How do I sell shares in my company?
This article sets out in general terms the operation of a share sale and the matters which you should have in mind during the course of such a transaction. The following is designed to be of help to you in negotiating with the prospective purchasers of the shares in the Company and as a general negotiating aid. It is not a substitute for taking specific advice from a solicitor.
A sale share is effected by two documents
(A) the Share Purchase Agreement which contains the Tax Indemnity;
(B) the Disclosure Letter.
The purpose and contents of these documents are considered in detail below.
(A) The Share Purchase Agreement (SPA)
This is the document which sets out the conditions upon which the transfer of the shares is effected. For the purposes of this letter, it can be split into four sections:-
(4) Continuing Obligations.
This will describe the Company, its status including the place of its incorporation, whether it is a private or public company, whether it has subsidiaries or is a part of a group structure, its business, its directors, its share structure and the selling shareholders. This section is designed to give a picture of the Company in outline.
This section will deal with the actual transfer of the shares themselves, including the consideration (purchase price) and the way in which any further consideration is to be determined, the dates of exchange of contracts and completion, the method of payment of the consideration, the means by which the transfers will be effected and will run through the procedure which will actually take place at the completion meeting. This last point will include the signing and dating of the main documents described above, the handing over of share transfers, the execution of appropriate Board Minutes and Resolutions and Company Resolutions, and the issuing of new share certificates. These are known as the “ancillary documentation”. The section will also contain details of how any dispute concerning any of these matters is to be resolved. For example, any dispute as to the consideration will normally be resolved by reference to an expert appointed by the President for the time being of the Institute of Chartered Accountants in England and Wales. This section will also deal with any formal steps which are to be taken following completion, for example in terms of press release or contact with clients.
The warranties constitute a major part of any SPA and are likely to form the basis of much of the detailed negotiation. The importance of the warranties stems from the fact that the purchase of a large shareholding in a limited company does not affect the rights and liabilities, contingent or otherwise, of that company which exist at the date of the transfer. Any problems that exist at that date whether they be, for example, pending or existing litigation, financial, or the disrepair of a property, will remain with the Company, and it is possible they will exceed by far the consideration which is paid by the purchaser for the shares which he acquires. Those difficulties will not automatically be retained by the selling shareholders. By requiring the selling shareholders to give warranties, although any liabilities or difficulties will continue to attach to the Company, the purchaser is, through the warranties, given recourse to the selling shareholders on the strength of those warranties. Warranties constitute a means of building up a detailed picture of the Company’s past and present and of gaining protection for the future.
The Purchaser would normally look to obtain warranties in the following areas:-
(a) Company Documentation: that the legal requirements concerning documentation in the Companies Acts have been complied with promptly and that all other matters of company documentation have been kept properly;
(b) Accounts and Financial Matters: that the past accounts and the projected profitability of the Company are accurate and that the Company’s accounts have been prepared on a proper basis and cover such matters as borrowing, trade debts and outstanding commitments for capital expenditure;
(c) Issue of Shares and Making of Distributions: that all shares and distributions have been properly issued and made and that there are no outstanding obligations relating to any shares;
(d) Ownership of Assets, Plant and Equipment: that the Company owns all its assets free from encumbrances;
(e) Insurance: that the Company has adequately insured its assets and kept such insurance on foot;
(f) Taxation: that proper accounts have been rendered to the Revenue, that tax has been paid at the due time and that there are no outstanding charges to tax or reason for the Revenue to conduct a back assessment. The same considerations apply to the employer’s National Insurance obligations;
(g) The Company’s Business: that the Company has carried on business only in its main trade and has not entered into any unusual or particularly onerous transactions;
(h) Contract and Arrangements: that the Company is not party to any onerous long term transactions or that it has no hire purchase or other similar commitments;
(i) Disputes or Litigation: that the Company is not involved in any disputes or litigation and there are no known circumstances making such matters imminent;
(j) Employees: this warranty covers all aspects of the employment of the Company’s work force including the fact that there are no back wages due and that there is no other claim which employees are likely to bring against the Company;
(k) Pension: that the purchaser has been supplied with all documents relating to any pension scheme and that all pension schemes have been kept up to date and promptly paid;
(l) Property: there are a number of warranties relating to any freehold or leasehold property owned or occupied by the Company. They comprehensively deal with those properties in aspects varying from the legal title to the physical condition of the buildings or whether any planning or other notices have been served.
