A keen entrepreneur looking to buy a new business had the opportunity to buy all the shares in a company that was for sale.  He was very excited and thought this would provide him with a quick income, so rushed to sign a share sale and purchase agreement without taking legal advice first. 

A few months later the buyer realised that the company had more debts than assets and was on the road to insolvency.  As a result he lost a significant amount of money. 

What does buying shares in a company mean?

Where a business is owned and operated by a company, one way of buying the business is to buy all the shares so that you become the only shareholder of the company itself.

A company is a registered legal entity, which often holds business assets, but equally can hold other assets such as property.

The buyer and seller usually sign a written share sale and purchase agreement and then the shares are transferred and registered to the new shareholder of the company. 

This differs from the more usual approach where the seller winds up their company, the buyer sets up a new company, and then buys the business‘s assets, goodwill, and intellectual property. 

Obligations on the buyer

Once the buyer owns the shares, they take on all responsibility for the company’s assets and liabilities, including any debts the company might already have incurred.  This can be an alarming and costly surprise for buyers who have not conducted thorough due diligence investigations before their purchase. 

As a buyer it is imperative that you look closely into the business, including its financial records and contractual commitments, and take professional advice from legal and financial advisors, to make sure you have a full picture of what you are buying. 

Written share sale and purchase agreement

The buyer and seller should always enter into a written agreement to clearly record the terms of the sale.  This is especially important in the event of a dispute about the transaction.  A business sale that is not properly recorded in writing is very risky, and could result in major financial loss. 

Conditions

Share sale and purchase agreements are often conditional upon certain events occurring, with conditions included for the benefit of the buyer to ensure that if any condition cannot be fulfilled then the transaction will not go ahead.

Examples of conditions often included in an agreement include:

  • Finance: allowing the buyer to arrange satisfactory finance to purchase the shares in the company;
  • Due diligence: giving the buyer time to conduct due diligence investigations into the company;

If relevant conditions are not included in an agreement, the buyer will be legally obliged to proceed with buying the shares regardless of their personal situation, in other words even if they cannot arrange suitable finance or are not satisfied with the position of the company after looking into it.  Prudent buyers must seek legal advice before signing an agreement, to ensure that all the conditions they might need are included.

Warranties

An agreement usually includes warranties from the seller that certain things are correct and/or have occurred.  From a buyer’s perspective these should be drafted carefully to give the widest protection available.  In contrast a seller will want to ensure that they limit their warranties as far as possible, so that is something for buyers to bear in mind. 

Examples of warranties that are often included in an agreement include:

  • Unencumbered shares: confirmation that the shares being transferred are free of any security interest;
  • True and accurate information: confirmation that the information being provided by the seller is true and accurate;
  • No liabilities: that the company has no undisclosed liabilities.

The value of legal advice

If the eager buyer in the above scenario had obtained legal advice prior to signing the share sale and purchase agreement, a warranty clause could have been included guaranteeing that the company had no undisclosed liabilities.  If the seller had breached that warranty then the buyer would have been able to recover their losses from the seller.  Unfortunately as that was not the case, the buyer had no recourse.

As a buyer it is vital that you obtain legal advice before entering into a share sale and purchase agreement, to ensure that the terms are tailored to your specific needs. 


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