At the conclusion of a merger and acquisition process, the buyer and seller finalize a sale agreement, commonly referred to as a "SPA" for "Share Purchase Agreement". This document notably specifies the price that the buyer is willing to pay to acquire the shares of the target company, an amount resulting from lengthy negotiations based on a detailed valuation of the business. However, the acquisition price is only one component of the agreement. The buyer often includes various protective clauses to guard against events that may occur during or after the negotiation.

What are the clauses of an SPA? What are the points of attention and negotiation that can be problematic?

The SPA conclusion process

During a sale, it is generally the buyer who drafts an SPA project with the help of their legal representatives. The process of concluding an SPA is divided into three main phases:

• the pre-contractual phase, during which the terms of the agreement are negotiated and legal documents are exchanged;
• the contractual phase, where the agreement is finalized and necessary consents are obtained;
• the post-contractual phase, where transfer formalities are completed and commercial costs, such as tax liabilities, are addressed.

In order to draft the SPA and negotiate its clauses, the buyer relies on detailed information about the company provided by the seller during the due diligence phase (financial data, tax information, ownership structure, ongoing litigation, assets and liabilities, as well as details on employees and company management). The negotiation of these clauses is essential in the context of an acquisition: if the SPA is too harsh towards the seller, they may favor another offer, and if it does not provide enough comfort to the buyer, they may withdraw their offer. Knowing the key clauses of an agreement and anticipating potential sticking points is therefore crucial to secure a transaction.

Negotiating the sale price

There are two main methods for establishing the sale price when negotiating an SPA:

• The traditional mechanism with closing accounts;
• The Locked Box mechanism.

Each of these methods has specific advantages and disadvantages, which are more or less favorable to the buyer or seller.

Closing accounts mechanism (or completion accounts):

In a classic process, the transaction price is established in two stages:

1. Establishing the provisional price:

The provisional price is based on the value of the target company, determined from the latest approved financial statements or interim financial statements. This value is calculated according to a formula agreed upon by the parties, often on a "debt-free cash-free" basis, excluding available cash and company debts. The provisional price is established at the time of the conditional contract (signing). At this stage, a closing date is then set: it will serve as the basis for the preparation of the closing financial statements (generally prepared by the buyer) according to which the price will be adjusted.

2. Determining the final price: adjustment of the provisional price

The final price is adjusted based on the accounts that will have been prepared at the closing date as well as the state of cash, debt, and working capital of the target to determine its real value. The definition of these financial aggregates is agreed upon in advance to avoid any divergence. It is recommended to include an expertise clause to resolve any disagreement regarding this adjustment, by calling upon a third-party expert if necessary.

Prudent management between signing and closing

It is essential to include in SPAs involving a price adjustment, clauses regarding the management of the target by the seller between signing and closing. These clauses must stipulate that the seller has the obligation to manage the company prudently, according to the normal course of business, to avoid any decrease in cash or detrimental commitment that could affect the value of the target.

It is also advisable to require the prior agreement of the buyer for certain important management decisions, such as investments or loans exceeding a certain threshold, or the sale of key assets. The objective of these clauses is to minimize price adjustments after closing.

The closing accounts mechanism offers significant advantages for the buyer, notably better certainty regarding the final price and the value of the acquired company, as they will pay the exact value at the time of acquisition. However, it also has disadvantages, such as post-closing disputes regarding price determination and associated costs. For the seller, this mechanism can also lead to conflicts over the final price, although the security provided by this system may reduce the guarantees required by the buyer.

Locked Box Mechanisms

The locked box mechanism sets the sale price based on financial statements prior to the conclusion of the sale agreement, without subsequent adjustment for changes occurring after this date. This mechanism offers price certainty at the signing date, however it does not exclude that adjustments may be made for any inaccuracies in the financial statements that would violate the representations and warranties of the contract.

To protect the buyer against a loss of value until the effective takeover, a period is defined between the date of the financial statements and the closing, where certain cash outflows (leakage), such as dividends or management fees, are prohibited. Under this mechanism, it is generally the seller who prepares the reference financial statements, requiring increased vigilance on the part of the buyer during the due diligence and in the required warranties.

To protect the buyer from any loss of value of the target between signing and closing, it is systematically recommended to includeanti-leakage clauses. These clauses aim toprevent any operation that could result in a loss of value of the target company(dividend distributions, billing of management fees, payment of exceptional remuneration, etc.). Carefully and exhaustively determining the list of these operations is essential. However, certain cash outflows are necessary to ensure the continuity of proper management of the company. These cash flows, such as the payment of salaries or suppliers, must be established aspermitted leakages. It is advisable to provide in the SPA a mechanism forprior authorizationfrom the buyer for certain operations, depending on their nature or amount, or that thesepermitted leakagesresult in a price reduction.

