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This is the first post in a three-part series that is a very basic, and lively, introduction to the typical structure of a stock purchase agreement in a transaction involving the sale of control of a private company. It is intended for a newcomer to the field or casual observer and does not delve into the nuances and strategy that would really excite your friends and neighbors. Other transactions, such as asset purchases, mergers, venture capital investments or transactions involving the sale of a public company, will have variations to this structure and different points that become the focus of the negotiations.
The stock purchase agreement is often only one agreement among dozens of documents that the attorneys and principals will need to understand and manage. However, it is often the document that receives the most attention and drives the sale process.
A stock purchase agreement for a privately-held target often includes the following parts in some variation on the following order:
The first post in this series will describe the representations (or “reps”) and warranties and the indemnification provisions. Indemnification claims can be based on inaccurate reps and warranties or breaches of the covenants (promises to act in a certain way) in the agreement (post 2). In addition to an indemnification claim, the reps play a role in the closing conditions (post 3) and fraud claims.
Definitions – Why are Words Randomly Capitalized?A capitalized word in a legal document usually indicates that the word refers to a defined term. Defined terms may be either defined in the body of the document (“Like This”) and cross-referenced by an index; defined in a section like a dictionary; or (most commonly) handled in a section that is a combination of the two. Definition sections are usually at the beginning or end of the document or in an annex. Tweaks in certain definitions can make a significant difference in the deal; however, definitions are only relevant in the context of how the words are used in the body of the contract. It is important to consider the body of the document and the definitions together, rather than separately.
Reps and Warranties – Promises About the Condition of the Business
There will typically be a section of reps and warranties for each of the target business, the buyer and the seller. Representations are statements about what has happened and warranties are statements about what will be. Sometimes the reps are intended to allocate risk of the unknown between the parties. For example, a seller could represent that something is true, even if the seller has no way of knowing whether it is true, and the idea would be that the seller is willing to assume the responsibility for some of the risks of the unknown in order to get the deal done.
If the seller's reps and warranties are found not to be true after the closing in a private deal, the buyer may be entitled to receive compensation (see indemnification below). In extreme situations, either party may be able to terminate the transaction, instead of closing it, if the reps are not true at the closing (see post 3).The reps that describe the operation and condition of the business are the longest and generally are going to lead to the most negotiations. The buyer generally wants the seller to make more promises about the quality of the business, and the seller wants to make fewer promises. The reps about the buyer generally speak to the buyer's ability to pay the purchase price and the reps about the seller generally deal with the seller's ability to transfer the business free and clear of obligations to third parties.
Indemnification – The Seller Puts its Money Behind its Promises
Agreements that deal with the sale of private companies often have indemnification sections. These sections include a lot of variables that can be adjusted and are often highly negotiated. At their core, these are agreements that could require the sellers (most commonly) to refund part of the purchase price to the buyer after the closing - either from an escrow account or their own pockets - if certain things happen.
Some of the grounds for an indemnification claim could include that a rep is not true, the buyer received an invoice that the seller should pay, one of the parties breached a covenant (a promise to act in a certain way) or a specified agreed event happened (e.g., a known lawsuit that is transferred with the business results in a post-closing judgment adverse to the business).
The next post on this topic will outline the sections of a stock purchase agreement that require the parties to take an action or refrain from acting - including the provisions that relate to the economics of the deal.
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Among the DealStage features available to lawyers and other deal participants are document status and responsibility tracking, signature page signing and delivery and deal closing-book creation. DealStage can be used internally by one team or across all parties to the deal. Visit www.dealstage.com to learn more about DealStage and to request a demo.
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