You’ve got a company and it looks like things are going well for you. Now you might be thinking about next steps for financing and growth. One of the most clear cut ways to do that is sell off parts of your ownership as stock. How does all that work exactly? We’ll cover all the details of Stock Purchase Agreements so you know all the ins and outs!
A stock purchase agreement (SPA) is the contract that two parties, the buyers and the company or shareholders, written consent is required by law when shares of the company are being bought or sold for any dollar amount.
In a stock deal, the buyer purchases shares directly from the shareholder. Stock acquisitions are the most common form of acquiring a private business. They are mostly used by small corporations selling stock, but not usually when the owner is the sole stockholder, or when the buyer is acquiring 100% of the stock.
It is important to note that in a stock deal the buyer also assumes title of all assets and liabilities. Contrast this with an asset deal, the other method of acquisition, in which the buyer purchases an agreed-upon set of assets and liabilities.
With a stock acquisition, it’s as if there was no change of ownership for the asset and liabilities - disclosed or undisclosed - and the target continues on as before. This potentially includes liability for past actions of the company.
SPAs can seem more straightforward than asset purchase agreements (APA), because SPAs does not need to itemize the assets and liabilities. However, they come with more opportunities for financial risk.
Whether buying or selling, it is helpful to have an attorney on hand to help you prepare or review the contract. They can also assist you if you need to file a claim.
Steps to file:
Prepare the legal document.
The parties may set forth some terms in an informal letter of intent (LOI). If they’re interested in pursuing the deal, they’ll prepare the primary transaction agreement. This could be a Stock Purchase Agreement, Asset Purchase Agreement, or Merger Agreement. The buyer may do due diligence, and if so, this could account for a purchase price adjustment if they move forward with the SPA.
Sign the entire agreement.
A witness whereof can also sign, but there must be a witness for the statement to be legally binding
Make signed copies.
Exchange payment and the stock certificates.
You may need to file the paperwork with the SEC.
What is a Stock Purchase Agreement?
An SPA is the contract containing the principle agreement between the parties in which the buyers purchase stocks from the shareholders. It is sometimes called a Securities Purchase Agreement, or just a share Purchase Agreement.
The key provisions detail the terms of the transaction:
the number and type of stock sold (i.e. common, preferred)
the purchase price
when the transaction will take place
price per share
It also has articles detailing the conditions of the sale. That way, the parties can refer to the SPA in case one needs to file a claim.
Key Provisions of a Stock Purchase Agreement
The major sections of the stock purchase agreement are as follows. Sellers should particularly pay attention to the purchase and sale of stock, and the representations and warranties section.
Definitions – Here is where you include the definitions of terms used in the document, including the types of applicable law that will be used. You will usually find the terms defined in this section capitalized throughout the agreement to show their importance. These terms are not made to stand on their own but are used throughout the contract to have a shared language between "seller" and "purchaser."
While it may be tempting to gloss over this article, terms such as “Liabilities,” “Material Adverse Effect” or “Seller’s Knowledge” can be a focus of debate, and are used throughout the contract.
This section must include the name of the buyer or “Acquirer” and the “Target” in which the outstanding shares are being sold.
Purchase and sale of stock – This section has transaction details such as the purchase price and number of shares. In this section, you will also find the price and any adjustments made to the purchase price as well as any other items that were shared between the parties when the deal was closed.
- Make sure to include purchase price adjustments, if any. The seller will want to note any differences here from the Letter of Intent (LOI). This will usually be the result of due diligence on the part of the buyer, and the adjustment should be negotiated pre-closing.
- Share certificates and other agreements to be exchanged upon completion of the sale.
- Legal opinions.
- Escrow agreements.
- Employment agreements, detailing how employee issues will be handled after the transaction. Employment agreements do not need to be renegotiated, unlike with a APA.
- Other ancillary documents.
Representations and warranties of the seller and buyer – Here the buyer and seller list all of the statements they are signing off to be true. For example, the seller warrants that they own the stock, and that the corporation is in good standing, and where the buyer warrants their ability to consummate the transaction. Any false statements can potentially open up costly litigations post transaction, including having the purchase price adjusted.
