This guide is made in consonance with U.S. Law, which in this case, is the Securities Act of 1933. This is an informational post to help entrepreneurs and is not legal advice.
Guide contents –
- What is a stock purchase agreement?
- The Purpose of a Stock Function Agreement
- When You Need to Use this Agreement
- When You Need Not Use this Agreement
- Essential Components of a Stock Purchase Agreement
- Instances when a Stock Purchase Agreement can be Used
- How to File a Stock Purchase Agreement
- Mistakes to Watch Out For
- Format of a Stock Purchase Agreement
Stock Purchase Agreement Overview
A stock purchase agreement is a contract signed by two parties when they buy or sell stock in a corporation in the US. Small firms that sell stock frequently use these agreements. Stock can be sold to buyers by either the corporation or its shareholders.
A stock purchase agreement is intended to safeguard you and your financial transaction, whether you are the buyer or the seller from unwanted legal outcomes.
However, it is important to note that an asset acquisition agreement is distinct from a stock purchase agreement. Stock purchase agreements basically sell company shares in order to raise funds or transfer ownership of shares from one holder to another.
The acquisition of the company’s assets is completed through an asset purchase agreement whereas a stock purchase agreement deals with the ownership of the company and its shares as a whole.
Some of the key items that are listed in a stock purchase agreement are:
- Name of the company whose shares are being bought and sold;
- Name of the buyer and seller of shares;
- The number of shares being sold and the par value of those shares;
- The date and place of the transaction;
- Representations and warranties made by both parties to the agreement with relation to the transaction;
- Issues with relation to employees if the shares being sold change the ownership or majority ownership of the company from one hand to another;
- Indemnification of the parties concerned over legal troubles that may occur or unanticipated costs that may arise.
Function of a Stock Purchase Agreement
Sale of company shares are not as simple as a sale of small goods or services.
Since they determine ownership of a company, stock purchase agreements are crucial. These agreements help formalize the terms of the stock purchase transaction. This can help to avoid misconceptions in the court if the sale is ever disputed by either of the two parties.
The contract also enables the seller to demonstrate and prove that they own the stock being sold and face liability if the representation is false or invalid. This increases the buyer’s trust in the deal.
Another significant advantage of a stock purchase agreement would be that it offers relevant details on share transfers.
This means that the seller’s warranties, representations and covenants are all laid out (more on the exact meaning of the terms later). The contract can also include a list of dispute settlement options for both parties such as mediation, arbitration or litigation at courts having particular jurisdictions.
You can also stipulate that the seller or purchaser of the shares will cover certain costs if a previously undisclosed issue causes loss to the buyer of the stock or shares.
Why You Need to Use a Stock Purchase Contract
#1. A well-designed stock purchase agreement provides protection to both the buyer and the seller of stock in a business.
- Provides legal assurance that all terms of the deal have been agreed upon
- Requires payment to be made at closing, freeing the seller from obligations to the buyer
- Protects against future claims of breach of contract for either party
#2. When the seller of the shares is the company itself, it allows the business to raise more capital for itself without it having the strain of a debt.
#3. It may allow for lower tax for the parties involved if tax structuring is done appropriately.
When You Need Not Use a Stock Purchase Agreement
Let’s be clear. It’s always safer to sell and buy shares using a stock purchase agreement – even when it’s between co-founders of a company. In fact, not using a share purchase agreement between founders of a company can lead to disagreements and sabotage the startup in the long-run.
However, in these limited cases, you may not use a stock purchase agreement-
- You are the sole and complete owner of the business;
- The stock purchase is a limited capacity offering that falls under the Regulation D exemption under the Securities Act of 1933 (Rule 504 and 506).
- For issuing of advisory shares to external advisors and consultants unless it is via a grant of options route.
The Essential Parts of a Stock Purchase Agreement
It is important to remember that a stock purchase agreement is just an agreement or a contract in its core.
As such, most of the essentials that applies to a contract, applies to a stock purchase agreement too.
However, this is quite a complicated agreement, as such I wouldn’t advise doing it on your own. But, knowing the its essential components is still important so that you can understand whether your lawyer missed out on any feature that you may want.
As such, here is the essential components of a stock purchase agreement that must be in pretty much every stock purchase agreement that you create.
#1. The Preamble
The preamble of stock purchase agreement is the part of the contract where the parties are identified and the purpose of the contract is stated. In this section, you will also see a description of what type of business entity is being sold.
The preamble of a stock purchase agreement generally starts with a statement such as “This Agreement is made by and between…” followed by the full legal name of each party to the agreement. Some agreements will also include details about the person(s) or entity that owns or controls each party. The purpose and type of business entity that is being sold will be listed after this section.
