Part 3: Contract negotiation and signing
Once the due diligence process(see previous article) has been completed by the potential buyer (or their advisor), the actual contract negotiation phase begins, at the end of which the contract is (ideally) signed.
Core topics of contract drafting and negotiation
In this phase, the focus is on drafting the share purchase and transfer agreement (SPA) and any supplementary draft agreements (e.g. consultancy agreement, rental agreement, service agreement).
As already mentioned in the article on due diligence at the beginning, the results of due diligence serve to better classify risks and regulate specific issues in the context of contract preparation and negotiation.
The focus of contract drafting and negotiation is usually on the specific structure of the purchase price, the buyer’s warranty rights/guarantees/exemptions, the classification and definition of the parties’ liability standards/duties of care as well as provisions for the dissolution of legal relationships between the seller and the target company (e.g. repayment of shareholder loans, rental agreements, etc.).
However, questions of implementation are also concretized in this phase of the transaction: for example, whether the acquisition is carried out directly by the purchaser or indirectly via a company (NewCo) yet to be founded as an acquisition vehicle. How the shares are to be transferred also plays a decisive role. The transfer of a GmbH share and therefore also the corresponding SPA must be notarized. Furthermore, any existing approval requirements must be clarified in advance. Common examples here are consent requirements from the articles of association of the target companies (restrictions on transferability, consent of spouses pursuant to Section 1365 BGB, etc.).
The design of the SPA
Even though there is basically no “right” or “wrong” way to design a spa, a standard structure has been established in practice:
- Regulation of the essential contractual conditions: Parties, subject matter of the contract, purchase price and payment modalities, cut-off date, withdrawal and termination; entitlement to profit for the current financial year;
- Completion: Generally at a later date than the signing. The buyer receives the economic power of disposal over the target company;
- Liability: Various assurances/guarantees by the sellers regarding the shares and the company;
- Non-compete clause;
- Taxes: Here, the delimitation of responsibility is generally based on the reporting date principle (before the reporting date = seller; after the reporting date = buyer);
- Costs: Cost regulations with regard to the conclusion and implementation of the contract and with regard to the external consultants involved.
The purchase price arrangements are varied and range from a fixed purchase price to a variable arrangement including an earn-out. Which one makes sense depends on the specific individual case and should be agreed with financial and tax advisors in particular. From a legal perspective, it is advisable to provide security in this context to ensure that (i) you actually receive the shares with payment of the purchase price or (ii) you secure any guarantee claims by retaining part of the purchase price, for example.
With regard to liability, statutory liability and warranty are usually excluded under the SPA and replaced by an independent warranty and liability regime. The background to this is that it is often difficult to prove when incorrect contract details lead to warranty claims as a material defect in individual cases. In addition, the seller could often exonerate himself from the accusation of fault.
Against this background, independent guarantee promises are usually agreed. The issue of such guarantees ensures that the seller is liable for missing or incorrect information regardless of fault. These guarantees can cover all areas or areas of the company that are the subject of the due diligence (if carried out). This means both the legal circumstances of the company as well as the economic circumstances, such as, for example, the financial situation.
- Accuracy and completeness of company information;
- Legal guarantees with regard to ownership and the right to dispose of the shares,
- the accuracy and completeness of the annual financial statements (balance sheet guarantee),
- the existence of a certain amount of equity (equity guarantee),
- the secured existence of the property rights,
- the existence of all permits required for the operation of the company,
- the contract portfolio (e.g. rental and employment contracts including any claims from employee participation models),
- Employees.
The legal consequences of a breach of warranty are also regulated differently and to the exclusion of the statutory provisions. In principle, liability for damages applies. The amount of the warranty claims can be limited (cap or agreement of a de mini-mis limit). In the same way, regulations on limitation periods that deviate from the law are often agreed.
The same applies to taxes as to liability. It is advisable to include comprehensive tax guarantees and a tax exemption clause in the SPA to protect against any risks in this area. In this case, the accrual principle is applied. This means that all tax matters (commenced and completed) and the associated tax risks prior to the reporting date are the responsibility of the seller. All tax risks after the reporting date are the responsibility of the buyer.
In summary, this also shows that comprehensive planning and a structured process are essential. This requires some effort, but it is definitely worth it, especially if it contributes to the successful completion of the planned transaction.
Outlook
This series of articles provides small and medium-sized companies with an initial guide on how a transaction process can be structured and successfully mastered. To this end, the following articles will present the key topics in the context of an M&A transaction in a compact and practice-oriented manner. In the next article, we will focus on the topics “Completion of the transaction” and “Integration of the target company into the existing structures of the acquirer”.
Do you have questions about the typical challenges? Please feel free to contact us.
The author and your usual contacts will be happy to answer any questions you may have!
Christian Schon
schon@tigges.legal
+49 211 8687 284