An equity sale or stock purchase is a type of business transaction in which a buyer purchases all, or part of, a selling business’ ownership, which may be represented by stock or other ownership shares, units, or interests. In other words, the buyer takes control of the business by purchasing the ownership rights in the existing entity held by the seller. Equity sales are one of the most popular deal structures when buying or selling a business because, compared to an asset sale, they can be relatively quick and easy to effect.
An equity sale may provide beneficial opportunities to both the buyer and seller involved in the transaction. As noted, one of the main draws of an equity sale for both parties is that, unlike an asset purchase, which generally requires negotiation and execution of numerous documents to transfer title of business assets, assign key contracts and accounts, and terminate and rehire employees, an equity sale can generally be completed with less paperwork and in a more timely manner as an equity sale keeps the existing business structure, employees, and assets in place and only changes the ownership makeup of the target entity.
Although equity sales can offer buyers and sellers ease of transaction, one of the biggest downsides to an equity sale, at least for buyers, is that, because the buyer is buying into an existing entity, the buyer “steps into the seller’s shoes,” and takes the entity as is, meaning the buyer becomes responsible for the entity’s existing liabilities. Although this can potentially be contracted around through use of indemnification provisions or agreements, and should be investigated by a buyer in the due diligence stage of an acquisition, not wanting to assume an existing entity’s liabilities is one of the main reasons many buyers push to acquire businesses through asset sales instead of stock purchases.
An equity sale is most often accomplished through negotiation and execution of a Stock Purchase Agreement. That said, other documents may also be used throughout the negotiation and closing of an equity sale, including Terms Sheets, Letters Of Intent, Non-Disclosure or Confidentiality Agreements, Corporate Resolutions, Promissory Notes, and Exclusivity Agreements, among others. Additionally, upon closing an equity purchase, a buyer may be required, or may wish, to execute other agreements such as Joinder Agreements, Shareholder Agreements, Buy-Sell Agreements, Amended Bylaws, or Amended Operating Agreements.
Because every deal is different, each Stock Purchase Agreement should be carefully drafted to fit the needs of each individual transaction. However, some key provisions that appear in many Stock Purchase Agreements, and that should be carefully reviewed and negotiated, include the following:
1. Purchase Price and Payment Terms. Although the purchase price of the shares or other interests involved in a stock purchase transaction is often one of the more straightforward provisions in a Stock Purchase Agreement, the payment terms can be, and often are, much more complicated. Because equity sale transactions, especially larger sales, rarely call for a single lump sum cash payment at closing, the Stock Purchase Agreement should clearly lay out if, and how, various payments or promises, such as escrow payments, cash payments, or promissory notes, will make up the purchase price. Likewise, the Stock Purchase Agreement, or related promissory note, should also clearly lay out if and how scheduled payment should be made, and include terms discussing interest rates and penalties for late payments.
2. Representations and Warranties. Buyers to a Stock Purchase Agreement will often want sellers to make various representations and warranties concerning, among other things, the financial and legal condition of the business being acquired, the employment status of the business’ employees, the condition of the business’ assets, the seller’s legal authority to agree to the transaction, and the seller’s promise to protect the assets until closing. Such representations and warranties are important to ensure that the buyer is getting what they are paying for. Accordingly, such representations and warranties should be carefully reviewed and drafted.
3. Closing Conditions. The parties to a Stock Purchase Agreement should agree on the conditions that must be met before the sale can be completed. Often, this requires the selling party to, among other things, provide the purchasing party with time, documents, and access reasonably necessary to allow the purchasing party to conduct reasonable due diligence into the business they are purchasing. Likewise, closing conditions also often require the parties to agree to various ancillary documents that are necessary to complete the transaction, such as Promissory Notes, Security Agreements, and Non-Compete Agreements.
4. Indemnification. As mentioned above, because equity sales generally result in a purchasing party becoming liable for the purchased business’ existing liabilities, it is imperative that the parties to a Stock Purchase Agreement understand the selling party’s indemnification obligations, if any, to the purchasing party. An indemnification provision serves to shift the costs and responsibility of defending against a claim onto a specific party. Buyers will generally want to try to obtain the broadest indemnification provision possible, shifting as much responsibility for existing liabilities, liabilities not yet arisen but based on past actions, and breach of representation and warranties to the seller. In contrast, a seller will generally want to limit their indemnification obligations to a purchaser as much as possible. Because such provisions provide important rights and remedies, and place binding obligations, on each of the parties to a Stock Purchase Agreement, such provisions are often heavily negotiated in equity purchase transactions
Although the above are a few of the key considerations that should be carefully considered when negotiating or entering into a Stock Purchase Agreement, as noted, numerous other provisions and considerations should also be taken into account, and each Stock Purchase Agreement should be carefully tailored to best fit the needs of each individual transaction.
