The acquisition agreement is one of the most important transaction documents in a private equity deal. It is long, verbose, and difficult to understand without the benefit of years of deal experience. In light of my six years of experience doing deals in Asia and Europe, and in the spirit of Brad Feld’s excellent series of blog posts on term sheets, I’ve decided to write a series of blog posts on the acquisition agreement.
I’ll start this series by providing an overview of the acquisition agreement (also referred to as a purchase and sale agreement, share purchase agreement, or sale and purchase agreement). This post will cover the purpose of the acquisition agreement, often abbreviated as SPA, and the key sections within the SPA. I will not explore any section in detail in this post; rather, I want to show how all the pieces fit together before delving into any section. Before I begin, I should emphasize that is is by no means meant to be a definitive guide to private equity acquisition agreements; that would be pure arrogance. It is merely a starting point.
The Purpose of the SPA
So, without further ado, the purpose of the SPA. The SPA is a legally binding document that sets out the terms that will govern the sale of the equity of the target company by the seller(s) to the purchaser(s). It will not set out the characteristics of the equity interests sold and will not set out the relationship of the parties after the closing. The former is defined in the constituent documents of the target company, which—depending on the jurisdiction in which the target company is incorporated—will be called the certificate of incorporation, the by-laws, the memorandum of association, the articles of association, or the charter. The latter is established by the shareholders’ agreement.
The Parts of the SPA
The SPA is divided into several parts (often referred to as “articles” or ”sections”), which I have set out in the table below.
|Definitions||Definitions for words used in the SPA, sorted alphabetically.||The definitions section is one of the most important sections of the SPA. As with most legal documents, many words and phrases will be given special meaning which can trip up the unwary, and the special meanings of these words and phrases will be specified in this section. When reading an SPA, one will frequently end up flipping back to this section to find the meaning of certain defined words and phrases. (I like to print it out separately so that I don’t have to keep flipping back and forth.)|
|Purchase Price||Defines the method used to calculate the purchase price that will be paid to the seller(s), and if a purchase price adjustment mechanism1 is used, the method by which the purchase price will be adjusted after closing.||The purchase price calculation method (and its associated adjustments) will be heavily negotiated. If there is an earnout, it will often be included in this part of the SPA.|
|Representations and Warranties||Representations and warranties made by, among others, the purchaser(s), the seller(s), and the target company. The representations and warranties will be qualified by specific disclosures made in a separate disclosure schedule.||The representations and warranties are one of the most negotiated sections of an SPA. Representations are statements of fact or opinion about something. Warranties are assurances or promises regarding something. There are legal distinctions between the two,2 and these legal distinctions can result in different remedies being available if there is a breach.|
|Covenants||The covenants in the SPA will frequently be divided into pre-closing and post-closing covenants, and are things that one of the parties to the SPA promises to do, or promises not to do||The covenants section is where the parties commit themselves to doing or not doing certain things. In most transactions, given that there will often be period of time between signing and closing, there will be certain things that purchaser(s) will want to prevent the seller(s) from doing, such as extracting value from the target company by paying dividends, issuing debt or equity securities in the target company or its subsidiaries, selling material assets of the target company, causing the target company to incur material liabilities, or competing with the business of the target company post-closing. The seller(s), in turn, will be interested in, among other things, compelling the purchaser(s) to cooperate with the seller(s) in obtaining required government approvals for the transaction, ensuring that the purchaser(s) keep confidential the terms of the transaction and the fact that the transaction is occurring, limiting the ability of the purchaser(s) to change the terms of its equity and debt financing, or imposing an obligation on the purchaser(s) to use best efforts to satisfy conditions precedent to the debt financing.|
|Conditions for Closing||The conditions precedent for closing are conditions that must be met at the time of closing, otherwise the closing need not occur.||These conditions will include the truth and correctness of the representations and warranties made by the seller(s) and purchaser(s) respectively, delivery of written legal opinions, performance of all material obligations under the SPA by the seller(s) and purchaser(s) respectively, and anything else that needs to be in place by closing in order for the purchaser(s) to be able to take over the target company and run it immediately after closing. While some are legal boilerplate included as a matter of course and not negotiated, some will be tailored to the specifics of the target company and the needs of the seller(s) and purchaser(s).|
|Indemnities||The conditions for a party to the SPA to make a claim against another party for a breach of the terms of the SPA.||The indemnities are the primary remedy for breaches of the SPA. This section is one of the most heavily negotiated sections of the SPA, with the seller(s) and purchaser(s) negotiating such matters as the duration of the indemnities, the thresholds below which the seller(s) are not obligated to indemnify the purchaser(s), the maximum amount that a party to the SPA will have to pay in indemnity claims, the duration of the indemnities, and the procedures by which a claim for indemnification will be made.|
|Termination||How and when a party to the SPA can terminate the transaction(s) and walk away from selling or buying the target company, and the consequences of terminating the transaction(s), including any break-up or reverse break-up fees associated with walking away.||This is another heavily negotiated section of the SPA. It can be a difficult topic to discuss, and one that often ends up being negotiated by seller(s)’ and purchaser(s)’ attorneys to limit the relationship damage that might occur if the parties discussed this directly.|
|Miscellaneous||A grab bag of clauses that are usually left for the end of the SPA and which do not fit well into any of the preceding sections.||This is where a number of legal boilerplate clauses are included, including such things as the law that will govern the SPA, the dispute resolution method that will be used (arbitration or litigation), and other similar clauses. This is not an area where your average private equity investment professional needs to get involved, except on the margins.3|
Drafting the SPA
In a negotiated sale, the purchaser(s)’ attorneys will prepare the first draft of the SPA. In an auction process, the seller(s)’ attorneys will prepare the first draft to ensure consistency across all the bids received. This is important for one reason. The party that prepares the first draft of the SPA sets the tone for the discussion. The party making changes to the draft is the party that must justify its changes.
I think of the SPA as a bundle of trade-offs. Each part of the SPA can be tailored to favor the seller(s) or the purchaser(s). Often, unless negotiating power is very significantly skewed towards one party, the parties will make trade-offs that reflect the value they place on different rights and obligations.
Because it is a bundle of trade-offs, it is important to understand each part of the SPA. Only then can one see where there is room to give and take in the negotiation of the SPA, and thus close the transaction.