As you will see from the above, the warranties are comprehensive in their scope. It is almost impossible for any vendor to be able to make all the warranties asked of them in the strict terms that are initially put forward. The effects of the warranties are modified by the disclosure letter which I shall go on to discuss in detail below. In considering warranties, one should always bear in mind that they are a means of forcing you, the selling shareholders, to make disclosures which build up a complete picture of the Company’s past present and future in all aspects of its commercial life.
(4) Continuing Obligations
The continuing obligations which commonly appear in the SPA relate to the retention of part of the purchase money by the purchaser, the time in which any claims are to be made and the limitation of liability of the selling shareholders.
A purchaser may seek a retention for as long a period as possible since the retention provides the purchaser with a fund against which it can set off the effects of any warranty or indemnity claim without having to chase the vendors who may have disappeared or dissipated the proceeds of sale. The seller will fight against any retention or the amount of it, and against the periods in which claims are to be notified. It is unusual to have a limitation period of less than one year or more than two in respect of warranty claims. Because of the ability of the Revenue to carry out back investigations, claims on the Tax Indemnity will often have a longer limitation period of seven years.
The vendor will also look to minimise liability under the warranties by having a provision that no claims should be brought under any warranties until the aggregate of such claims has reached a certain amount, with claims below a certain small amount being discontinued completely. This is covered in the Vendor Protection Provisions.
Another continuing obligation which frequently appears is a covenant by the vendor not to compete with or solicit business from the Company following the share sale. This is normal, but one should seek to limit the scope of this as much as possible.
(B) The Tax Indemnity
The effect of the Tax Indemnity is to strengthen the tax warranties given in the SPA. Its purpose from the purchaser’s point of view is that it requires the vendors to indemnify themselves and the Company against any payment of tax which it has to make following the sale of the shares resulting from activity carried on prior to the sale of the shares. The indemnity relates to both tax payable by the Company arising from its own activities and any tax which is paid by the Company on behalf of others. The effect of the general indemnity is restricted by excluding claims:-
(1) in respect of which reserves or which have been allowed for in the Accounts; and
(2) arising as a result of the purchasers conduct.
(C) The Disclosure Letter
In discussing the SPA and the Tax Indemnity we have made reference to disclosure and the Disclosure Letter. In negotiation, we first seek to reduce the severity of warranties and indemnities by removing them from the draft documents and varying their form within those documents. This process will establish which warranties and indemnities are the keynotes which the purchaser will not allow to be modified or removed. The vendor should then seek to reduce the effect of the remaining warranties and indemnities by disclosure.
This process will build up a more complete picture of the Company for the purchaser and will identify for the purchaser those areas which most concern the vendor and to which he should himself pay most attention. Frequently more detailed enquiries will be made of the vendors in those areas.
This article has concentrated principally on the documents involved in a share sale. There are a number of other avenues of enquiry other than in connection with the documents which the prudent purchaser will follow.
The first in time of these is “due diligence”; an investigation into the financial position of the company. This involves accountancy advice to carry out analysis of the accounts and detailed auditing of any financial matters which the process of warranties and disclosure needs to deal with. It is usual for a purchaser also to carry out the investigation procedure relating to property which he would were he a purchaser of the Company property. Searches will be made of local and national property registers and enquiries will also be made of the vendors as to the general state of repair of the property, its use and the history of its occupation. An investigation of the title to the property will also be carried out.
Finally, investigation will be made of any matters which in the particular case the warranty and disclosure process draws attention to. Close scrutiny should be made of any pension scheme. The purchaser will also wish to satisfy himself that there is nothing onerous or difficult in any of the contracts of employment of any of the Company’s staff.
Who Does What?
The starting point should be a Heads of Agreement (or Heads of Terms), which sets out in summary, and without legalese, the basic terms the vendor and the purchaser have agreed to. This ensures that the drafting process does not commence until it is confirmed that each party is doing the same deal. The Heads of Agreement will be “Subject to Contract”.
The normal course of a share sale is for the purchaser’s solicitor to then prepare the draft SPA following instructions from his client, but not always so. It is inevitably a long and comprehensive document to which extensive amendments will be made. During the course of negotiation, the disclosure letter takes shape. The disclosure letter is drafted and at all times redrafted by the vendor’s solicitor. It is also useful in acquisitions for a completion date to be set near the commencement of negotiations to prevent them from dragging on. It is not unusual for exchange of contracts and completion to take place on the same day.