Most business transactions are structured as either a “stock sale” or an “asset sale.” When a business owner sells stock, the primary agreement governing the transaction is a Stock Purchase Agreement (the “SPA”). While the specifics of each business transaction will drive the details contained in the SPA, there are several key questions that will be addressed and answered in a well-drafted SPA:
What is being sold?
This is an easy question in a stock transaction. Quite simply, the stock is what is being sold. The SPA should also address whether any assets (such as cash or non-business personal effects) may be removed by the seller prior to closing. Also, if the buyer is also purchasing real estate from a related entity, this should be spelled out in the SPA or a related real estate purchase agreement.
Are any debts of the seller being assumed by the buyer?
When the stock of a corporation is sold, it is sold together with all of the corporation’s “skeletons in the closet.” If a debt isn’t taken care of prior to or at the closing, the buyer has just bought it and is now responsible for it. If debts are expected to remain and be the responsibility of the buyer, they should be listed on a schedule to the SPA. One way of reducing the buyer’s risk is by requiring indemnification from the seller for any non-scheduled debts.
What is the purchase price?
The purchase price for the stock will be documented in the SPA. There will likely be several adjustments to the stated purchase price at closing. These could be for prorations of prepaid expenses, utilities, taxes, payroll, etc. There could also be an escrow holdback from the closing proceeds to protect the purchaser if indemnification claims arise. Finally, the SPA may also require an adjustment if certain assets are not on hand at the time of closing, such as a minimum amount of working capital on inventory.
How will the purchase price be paid?
There are several ways that the buyer can pay the purchase price: cash, bank financing, and seller financing are common. Sometimes the parties will use a hybrid approach (such as a combination of bank financing and seller financing). If the seller is financing all or some of the purchase price, the payment obligations should be documented, and if security for payment of the seller financing is required, the parties will need to negotiate and document the security instruments.
How will the buyer make sure that it is getting good title to the business and its assets?
The buyer will need to undergo “due diligence” to make sure it is getting exactly what it thinks it is getting. Due diligence is simply a legal term for “kicking the tires.” Typically, the buyer will have some time to ask questions, review financial and tax information, and learn about the business before closing. Part of that process will likely involve doing lien searches and reviewing title documents for specific assets.
Another protection for the buyer is the seller’s agreement to indemnify for any breach of its representations and warranties. The representations and warranties section of the SPA will go through a laundry list of items that the seller is asserting to be true. Clearly, there is some tension here – a seller is benefited by having a short list of warranties and the buyer wants as much warranted as possible. It is not uncommon to have some back and forth to settle on the final wording of this section of the SPA.
When will the transaction be closed?
The SPA should also address when the transaction will be closed. Sometimes the SPA is signed well before closing; other times it is signed immediately before closing. At the closing, there will be an exchange of many documents. These agreements will derive from the promises contained in the SPA and will vary from transaction to transaction. They may include: stock assignments, Warranty Deeds, other transfer documents, resolutions, third party and landlord consents, closing statements, noncompetition agreements, employment or consulting agreements, lease agreements, escrow agreements, financing instruments, etc.