The preamble should be written in everyday language so that it is clear to all parties what type of transaction is taking place and who will benefit from it. It may also contain additional information if necessary (such as whether there are any liens on assets owned by either party).
Here is an example of the format of a preamble –
This Agreement is entered into as of the ___ day of ________ 20__, by and between ____ a corporation organized and existing under the laws of ____ (hereinafter referred to as “Buyer”), and _____ a corporation organized and existing under the laws of _____ (hereinafter referred to as “Seller”).WHEREAS, Seller is the owner of all of the issued and outstanding shares of Common Stock (Par Value $0.01 per share) (the “Shares”) in the capital stock of Agri-Coop, Incorporated, a Minnesota corporation (the “Corporation”);WHEREAS, Buyer desires to purchase from Seller, and Seller desires to sell to Buyer, on the terms and conditions set forth herein, all such Shares owned by Seller; andWHEREAS, Buyer will acquire 100% ownership of the Corporation.
#2. The Recitals
The recitals are a series of statements setting forth facts that pertain to the parties’ dealings and form the basis for their agreement. The recitals should be arranged in chronological order and begin with the earliest agreement or event that pertains to the deal.
#3. Definitions of Terms in the Agreement
Various definitions used across the agreement will be listed alphabetically in the definitions part. The terms stated in this section are frequently capitalised or highlighted in bold font throughout the contract to emphasise their significance.
These definitions are not intended to exist alone, but are utilised all through agreement to provide a common vocabulary between “seller” and “buyer” of the shares.
Most entrepreneurs often skim through these definitions, believing that these are common concepts.
However, it is critical to thoroughly examine them because these phrases can drastically alter the interpretation of sections of the agreement based on how they are defined initially.
The following are some terms that, depending on their context, can have a big impact on the stock purchase agreement:
- Knowledge of the Seller
However, there can be many more important terms. So, go through the definitions thoroughly and try and memorize them and understand how they are used in the rest of the agreement.
#4. Details of the Stock Purchase Transaction
This section contains extremely detailed information on the transaction such as the number of shares on offer, the par value or the share price at which the stock purchase is going through.
In this section, details are provided as to the share certificates, payment agreements, whether the transaction will be supervised by any investment firms, whether and how the payment will be put into escrow, conditions to be satisfied at the time of the purchase etc.
These details are key for preventing unwarranted situations, such as a big loss faced by the company after the agreement has been entered into but before it has been closed by the parties, causing for the buyer to have to face a massive loss in value, having already paid for quite a lot of shares.
If the majority shares are getting transferred, then the purchaser may need to provide for additional details in the transaction document, such as agreements with relation to the employees in the company and the buyer also needs to provide for legal information relating to the company whose stock is being sold.
- Related Read: Rights of US Employees through the COVID period
#5. Warranties and Representations given by Seller of the Stocks
In this section, the seller or the selling company provides details as to the financial condition of the company, information relating to its working capital, the legal issues and litigations that it faces, its assets, mortgages, charges and other forms of liabilities.
The seller also provides representations as to the future possible growth of the company and backs it up by providing requisite details such as market research reports, business strategy etc.
In case of large buyouts of stocks, the buyer is also presented with other relevant information by the selling company such as the business model, revenue model and business plan of the organization as well as other relevant business information that may affect the agreement.
It also has to lay out its properties and assets owned by the company as well as provide warranty in case any of the above information turns out to be false.
#6. Representations and Warranties by Buyer of Stocks
Usually it is the seller who provides for representations and warranties but at times agreements entered into by the buyer is made by a power of attorney or the buyer is a company, which complicates things.
As such, the seller must know that the person entering into the agreement has necessary authority to bind the buyer as well.
Here’s a sample of how a section on representation and warranties by the buyer may look like –
1. The buyer is a company duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation or organization and has all necessary power and authority to carry on its business as it is now being conducted;2. The buyer has full power, authority and legal right to enter into this Agreement, to perform its obligations hereunder and consummate the transactions contemplated hereby;3. The execution, delivery and performance of this Agreement by the buyer have been duly authorized by all requisite corporate action on its part;4. This Agreement constitutes the valid, binding and enforceable obligation of the buyer, subject only to applicable bankruptcy, insolvency and other similar laws affecting creditors rights generally and to general equity principles.
Typical representations and warranties include:
- good standing;
- ownership of assets;
- lien free assets;
- material contracts;
- title to assets;
- sufficiency of financial statements;
- compliance with law.
