Stock Purchase Agreement: Everything You Need to KnowStartup Law ResourcesVenture Capital, Financing
A stock purchase agreement is the agreement that two parties (the company or shareholders and buyers) sign when shares of a company are being bought or sold. 7 min read
Updated October 26, 2020:
Stock Purchase Agreement: What Is It?
A stock purchase agreement is an agreement that two parties sign when shares of a company are being bought or sold. These agreements are often used by small corporations who sell stock. Either the company or shareholders in the organization can sell stock to buyers. A stock purchase agreement is meant to protect you, whether you're the purchaser or the seller.
A stock purchase agreement is separate from an asset purchase agreement. Stock purchase agreements merely sell shares of the company to raise money or transfer ownership of shares. An asset purchase agreement finalizes the sale of the company's assets. The stock purchase agreement lists several things:
- Name of company
- Purchaser's name
- Par value of shares
- Number of shares being sold
- When/where the transaction takes place
- Representations and warranties made by purchaser and seller
- Potential employee issues, such as bonuses and benefits
- Indemnification agreement over unforeseen costs
Before an agreement is finalized, a letter of intent (LOI) is created explaining the proposed sale. A buyer should have due diligence and ensure the purchase agreement has the same terms as the LOI.
The Anatomy of a Stock Purchase Agreement
Stock purchase agreements are broken up into a variety of sections which help to define what certain concepts mean and explain how the transaction process works. When broken down into parts, the anatomy of a stock purchase agreement is as follows:
- Article 1: Definitions
- Article 2: Transaction Details
- Article 3: Seller's Warranties and Representations
- Article 4: Buyer's Representations and Warranties
- Article 5: Covenants
- Article 6: Closing Conditions
- Article 7: Indemnification
- Article 8: Termination
- Article 9: General Provisions
The first section of your stock purchase agreement is often referred to as the preamble. In this section, the agreement will be named, the parties identified, and the date of the contract will be set. In the preamble, you will often see parties referred to as "seller" and "purchaser."
Directly after the preamble, you will come to the section that is referred to as the Recitals. It is this section that will have a series of statements often starting with the term "whereas." While these statements are made to layout the intentions of the contract, they are not meant to be binding agreements between the parties.
Article 1: Definitions
The first article of your stock purchase agreement is the definitions section. It is in this section that the various definitions used throughout the agreement will be listed in alphabetical order. You will usually find the terms defined in this section capitalized throughout the agreement to show their importance. These terms are not made to stand on their own but are used throughout the contract to have a shared language between "seller" and "purchaser."
The temptation is to run through these definitions quickly, assuming they are standard terms. However, it is important to read through them thoroughly, as these terms can significantly change the meaning of parts of the agreement depending on how they are defined early on. Some terms that can have a significant effect based on their context include the following:
- Material adverse effect
- Seller's knowledge
Article 2: Transaction Details
In this section, the specific terms of the sale of the stock will be clearly outlined. You will see language in this section referring to the seller transferring or selling to the purchaser or the purchaser acquiring from the seller a certain number of shares.
In this section, you will also find the price and any adjustments made to the purchase price as well as any other items that were shared between the parties when the deal was closed. This will include the following:
- Share certificates
- Purchase price
- Legal opinions
- Employment agreement
- Escrow agreements
- Other ancillary documents
Article 3: Seller's Warranties and Representations
In this section, the warranties from the seller will be defined and stated. This can include statements regarding both past and present facts that are related to the business, such as the following:
- Operating results
- Operations and prospects
Inaccurate representations can result in the liability of the party that made the statements.
Article 4: Buyer's Representations and Warranties
This section is similar to section 3, although it is the representations and warranties that are coming from the side of the buyer. These two sections will often mirror each other. Since the buyer is most likely paying cash for the stock, their representations and warranties can be more limited than the seller's.
Article 5: Covenants
Since most deals will have a period of time between the time the parties sign and the closing, a covenants section will be created to define activities that each party should refrain from doing during this time period. This usually involves a long list of actions that need to occur during this time as well as actions that are prohibited.
Article 6: Closing Conditions
This section will be comprised of conditions that either need to be taken care of or waived before the time that closing occurs. This will often include both parties performing their pre-closing covenants and all regulatory approvals being completed.
