wish to set this out in writing by using “Heads of Agreement”.

Heads of Agreement is the document which sets out the basic but fundamental terms that the parties have agreed. It will detail the shares being purchased, how much is being paid for them and any other important terms that are known at this stage, such as whether there will be deferred payments of the price, whether the seller might continue to work in the company as a consultant or employee, whether the price is dependent on the asset value or performance of the company, whether the final price is to be linked to an “Earn out” mechanism.

The Heads of Agreement are usually stated not to be legally binding, with the exception of clauses relating to confidentiality and any “lock-out” provisions. Lock-out provisions are usually intended to stop the seller negotiating with any other prospective buyers for a fixed period, and to allow the buyer to carry out all the necessary investigations into the business.

The advantage of Heads of Agreement is that they help to clarify exactly what the parties understand the basis of the deal to be. Potential “deal breakers” can be identified and dealt with before significant legal fees are incurred.

It is therefore important that the Heads of Agreement are properly prepared. Lanyon Bowdler Corporate Team have a wealth of experience in negotiating and drafting Heads of Agreement for all types of deals.

Once the Heads of Terms have been agreed, the next stage is for the seller to obtain a non-disclosure agreement or confidentiality undertaking from the buyer. Once that has been obtained the next stage is Due Diligence. Sometimes if the seller and buyer want to discuss matters, but do not know what the terms of the deal should be, they enter into a Non-Disclosure Agreement and then Heads of Terms.

Due diligence is the name given to the process by which the buyer of a company discovers all the information he would like to know about the company he is buying.

Very often a buyer will have done his basic due diligence and obtained various copies of accounts, contracts, marketing materials and other documents before instructing his lawyers. However, one of the first things that the buyer’s lawyers will do is to prepare a detailed list of questions about the accounts, assets, affairs, financial and tax position of the company. This questionnaire is forwarded to the seller’s lawyers, who will often answer the more technical questions themselves, but the majority of the questions would be answered by the seller, usually with the assistance of his or the company’s accountant.

Very often, a buyer’s due diligence questionnaire will contain questions that the seller might think, on the face of it, to be irrelevant. However, the buyers and sellers need to remember that a lawyer is looking for detailed technical points that a layperson cannot be expected to appreciate might have a significant effect on the company, its assets or business.

The due diligence process is a constantly evolving one, and does not end with the sending of the first questionnaire and the receipt of the answers to it. Very often, the due diligence answers will raise more questions of their own. The answers themselves will usually be accompanied by large volumes of documents.

It is very important that the parties and their lawyers keep a careful record of the due diligence answers and documents received, as they will usually be referred to in the Disclosure Letter (see below).

The due diligence process referred to here is that carried out by the buyer into the affairs of the company. It is the experience of Lanyon Bowdler’s Corporate Team that many sellers underestimate the amount of management time that dealing with the buyer’s due diligence takes. This can be an unwanted distraction from actually managing the business and may involve the sellers having to request and chase documents and information from third parties. It is our advice that sellers do their best to get as much information and documentation (such as material contracts) in order at an early stage and prior to actually putting the company up for sale.

The buyer’s lawyer will usually prepare the first draft of the SPA. This will be forwarded to the seller’s lawyers as quickly as possible for review. It is extremely unlikely that the first draft will be the final draft. Indeed, it is entirely normal for a SPA to go through several drafts before a final version is agreed. The reason for this is that the first version of the draft SPA often raises new issues even where the parties have entered into Heads of Terms. The parties will wish to put in detailed provisions regarding how and when the price is to be paid, the warranties the seller is to give (see below), how the sellers liability is to be limited (see below) and possibly non-competition provisions preventing the seller from competing in the future with the company he is selling.

It is not unusual for the SPA to take several weeks of negotiation from first to final and agreed draft.

The warranties are a detailed list of statements by the seller regarding the state of the company and its affairs and are usually drafted in generally unqualified terms. They will include warranties relating to the seller’s legal ownership of the shares and his right to sell them, the accounting and tax affairs of the company, employment terms of the company’s employees, that there are no disputes or litigation involving the company, no problems with the company’s trading, details of all land and property owned or used by the company, and the accuracy of details of intellectual property (such as copyrights, computer software, trademarks etc) used by the company, etc.

The warranties form the basis upon which the buyer has recourse against the seller if anything goes wrong in the future. The buyer will therefore want the warranties to be as comprehensive and detailed as possible. The seller will wish to give as few warranty promises as he can. This means that the first draft of the SPA will contain very strong and lengthy warranties. The seller can seek to reduce his exposure in several ways.

• Amend the warranty to something that is more acceptable.
• Delete any warranties that are irrelevant to the business and affairs of the company.
• Limit the scope of the warranty by a disclosure (see below).

The negotiating of the final form of the warranties is perhaps the most lengthy part of the negotiation process.

Although there are some standard warranties, the precise form and details of the warranties will depend largely on the result of the Due Diligence process. As the Due Diligence process is likely to be ongoing while the contract negotiating process is running, it is likely that a buyer would seek to introduce completely new Warranties at any time during the negotiating process, as information becomes available. In addition to warranties, a buyer might seek indemnities in respect of specific matters. An indemnity is stronger than a warranty, in that a warranty is a general statement by the seller that there is no particular problem, so it is therefore up to the buyer to find a problem. An indemnity is used where the buyer has actually identified a specific or likely problem, and is seeking a promise from the seller to make good any loss arising out of that particular problem on a £ for £ basis.

Alongside the SPA, there is a further document called a Disclosure Letter, which seeks to limit the scope of the warranties.

The disclosure letter is a document signed by the seller in which the seller sets out matters of which he is aware that are at odds with the warranties and thereby seeks to qualify the Warranty. For example, if there is a warranty that the company is involved in no litigation but, in fact, the seller knows that the company has a pending lawsuit, the disclosure letter will contain a “disclosure” referring to that lawsuit.

The point of the disclosure letter is to bring to the buyer’s attention before completion of the sale any potential problems. The buyer would then lose the right to sue the seller if any losses occurred as a result of those “disclosed” problems, provided they have been fully and fairly disclosed. The disclosure letter is therefore an extremely important document for the seller, because it gives the seller the opportunity to exclude or limit his liability in relation to problems that he knows exist.

From the buyer’s point of view, the disclosure letter is also an important document, as it causes the seller to bring the buyer’s attention to problems before he is committed to buying the company. The buyer might choose to accept a disclosure and take the risk accordingly, or he might seek an indemnity (see above) in respect of the specific problems disclosed, as specific indemnities would not be limited by the disclosure letter. If a problem is serious enough, a buyer might seek to renegotiate the price or even to pull out of the deal completely.

The seller also has means other than the disclosure letter for limiting his liability.

The completion of the sale of the shares usually takes place at the offices of the buyer’s lawyers, usually immediately after signing the SPA. However, sometimes the SPA provides for a delayed completion to take place after a gap period, e.g. where the SPA is conditional upon certain matters taking place before completion can take place. All sellers and buyers, their lawyers, and sometimes their accountants as well, will attend the completion meeting at which any final few items remaining to be agreed will be finalised, final drafts of the documents prepared and the parties will then sign all the SPA and ancillary documents.

At the completion meeting, officers of the company being sold will usually resign and new ones will be appointed, board meetings will be held to deal with the various company affairs arising out of completion, and sometimes shareholders’ meetings will be required also, as it is common for the constitution documents (the Memorandum and Articles) of the company to require changing as part of the deal process.

All of the company’s records and documents will be handed over at completion, and the money will be paid, usually by telegraphic transfer between the respective parties’ lawyers.