Typically stock purchase agreements come after you had investors getting excited with your pitch deck and something that perhaps you created out of a good pitch deck template.
In essence, stock purchase agreements are divided into sections breaking down the transaction process and specifying what particular terms mean. The structure of a stock purchase agreement is as follows when broken down into parts:
- Preamble
- Definitions
- Transaction Details
- Seller’s Warranties and Representations
- Buyer’s Warranties and Representations
- Covenants
- Closing Conditions
- Indemnification
- Termination
- General Provisions
The Preamble
The preamble is a term used to describe the first section of a stock purchase agreement. The agreement will be named, the parties will be identified, and the contract’s date will be set in this section. The parties get referred to frequently as the “seller” and “purchaser” in the preamble.
The following section is the Recitals section, which contains a sequence of statements, many of which will begin with the phrase “whereas.” These declarations are produced to lay out the contract’s goals but aren’t necessarily specific agreements between the parties.
Definitions
In this section, the different definitions that get used in the agreement get listed in order. These terms are not intended to stand alone; rather, they are used throughout the contract to establish a common language between the “seller” and the “purchaser.”
Make sure you read through each section thoroughly, as the meaning of each term can have different meanings throughout the agreement, depending on how they get defined at the start. Examples of terms that can have a significant effect based on their context include:
- Seller’s knowledge
- Liabilities
- Material adverse effect
Transaction Details
Here you will find a clear outline of the specific terms of the stock’s sale. For example, you’ll see wording in this section about the seller transferring or selling a specific number of shares to the purchaser or the purchaser receiving a particular number of shares from the seller.
The price, purchase price adjustments, and any other items shared between the parties after the sale was closed get included in this section. The following get included:
- Purchase price
- Share certificates
- Escrow agreements
- Legal opinions
- Other ancillary documents
Seller’s Warranties and Representations
The seller’s warranties will get defined and stated in this section. This can include statements on both previous and current facts about the startup, such as:
- Operating results
- Property
- Liability
- Assets
- Condition
- Operations and prospects
Inaccurate representations can result in the party making the statements being held liable.
Buyer’s Warranties and Representations
Compared to the previous section, the warranties and representations are coming from the buyer’s side, and the two sections will regularly mirror each other. The buyer’s warranties and representations can be more limited than the seller’s.
Covenants
Because most deals will have a period between when the parties sign and when they close, a covenants section will be created to describe what each party should not do during that time. This typically involves a comprehensive list of activities that must be completed during this period and those that are prohibited.
Closing Conditions
This section will include any criteria that must be met or waived before the closing can take place. This usually entails both parties fulfilling their pre-closing covenants and obtaining all regulatory approvals.
Indemnification
The indemnity rights will get outlined, including the circumstances under which the other party will get compensated if one party breaks the contract. This section frequently includes losses that may occur as a result of specific circumstances. The following also get included:
- Indemnification time limits
- If applicable, the use of escrow funds for indemnification
- The outlined period where claims against warranties and representations can’t be brought
- How the recoverable losses will get calculated
- The degree to which indemnification is the primary solution for a breach
Termination
The details of each party’s right to terminate the contract will be stipulated here. The following reasons will typically allow for termination:
- Termination by mutual consent
- Termination due to expiration
- Termination due to the failure of a condition
- Termination by the buyer due to the startup having a material adverse effect
- Termination for failure to get a third-party or government consent on time
General Provisions
Every agreement will have a section at the end that covers any further provisions. These can include a wide variety of topics, including the following:
- Governing law
- Expenses
- Assignment
- Notice
- Severability
- Dispute resolution
- Counterparts
Steps to Take When Filing a Stock Purchase Agreement
- Review the stock purchase agreement
- Both buyer and seller will need to sign the agreement, along with witnesses.
- Make copies of the signed agreement for the startup and buyer
- Give the buyer certificates which represent the startup’s stock after they pay for the stock
- You may still need to record the transfer with appropriate agencies
Why a Stock Purchase Agreement is Important
A stock purchase agreement is significant because it has the terms of the sale in writing, and a legal battle can be avoided from any misunderstandings. This increases the buyer and seller’s trust in the deal.
Another advantage of a stock purchase agreement is that it specifies the details of the stock transfer. This means that the seller’s warranties are clearly stated and provides a list of options for resolving disputes. You can also document that if a previous issue produces a loss, the seller or buyer will cover specific expenses.
Examples:
- Someone with a significant stake in the startup may want to sell their shares if they decide to leave. They can sell these to outsiders without asking other shareholders if they don’t have an agreement. A “right of first refusal” clause can be included in an agreement so that other shareholders can buy the shares before they get sold to a third party.
- The buyer may expect a return on their investment in the form of dividends. If there is no stock purchase agreement in place, they could later claim that they were guaranteed certain dividends.
- A conflict between the buyer and seller could arise due to unforeseen costs or other concerns. There is no form of dispute resolution established without a stock purchase agreement. Court fees may be incurred as a result of this. If a contract is in place, the parties will have a set of rules to follow in the event of a disagreement.
Common Mistakes to Avoid
- Filling out a generic stock purchase agreement template that you found online. Every jurisdiction has different laws, making laws complex. Get a legal professional to draft your agreement.
- Failure to establish an agreement because you know the buyer. It’s critical that you don’t take any chances, as it can impact your startup.
- Not thinking about the tax consequences. Before you sign anything, speak to your accountant.
Conclusion
Although it’s not essential to have a stock purchase agreement in place, it can create a financial risk for you and your startup over the long term. Avoid using templates generic found online, and instead, get a legal professional to draft your document.
Avoid making inaccurate warranties or representations, resulting in you going to court and reimbursing the buyer for losses.
Stock purchase agreements are there to protect your startup, especially if your business grows and more investors and shareholders come on board.