The locked box mechanism has the advantage of providing the seller and buyer withsimplicity and certainty on the sale price.Nevertheless, it presents a risk for both parties, especially for the buyer:

• For the buyer due to potential fluctuations in the company after the date of the reference financial statements and uncertainty about the future state of the target.
• For the seller who gives up any potential gain resulting from the increase in the company's value until closing.

In summary, the main disadvantage lies in the interim period between signing and closing, where the buyer bears the economic risk while the seller continues to manage the company.

The main difference between the two price determination methods lies in when the risk is transferred. In the locked box mechanism, the risk is transferred when the financial statements are established before the execution of the agreement. On the other hand, for closing accounts, the risk is transferred at the time of closing. The choice between these mechanisms will depend on the specifics of the transaction and the interests of the parties involved. To avoid disputes and blockages in the operation, it is crucial that the SPA is drafted clearly and precisely.

Price Supplement ("Earn-Out")

The price supplement, or Earn-Out clause, often appears due to the differences in objectives between the seller, who anticipates future development of the company, and the buyer, who is cautious in the face of uncertainty. This clause allows for adjusting the sale price based on the future performance of the company. Generally, the price supplement does not exceed 15% of the sale price and extends over a period of 1 to 3 years. To avoid abuse, it is essential to define simple and transparent calculation rules. This supplement can be based on future profits or the achievement of certain performance targets.

When negotiating an earn-out clause, the advantages and disadvantages differ depending on whether you consider the seller's or the buyer's perspective:

• For the seller, this clause allows for maximizing the sale price if the company achieves its future objectives, although it involves waiting to receive part of the sum.
• For the buyer, the earn-out facilitates financing the acquisition by spreading out payments and reducing initial risk. However, if the company exceeds expectations, the buyer could ultimately pay more than the initially envisaged fixed sale price.

To effectively draft an earn-out clause, it is essential to clearly define thedurationof the period, thescheduleof payments, the performancecriteria, and themeasuresto be taken in case ofdispute. The complexity of the earn-out lies in several key factors:

1. The scope: The earn-out is calculated solely on the acquired entity, which requires accounting parallel to that of the acquirer. This can complicate post-acquisition integration due to divergences in accounting methods between the two parties.
2. The temporality: The duration of the earn-out period is crucial. A buyer prefers a long period to defer payments and verify the economic viability of the target, while the seller, not managing post-sale, favors a shorter period.
3. Performance criteria: These can be financial (revenue, EBITDA) or non-financial (number of new products launched). The measurability of financial criteria is paramount and may require audits to ensure the buyer's good faith.
4. The calculation formula: Formulas can vary, ranging from tiers to options, including multi-criteria structures. The more complex the formula, the more difficult the valuation of the earn-out becomes.

Finally, it is recommended to include protection mechanisms such as escrow clauses to secure the interests of both parties and minimize the risk of disputes. These elements ensure that the earn-out is fair and accurately reflects the future performance of the company.

Vendor Financing

The seller can offer a payment facility for part of the sale price, whether remunerated or not at a market rate, thus reducing the need for bank loans and strengthening the confidence of financial institutions. This amount generally represents between 5% and 20% of the total sale price and is repayable in less than 3 years without interest.

A life insurance policy is often required if the buyer is appointed as the future manager.

Vendor financing, or deferred payment, allows the seller to grant a payment delay to the buyer, consisting of a partial or total deferred payment of the sale price. This receivable is certain and is not subject to any conditions. The risk of non-payment is thus covered by a first-demand bank guarantee or surety.

This method is advantageous for the buyer as it allows for involving the seller in the takeover process. If the operation fails and the company cannot repay its loans, the acquirer would not be able to repay the loan granted by the seller.

For the seller, deferred payment allows for setting a higher price by offering financing facilities to the buyer. The longer the loan duration, the higher the risk for the seller. It is also a means to negotiate the acquisition price and financing conditions. Experienced lenders often require that the vendor financing be subordinated to senior debts.

La Clause de Garantie Actif-Passif (GAP)The Asset and Liability Warranty Clause (ALW)

La clause de garantie actif-passif (GAP) est une composante cruciale du SPA, protégeant l'acheteur contre les risques de passifs non divulgués (litiges fiscaux, sociaux, etc.) ou d'actifs surévalués découverts après la cession. Elle assure que le prix payé reflète fidèlement la valeur réelle de l'entreprise cible, en tenant compte des ajustements nécessaires pour tout élément financier non prévu initialement. La clause GAP permet d'identifier et de gérer ces risques en stipulant que le vendeur doit indemniser l'acheteur pour toute perte financière résultant de passifs ou de diminutions d'actifs dont l'origine est antérieure à la transaction.