#7. Covenants in a Stock Purchase Agreement
Because most transactions will have a length of time between both the parties signing and the closure of the contract, a covenants section is included to describe activities that both sides should avoid undertaking during this period of time.
This usually entails a large list of things that must take place during this period, as well as actions that are forbidden.
#8. Closing Conditions in a Stock Purchase Agreement
Closing conditions are conditions that must be met or waived before the transaction may be completed. This frequently includes both parties fulfilling their pre-closing agreements and obtaining all regulatory approvals.
This may also include the buyer asking the seller to negotiate with its suppliers so that they continue to deal with the buyer or the buying company once the stock has been transferred.
At times there are even post-closing conditions that must be met by either parties after the closure of the contract. These are known as post-closing conditions.
Usually breach of such conditions do not result in the termination of the contract as they are not considered to be material to the contract. However, it does result in the party committing the breach having to compensate the other party for the breach.
#9. Indemnification in Stock Purchase Agreement
Indemnification section will outline the indemnification rights, laying out the terms under which the other party will be compensated in the event that one party breaches the contract.
At times there may be legal or financial issues, the outcome of which are undeterminable. As such, the buyer can provide a clause that says that the seller will have to indemnify the buyer in case, these issues cause a negative effect to the buyer.
Of course, a seller will not like to take unlimited liability. As such, they will cap their indemnity up to a certain amount.
However, the buyer should also ask the seller to indemnify it in case, the seller provides any wrong information or commits fraud and these types of indemnity should never be capped.
#10. Termination of the Contract
There can arise certain cases in which it is unwise to go ahead with the stock purchase.
These cases in which a stock purchase agreement can and should be terminated are often provided for in the agreement by the concerned parties.
Some examples are –
1. A failure to get the required approvals from regulatory authorities to complete the deal.
2. A failure of a buyer to meet certain conditions such as getting financing for the deal or other requirements in the contract.
3. If a seller breaches the terms of the agreement, a buyer may terminate if he or she does not cure it within a specified period of time.
4. A material adverse change has occurred to either party that is outside of its control and affects its ability to fulfill its obligations under the contract. This could include natural disasters, business losses due to an economic downturn or other similar circumstances.
5. An event of default occurs under the loan documentation for the company.
Either way, for ease of classification these reasons for termination of the contract can be classified into three categories. These events are commonly referred to as “conditions subsequent,” and they fall into three categories:
- Conditions that must occur before the closing;
- Conditions that must occur on or before the closing; and
- Conditions that must not occur on or before the closing.
#11. Boilerplate Provisions
These are known as miscellaneous provisions. They provide for the anciliary issues relating to the stock purchase agreement such as applicable laws, dispute resolution processes that should be used between the parties in case any dispute arises, how expenses that may arise in the transaction should be dealt with, severability of the parts of the agreement in case any default or issue arises, assignment and intellectual property considerations etc.
Instances when a Stock Purchase Agreement is Used
The following are instances in which a stock purchase agreement should be used:
- If you are selling or buying shares in a privately owned company;
- If you are selling or buying shares in a family owned business;
- If you are making an investment in an early stage startup company;
- If a big stakeholder in a company chooses to depart, they may seek to sell their stock ownership. They can sell these to individuals outside the company without asking other shareholders if they don’t have a stock purchase agreement that forbids outside sale of shares. A “right of first refusal” provision can be constructed using a stock purchase contract. This means that other stockholders will be able to buy the stocks before they are offered for sale to individuals outside the company.
How to File a Stock Purchase Agreement
1. Once the agreement has been created, completely review the stock purchase agreement with the buyer and have your lawyer review it too.
2. If everything is alright, sign the contract. Both the contracting parties must sign. If you don’t know the buyer well or have reason to believe they would back out of the deal, you can have a witness sign the agreement as well. Make copies of the signed agreement.
3. If you don’t know the buyer well or have reason to believe they would back out of the deal, you can have a witness sign the agreement as well.
4. After the buyer has paid for the stock, provide them with the share certificates signifying the company’s stock.
5. The stock purchase agreement is not required to be lodged with either the municipal or federal governments. However, if you meet certain requirements, you may still be required to record the transfer with the SEC.
Mistakes to watch out for when Creating and Filing a Stock Purchase Agreement
- Not considering the tax implications of the sale or purchase;
- Not having your lawyer review the final draft of the agreement;
- Not creating a stock purchase agreement just because you qualify for the exemptions.
Wrapping it Up – Sample Formats of the Stock Purchase Agreement
Well, that’s all for the complete guide on stock purchase agreement. Need help with your agreement? Send us an email and we’ll guide you through the process.
Also, here are some formats of stock purchase agreements so that you can ease yourself better into the process.
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