Six Mistakes to Avoid in a Share Purchase Agreement

As an entrepreneur, you may be looking to expand your operations. This process involves negotiating and executing a share purchase agreement, a legally binding document that outlines the terms and conditions of the acquisition. However, share purchase agreements are complex; even a minor oversight or mistake can have severe legal and financial consequences. Failure to address these issues could jeopardise the entire transaction and expose you to potential liabilities, disputes, and long-term operational challenges. This article will explore common mistakes to avoid when drafting and negotiating a share purchase agreement, ensuring a smooth and successful acquisition process.

1. Inadequate Due Diligence

Be sure to conduct thorough due diligence on the target company. Due diligence investigates and verifies the company’s financial, legal, and operational aspects to assess potential risks and liabilities. Skipping or rushing through this step can lead to unpleasant surprises down the line, such as undisclosed debts, pending litigation, or intellectual property issues. Ensure that the share purchase agreement includes provisions for comprehensive due diligence and addresses any identified risks or contingencies.

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2. Ambiguous or Incomplete Representations and Warranties

Representations are statements the seller makes regarding the company’s condition and operations. Warranties are assurances or guarantees the seller provides about the accuracy of specific facts or circumstances related to the business. For example, a warranty might state that the company owns all intellectual property rights necessary for its operations. 

Ambiguous or incomplete representations and warranties can lead to misunderstandings and disputes between the parties. To avoid ownership disputes, the share purchase agreement must clearly define the scope of transferring intellectual property rights. Ensure that the representations and warranties are clearly defined and cover all critical aspects of the business.

3. Failure to Address Post-Closing Obligations

The share purchase agreement should focus on the closing process and outline the parties’ obligations after completing the transaction. This includes provisions for:

• employee retention;
• customer and supplier transitions; and 
• any ongoing support or training required from the seller. 

You should address these post-closing obligations to avoid operational disruptions, potential contract breaches and hindering the acquired company’s ability to maintain business continuity. 

4. Inadequate Restrictive Covenants

Restrictive covenants are provisions in the share purchase agreement that limit the seller’s ability to compete with the acquired business or solicit its employees or customers after the transaction. These covenants are essential to protect your investment and prevent the seller from undermining the acquired company’s operations. Failure to include robust restrictive covenants or drafting them inadequately can expose you to significant risks, such as the seller:

• setting up a competing business;
• poaching key employees; or 
• luring away valuable customers. 

Ensure that the restrictive covenants are tailored to your specific circumstances, enforceable under applicable laws and provide sufficient protection for your investment.

5. Inadequate Indemnification and Limitation of Liability Clauses

Indemnification clauses require one party to compensate the other party for potential losses or liabilities arising from the transaction. For example, the seller may indemnify you against undisclosed liabilities or legal claims related to the acquired company. 

Similarly, limitation of liability clauses limits the extent to which one party can seek compensation from the other in case of a breach or default. Please include these clauses or draft them appropriately to avoid exposing both parties to significant financial risks. Ensure that you clearly define and negotiate these clauses to provide appropriate protection for both parties.

6. Overlooking Price Adjustment Mechanisms

In many share purchase agreements, the final purchase price is subject to adjustment based on the target company’s financial performance or other factors. These price adjustment mechanisms ensure that the buyer pays a fair price based on the company’s actual condition at closing. Failing to include appropriate price adjustment provisions or overlooking the need for such mechanisms can lead to overpayment or underpayment. Common price adjustment mechanisms include working capital adjustments, net debt adjustments, and earn-out provisions. Ensure that you carefully consider the need for these mechanisms and clearly define the adjustment criteria and calculation methods in the share purchase agreement.

Key Takeaways

Negotiating and executing a share purchase agreement is a critical step in the acquisition process. Avoiding common mistakes is essential to ensure a successful transaction. You should remember to:

• conduct thorough due diligence on the target company to identify potential risks and liabilities;
• ensure that representations and warranties are clearly defined and cover all critical aspects of the business; 
• address post-closing obligations to ensure a smooth transition, maintain business continuity, and avoid legal disputes; 
• include robust restrictive covenants to protect your investment and prevent the seller from undermining the acquired company’s operations; and 
• include adequate indemnification and limitation of liability clauses to protect both parties from potential losses or liabilities.

Navigating the complexities of a share purchase agreement can be daunting. Our experienced commercial lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. So call us today on 0808 258 4780 or visit our membership page.

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