To establish an ALW clause, essential points to cover are:

1. Guarantee Cap: It is common to set an indemnification cap, often between 15% and 30% of the sale price. This cap generally reduces over the years, reflecting the gradual decrease in risks related to old liabilities.
2. Deductible or Indemnification Threshold: The clause must include an indemnification threshold, which typically varies between 1% and 5% of the sale price. This means that only losses exceeding this threshold can trigger compensation by the seller.
3. Duration of the Guarantee: The duration of the ALW is often aligned with the tax statute of limitations, generally 4 years (3 years of tax statute of limitations plus 1 additional year). This duration can be adjusted based on the specifics of the transaction.
4. Triggering and Application Modalities: The clause must specify the triggering conditions, including notification to the seller and proof of losses incurred. Binding modalities, such as strict deadlines for notification, must be in place to prevent abuse.
5. Exclusions and Limitations: It is crucial to define what is excluded from the guarantee, such as uncertain or indirect damages. Additionally, amounts recovered from insurers must be deducted from the compensation amount due by the seller.
6. Guarantee of the Guarantee: To secure the execution of the ALW clause, the buyer can require counter-guarantees, such as escrow of part of the sale price, personal or real securities, or subscription to a liability guarantee insurance.

The ALW clause is essential for securing the buyer's interests in a merger and acquisition transaction. Its negotiation requires meticulous attention to detail and a thorough understanding of potential risks. A clear and precise drafting of this clause, combined with appropriate guarantees, can minimize post-sale disputes and ensure a smooth transition for both parties.

Conditions Precedent

Conditions precedent are essential provisions in business transfer agreements, allowing for securing the commitment of parties until certain prerequisites are met. They offer legal protection to the buyer by ensuring that certain situations or events materialize before the acquisition becomes final.

They may include conditions such as obtaining specific financing, satisfactory completion of audits (accounting, financial, legal, etc.), or approval by shareholders or governing bodies of the target company. These clauses must be drafted precisely to avoid any ambiguity and ensure they cover all critical aspects of the transaction. A typical condition precedent clause in an SPA might stipulate that the acquisition will only be finalized if the buyer obtains bank financing for a certain amount of money before a specified date. This clause protects the buyer by allowing them to withdraw from the agreement without penalty if financing is not obtained, thus reducing the financial risk associated with the transaction.

It is also crucial to specify the deadline by which these conditions must be met and to clearly define the consequences of their non-fulfillment. If the conditions precedent are not met within the specified timeframe, the sale may be canceled without penalty, unless one of the parties has acted in a way to prevent the fulfillment of these conditions.

For sellers, it is important to understand that the inclusion of conditions precedent can prolong the sale process and introduce uncertainty until all conditions are satisfied. However, these clauses are often necessary to ensure transparency and good faith in negotiations, by allowing the buyer to carry out their due diligence and secure the resources necessary for the acquisition.

Specific Clauses

In addition to the general clauses discussed previously, it is crucial to take into account certain specific clauses when drafting an SPA. These clauses can have a significant impact on the transaction and must be carefully negotiated and drafted. The following clauses are regularly encountered:

• Shareholders' current accounts: These accounts are generally repaid before or at the time of the transfer. It is important to clearly define the repayment terms to avoid any post-transfer disputes.
• Employment contracts of family members: it is necessary to decide whether these contracts will be maintained or terminated. Clauses must be added to specify the conditions for maintaining or terminating these contracts.
• Real estate: if it is outside the scope of the transfer, its use must be clearly defined. This may include options such as immediate buyback, term buyback, or rent setting. The clauses must specify the terms of these agreements to avoid any ambiguity.
• Benefits in kind (company vehicles, IT equipment, etc.): it is common to include clauses for the return of these benefits or their buyback by the seller.
• Non-compete clause: the objective is to protect the buyer against direct competition. This clause must clearly define the geographical scope and duration of the non-competition.
• Transition support: the terms of the support, which is generally for a duration of 3 to 6 months, must be clearly defined.

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Negotiating and drafting an SPA (Share Purchase Agreement) are crucial steps in the business transfer process. It is essential to thoroughly understand the various clauses and mechanisms, such as determining the sale price, earn-outs, vendor financing, asset and liability guarantee, and conditions precedent, in order to best protect the interests of each party. Particular attention must be paid to the precise and clear drafting of these clauses to avoid post-sale disputes and ensure a smooth transition. Ultimately, a well-negotiated and drafted SPA contributes to the success of the transaction and the satisfaction of both parties involved. We recommend that you seek assistance for this key step.