What Is a Stock Purchase Agreement & How Does It Work?

A stock purchase agreement (SPA) is a legally binding contract that formalizes the terms and conditions for buying and selling company shares. It provides a structured framework for the transaction, outlining the specific details of the stock transfer and establishing the rights and obligations of all parties involved.

What a Stock Purchase Agreement Is

An SPA is a contract between a buyer and seller for the transfer of a company’s shares. It transfers ownership of the entity, or a portion of it, through the acquisition of its stock. The agreement establishes all terms and conditions related to the sale.

This type of agreement differs significantly from an asset purchase agreement, where a buyer acquires specific assets and potentially assumed liabilities, but not the entire legal entity. In a stock purchase, the buyer acquires all assets and liabilities of the company, known and unknown, by purchasing the shares from the existing shareholders. This comprehensive transfer of ownership makes the SPA a central document in business acquisitions.

An SPA formalizes the deal, protects buyer and seller interests, and specifies sale terms. It minimizes disputes by defining each party’s responsibilities and obligations. The primary parties are the buyer, who acquires shares, and the seller, the existing shareholder(s) of the target company.

Key Elements of a Stock Purchase Agreement

A stock purchase agreement contains several provisions that define the transaction. These include the identification of the buyer, seller, and the specific shares being transferred. The agreement details the number and type of shares, such as common or preferred, along with their value.

The purchase price and payment terms are also clearly outlined within the SPA. This section specifies how the price for the shares is determined and the method of payment, which can include cash at closing, deferred payments, or earn-outs based on future performance. It may also detail any adjustments to the purchase price that might occur based on certain conditions, like working capital at closing.

Representations and warranties are statements of fact made by both the seller and the buyer about the company and its business. The seller provides assurances regarding the company’s financial health, legal compliance, and the absence of undisclosed liabilities. These statements are for risk allocation, providing the buyer a basis to seek remedies if information proves inaccurate.

Covenants are promises and obligations that the parties agree to fulfill both before and after the closing of the transaction. Pre-closing covenants might require the seller to operate the business in the ordinary course and allow the buyer access for due diligence. Post-closing covenants can include non-compete clauses, non-solicitation of employees or customers, and confidentiality agreements.

Conditions to closing list the events or actions that must occur or be waived before the transaction can be finalized. These often include obtaining necessary regulatory approvals, securing third-party consents, and ensuring the accuracy of representations and warranties at the time of closing. If these conditions are not met, either party may have the right to terminate the agreement.

Indemnification provisions outline how one party will compensate the other for losses arising from breaches of representations, warranties, or covenants. This clause benefits the buyer, who relies on the seller’s assurances about the company’s condition. It clarifies which party is responsible for specific liabilities that may arise post-closing.

Closing mechanics detail the practical steps for completing the transaction, including how and when the transfer of shares and payment will occur. Termination provisions specify the conditions under which the agreement can be ended, such as failure to meet closing conditions or by mutual consent. These clauses manage risk by providing an exit mechanism for both parties.

The Process of a Stock Purchase Agreement

The process of a stock purchase agreement begins with initial discussions and negotiation of core terms. Parties formalize these understandings in a non-binding Letter of Intent (LOI) or Term Sheet. This document outlines the basic deal structure, including the proposed purchase price and conditions.

Following the LOI, the buyer undertakes a thorough due diligence investigation. This phase involves a comprehensive review of the target company’s financial, legal, operational, and commercial aspects. Due diligence findings inform and influence the specific terms and conditions incorporated into the stock purchase agreement. For example, undisclosed liabilities found could lead to adjustments in the purchase price or additional indemnification clauses.

Next, legal teams representing both the buyer and the seller draft and negotiate the detailed terms of the SPA. This involves incorporating due diligence findings and refining clauses such as representations, warranties, covenants, and indemnification provisions. The negotiation process is iterative, with multiple rounds of revisions.

Once negotiations conclude and all terms are agreed upon, the SPA is formally executed when all parties sign the agreement. This signing signifies a binding commitment to proceed, though ownership transfer may be contingent on certain conditions. The final stage is closing, where shares are officially transferred to the buyer, payment is made, and all conditions precedent are satisfied. This is when ownership legally changes hands.