By Giulio Carbonari, Davide Martinoni
The aim of this article is to briefly describe a principal transaction document for a Private Equity deal: the Sale and Purchase Contract. This is an extremely complex topic to which many articles would be needed to give a full understanding to the reader so rather the intention is to provide a brief introduction to an aspect which is irregularly discussed.
Among the steps of an acquisition process, the negotiation of the Sale and Purchase contracts (hereinafter the Share Purchase Agreement or the SPA) represents, without doubts, one of the most important aspects. As its name suggests, the SPA is a contract between buyers and sellers regarding the sale of the controlling shares of a business (the target).
Consequently, unlike an Asset Transaction, according to which the buyer will assume only specific assets or liabilities from the selling company, the SPA involves the transfer of the equity interests in the target company from the equity holders to the acquirer. Therefore, the buyer will acquire all assets and liabilities representing the business of the target and more importantly, the acquirer will discuss this acquisition directly with the shareholders of the target company.
American law firms were the first ones to use this type of contract. Consequently, the Share Purchase Agreement is strictly influenced by the Common Law system. This influence is represented by the efforts of the parties to negotiate all possible details about the deal. Additionally, compared to the Civil Law system, the SPA introduces several complications as in the Italian case, where, for example, the legislation does not provide a difference between signing and closing of a contract.
Despite these irregularities, the SPA is frequently used to settle deals in Italy.
To be clear and thorough, the remaining part of the article describes the SPA in a general view, without considering what is implied by specifics legislations.
The long and intensive negotiations between the relevant parties, assisted by their lawyers, constitute the final step of the acquisition timeline. This is when there is a concrete interest from both parties to close the deal and business owner has selected the potential buyer.
Although the SPA is drafted by the buyer’s lawyer, there is a close relationship between the acquirer and his/her attorneys, especially regarding the preparation of the main clauses. These clauses, explained below, have impact greatly on quality of the deal and are negotiated with the counterparty.
With this in mind, there is a need for greater analysis of certain elements.
Firstly, the target financial standing and economic positioning can vary over time. As a consequence, structuring the deal can be difficult, especially for enterprises who operate under the condition of strong seasonality. This is the reason why normally the actors schedule the deal at two different dates: Signing (the parties signed the SPA outlining how the acquisition will proceed) and Closing (the agreement is legally recorded and come into effect).
Secondly, the acquisition of a target is governed by an underlying valuation whose aim is the reaching of a Purchase Price (or Equity Value). According to the classic valuation scheme, the Equity Value, the amount that the seller will earn after his/her exit, is calculated by indirectly adjusting the Enterprise Value with the normal balance sheet elements, typically the actual cash, debt and working capital in the target as at the Closing Date. Therefore, the mechanisms to determine the price adjustments are included in the SPA and are subsequently part of the negotiations between parties.
Additionally, the Interim Management (the period between signing and closing) is crucial for the buyer as it is exposed to the risk of the seller’s value diminishing (i.e. value leakages). In fact, this lead to opportunistic vendor behavior, including all possible actions that the seller could exercise in order to receive a higher purchase price. However, the equity price can be calculated as fixed. In this case the most common mechanism is called ‘Locked Box’.
In conclusion, as explained in the first paragraph, since the scope of this article was to give a brief introduction of the Share Purchase Agreement, some details were not mentioned, even though they represent significant clauses. As transactions have reached a higher level of sophistication the hedge of a deal may be in the details: in this sense, it is fundamental to be knowledgeable about SPA’s different aspects.
Giorgio De Nova, “Il Sale and Purchase Agreement: un contratto commentato”, Seconda edizione aggiornata, G. Giappichelli Editore
Chris Tattersall, Jvo Grundler, Sabina Hohenegger, “Share purchase agreements, Purchase price mechanisms and current trends in practice”, 2nd edition, Ernst & Young