Covenants and Closing Conditions -- If there is a space of time between signing and closing date, the two parties will make covenants here for how the two parties will handle the gap. These are mostly assurances requested from the buyer to ensure that the business will continue to operate in the way it did when the buyer did due diligence. Closing Conditions will be comprised of conditions that either need to be taken care of or waived before the time that closing occurs. This will often include both parties performing their pre-closing covenants and all regulatory approvals being completed.
Indemnifications -- This provides the terms for how the buyer or seller will handle protections and compensations against damage, loss, or injury post-transaction as a result of conditions that existed before the deal closed.
Tax purposes - this section covers any special tax treatments or financial statements either buyer or seller are entitled to.
Termination -- This provides you the details for each party's right to terminate the contract.
General Provisions -- Every agreement will close out with a section that covers any miscellaneous provisions.
How Does a Stock Purchase Agreement Differ From an Asset Purchase Agreement?
With a common stock acquisition, the buyer assumes all assets and liabilities, whether disclosed or not. With an asset purchase, the buyer is selecting specific assets and liabilities they want to buy.
An asset purchase agreement (APA) might benefit a buyer who wants to exclude liabilities or redundant assets. For example, a target may have uncollectible accounts receivable. All assets and liabilities being bought and sold must be itemized in the APA. This can include licenses, contracts, equipment, agreements, goodwill, customer lists, leases, or inventory.
Sometimes, contracts may have a specific clause that prevents licenses from being transferred over. This could include an exclusive distributorship, license, or right. It could be titles for a fleet of cars. A stock purchase agreement may be the best choice when the target has exclusive contracts or licenses that cannot be transferred over.
When is a Stock Purchase Agreement More Desirable Than an Asset Purchase Agreement?
Stock deals might be good in a situation where the buyer thinks that the liability is low or manageable, or who sees growth potential in the company. Or the buyer may be looking for a tax write-off.
Because the assets and liabilities don’t need to be itemized, it can seem less complicated to go with an SPA. But they can come with risk. It is important for a buyer to do their due diligence.
In a stock acquisition, it’s as if there was no change of business owner for the assets and liabilities. The tax attributes of the assets and the liabilities carry over as well. The buyer assumes the same tax responsibilities and the deprecation schedule of the assets. This includes the existing tax status of the corporation.
Stock acquisitions can also be less expensive because they are not subject to the Bulk Sales Act, often resulting in a lower selling price. The seller is considered to have disposed of equity, and instead is subject to a capital gains tax.
Also, in cases where both the buyer and seller are C corporations, the transaction may qualify for tax treatment as a tax-free reorganization. Stock purchase agreements can also be useful in cases where the buyer needs a tax write-off.
Two reasons not to use a SPA include:
You have a limited capacity offering that qualifies for Regulation D exemption.
You are the only shareholder in the organization.
There are various tax implications with a SPA. However, it can still be good to have a purchase agreement. It is best to speak with an accountant before filing. You can learn more about the differences between a SPA and an APA at CFI Education, Asset Purchase vs Stock Purchase - Pro/Cons Reasons for Each Type.
Do I Need a Lawyer to Help Me Fill Out a Stock Purchase Agreement?
It is important to conduct a stock acquisition properly. You should have legal advice, whether preparing or reviewing a claim. Typically, it is lawyers who prepare the SPA.
SPAs can be found to be invalid when they violate business or corporate governing law. This is common when they have securities violations, such as insider trading.
Because they have to do with the sale and purchase of stocks, SPAs are subject to applicable securities laws. This can lead to penalties, and even federal charges and costly court fees.
SPAs can also be found to be invalid if there is fraud, deceit or duress. For example, if there is a misrepresentation about the type of stocks, this can open up the seller to litigation.
A common mistake people make is trying to fill out a SPA template on their own. You are highly advised to consult a lawyer for legal counsel, whether drafting an SPA or reviewing one. They can help you throughout the process, and represent you if you ever need to file a claim.