Guide To Buying A Company Through Share Purchase

When considering the purchase of a business, it is important to distinguish whether the purchase will be made through an asset purchase or a share purchase. 

In a share purchase, the buyer will acquire the shares of the company (which operates the business) from the current owners of the company; in an asset purchase, the buyer will acquire the business and assets of the company from the company directly. 

By purchasing the shares, the buyer takes control of the company and assumes responsibility for all present and past company liabilities. 

Therefore, detailed due diligence is important to uncover potential company liabilities and use the share purchase agreement to allocate the risk of such liabilities between the buyer and the seller(s).  

For example, potential liabilities include unpaid taxes, potential employment claims, and property dilapidation issues.

Corporate

As the buyer is purchasing the shares in the company, they inherit all company liabilities, including any historical issues regarding the company shares. 

Typically, the buyer will take particular interest in ensuring that the company's statutory registers are up to date and accurate, the Companies House filings are up to date, and any historic share restructuring (such as any share buybacks, issue of shares or subdivision of shares) has been done correctly and in line with any statutory procedures. 

Commercial

The company's commercial contracts will remain in the company's name (as you are not assigning the contracts, as you would be in an asset purchase).

That being said, it is important to ensure that all contracts are entered into by the company (rather than any group company) and that these contracts are not subject to any change of control provisions, which may allow a third party to terminate the agreement when control of the company changes hands. 

In terms of intellectual property, it is key to check that the company owns all key intellectual property and that any third parties that have taken part in the development of such intellectual property have assigned any rights they have in such intellectual property to the company. 

Furthermore, in a business where software provision is a key aspect of the business, consideration of any open-source software and licensed-in software used in the development of the software will be an important aspect of the due diligence. 

Property

Whether the company has freehold or leasehold property or a licence to use property in connection with the business, the buyer must ensure that the arrangements are appropriate for the buyer's plans post-completion.  Any change of control provisions and landlords' consent should be considered. 

Where the company has taken on a lease, any potential dilapidation claims will be an important aspect of due diligence. 

Dilapidations is a potential cost to the company to put the property at the end of the lease back in the state that the property was in when the company first took possession of the property. 

This could include repairs and re-instating the property if any alterations to the property have taken place.

Commercial property lawyers will also typically review title, access to the property, planning, use and environmental matters.

Employment

In a share purchase, the employee contracts continue the same way as before completion (as the employer remains the same), so there is no consultation requirement. 

However, historic employment issues must be considered as the buyer takes on these contracts and arrangements.  These may include:

• Non-compliance with working time regulations
• Non-compliance with pension auto-enrolment and any incorrect pension payments
• Employee claims for unfair dismissal and claims under the Equality Act 2010
• Any promises or contractual commitments about bonuses, pay increases and/or holiday entitlement

Financial/Tax

Your accountant/tax advisor should lead the undertaking of financial/tax due diligence. 

This aims to investigate the company's accounting records, performance, profitability and any tax liabilities (among other things). 

This will also form part of verifying the valuation attributed to the company.

Purchase Price

The purchase price can be made up in many different ways.

It is typically expected that not all of it will be payable on completion of the transaction, and there is often an element of deferred consideration. 

In particular, there is a current trend in buyers insisting on an earnout, which allows the buyer to set a deferred payment against financial targets (for example, an annual  EBITDA target) agreed upon by the Buyer and the Seller(s). 

If these targets are hit, the buyer pays an additional amount (this is often scaled, so more is paid if a minimum target is hit up to a maximum amount). 

Where this type of structure is used, the seller (s) will often want to ensure some protection in the share purchase agreement to support the achievement of the targets. 

For example, the company will not divert customers elsewhere, will not do anything to reduce profitability, maintain a certain level of working capital and will not cease to operate a key part of the business.

Often, a purchase price adjustment mechanism will be included in the share purchase agreement to reflect the actual position of the company in terms of cash (and cash-like items) and indebtedness (commonly known as "cash-free / debt-free").

In addition, the adjustment will also include a requirement to have a certain level of working capital and where the company at completion does not have the requisite level of working capital, any shortfall reduces the purchase price (and sometimes increases to reflect any excess).

Warranties and indemnities

Warranties and indemnities are the key protection for a Buyer when purchasing a company.

Warranties are statements made by the seller (s) that are warranted as true, accurate and not misleading. 

For example, "there are no outstanding claims from any of the company's employees". 

Where a warranty proves false, the buyer may be entitled to bring a claim for breach of warranty (in effect, a price adjustment after completion). 

The seller (s) may, before completion, disclose any matter in respect of a warranty (in the example above, this may be any outstanding employee claims) to prevent a claim for breach of the warranty being made; this is done formally in a disclosure letter but may also be disclosed as part of the due diligence process. 

Where seller (s) have made a disclosure, a Buyer may seek comfort for that matter by way of an indemnity. 

An indemnity is a promise to pay, on a pound-for-pound basis, the losses (including costs) incurred by the buyer in connection with the identified matter. 

Alternatively, matters disclosed (or raised as part of due diligence) may warrant a renegotiation of the purchase price.

Tax covenant

The Tax covenant is part of the share purchase agreement that prescribes how the company's tax liabilities and tax assets (such as reliefs) will be allocated between the seller (s) and the buyer. 

Subject to certain exclusions and exceptions, the tax covenant effectively operates so that the seller (s) are responsible for tax liabilities arising from pre-completion events, and the buyer is responsible for tax liabilities arising from post-completion events.

The lawyers and accountants should work closely together to ensure the drafting of the tax covenant is specific and detailed and captures all relevant items (and exclusions) regarding the company.

Restrictive covenants and consultancy arrangements

To protect the company's goodwill, a Buyer will commonly require the seller (s) to enter into restrictive covenants for a period of time after completion.

These will commonly include restrictions on  the seller (s) that will prevent them from:

• Poaching members of staff
• Engaging with or contracting with clients/customers of the company in competition with the company
• Engaging with suppliers of the company, which may result in the supplier ceasing to provide goods or services to the company
• Being interested in any business which is materially the same as or in competition with the company's business

It is often the case, especially when the purchase price includes an earnout, that the seller (s) will remain involved in the company for a period of time after completion to ensure a smooth transition (and, where appropriate, to protect the earnout). 

Therefore, the company and the seller (s) should enter into new service or consultancy agreements for such a period, setting out the seller (s) 's roles and responsibilities. The restrictive covenants should be drafted to carve out any actions taken in good faith in connection with the service/consultancy agreements.