Article 7: Indemnification
This 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. Article 7 will often include losses that can arise from specific causes as well. The article will also include the following:
- The outlined period of time during which claims against representations and warranties cannot be brought
- Time limits for indemnification
- The use of escrow funds for indemnification, if applicable
- The extent to which indemnification is the main remedy for a breach
- How the losses will be calculated for recovery
Article 8: Termination
Under Article 8, you will find the details for each party's right to terminate the contract. This includes such reasons for termination as the following:
- Termination due to a failure of a condition
- Termination by mutual consent
- Termination by the buyer if the company had a material adverse effect
- Termination in the event of expiration
- Termination for failure to get government or third-party consent in a timely fashion
Article 9: General Provisions
Every agreement will close out with a section that covers any miscellaneous provisions. These can touch on a variety of subjects, such as the following:
- Governing law
- Dispute resolution
Why Is a Stock Purchase Agreement Important?
Stock purchase agreements are important because they put the terms of a sale into writing. This can prevent misunderstandings that may end up in the courtroom. The agreement also allows the seller to show and explain that they are the owner of the stock being sold. This gives the purchaser more faith in the transaction.
Another important benefit of a stock purchase agreement is that it provides specific information on the transfer of stock. This means all of the warranties from the seller are spelled out. It can also list dispute resolution measures. You can even document that the seller or purchaser will cover certain costs if an unknown preexisting issue causes loss.
Reasons to Consider Not Using Stock Purchase Agreements
Because stock purchase agreements are meant to protect everyone involved, there are very few instances when you should consider not using one:
- You are the only shareholder in the organization.
- You're offering a limited capacity offering that qualifies for Regulation D exemption.
Keep in mind that it's still safer to create a stock purchase agreement. These are only possible reasons for not creating an agreement. This doesn't mean that forgoing a stock purchase agreement is the best decision.
Reasons to Consider Using a Stock Purchase Agreement
- It creates a binding agreement that the sale will take place.
- It allows businesses to raise revenue for the organization.
- The purchaser and seller have time to review the agreement before anything is finalized.
- It explains special tax treatments the signers may receive for the transfer.
Examples of Why a Stock Purchase Agreement Is Important
- The purchaser may expect to receive dividends on their investment. They could later claim that they were promised certain dividends if there's no stock purchase agreement in place. Dividends can be fully explained when an agreement is in place.
- A dispute over unforeseen costs or other issues could cause a disagreement between the purchaser and seller. Without a stock purchase agreement, there is no method of dispute resolution explained. This could result in court costs. If an agreement is in place, the parties at least have guidelines on how to handle the disagreement.
- If someone with a large stake in the company decides to leave, they may want to sell their shares. Without a stock purchase agreement, they can sell these to company outsiders without asking other shareholders. With an agreement, a “right of first refusal” clause can be created. This means other shareholders will have the option to purchase the shares before they're sold to someone else.
Frequently Asked Questions
- Do I have to use a stock purchase agreement? No, but this could create financial risk for you.
- What type of warranties can I provide? You can make any legal warranties you would like, but make sure they are true. Making inaccurate representations or warranties can land you in court. You'll have to reimburse the purchaser for any loss.
- Can I create my own stock purchase agreement? This is an option, and you can find templates online to download, but it's not the best decision. Federal law is complex, and laws are different in every state. It's better to have a legal professional craft your document.
- Using a stock purchase agreement template downloaded online and filling it out yourself.
- Failure to create an agreement because you know the purchaser. This affects your company, so it's important not to take chances.
- Failing to consider the tax implications. Speak with your accountant before signing.
Steps to File
- Fully review the stock purchase agreement with the purchaser.
- Sign the agreement. Both the purchaser and seller must sign. A witness can sign too if you don't know the purchaser well or have reason to think they may pull out of the agreement.
- Make copies of the signed document for the purchaser and company.
- After the purchaser pays for stock, give them certificates that represent the company's stock.
- The stock purchase agreement doesn't need to be filed with the local or federal government. However, you may still need to register the transfer with the SEC if you meet certain criteria.
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