Share Purchase Agreement (SPA)

A share purchase agreement is the contract that transfers ownership of a corporation by transferring its shares. The sellers are the shareholders, whether individuals, a family trust or a holding company, and the buyer is often a corporation formed for the acquisition. The corporation whose shares are sold, usually called the target, sometimes signs as well so that it is bound by the covenants that apply before closing.

Nothing the target owns changes hands. Its bank accounts, leases, customer contracts, licences, employees and tax history stay where they were; only the owners change. That is the defining feature of the document. A buyer under an SPA takes the corporation with every liability it has, known or not, so the agreement exists largely to price that risk and give the buyer recourse if the sellers' description of the business proves wrong.

The SPA usually follows a letter of intent and a period of due diligence. Our guide to how a letter of intent, a term sheet and a purchase agreement differ explains the sequence. In owner-operated deals the parties often sign and close on the same day; in larger deals they sign first and close weeks or months later, once approvals and consents arrive. Whether to buy shares at all, or the business's assets under an asset purchase agreement, is a separate decision, and our free asset vs. share sale checker walks through the factors.

Many SPAs for private Ontario businesses do not simply state a number. They often start from an agreed enterprise value on a cash-free, debt-free basis and adjust it at closing:

• Debt owed by the corporation, such as bank loans and shareholder loans, is deducted and usually repaid from the proceeds using a payout letter from each lender.
• Cash left in the corporation is added to the price, or paid out to the sellers before closing.
• Working capital is compared with an agreed target, or peg, and the price moves up or down by the difference. The working capital adjustment is normally estimated at closing and trued up after closing, once closing financial statements are prepared.

Part of the price is often deferred or put at risk. A holdback or escrow secures indemnity claims, an earn-out ties part of the price to results after closing, and a vendor note lets the sellers finance part of the purchase. Each needs detailed terms in the SPA, because the sellers become creditors of a business they no longer control.

Because the buyer takes the corporation with its history, the sellers' representations and warranties in an SPA are broader than in an asset deal. They start with fundamental statements: the sellers own the shares free of encumbrances, the shares were validly issued, the capitalization is as described and no one holds options or other rights to acquire shares. The business representations then cover the financial statements, tax filings, material contracts, employees, litigation, real property, intellectual property, privacy and compliance with law. Exceptions are listed in disclosure schedules, and a matter fairly disclosed there is generally not a breach.

The indemnification clause turns those statements into money. It sets how long each category of representation survives after closing, the minimum claim threshold (the basket), the maximum liability (the cap) and the claims procedure. Two features matter more in share deals than in asset deals:

• Pre-closing tax indemnity. The corporation stays liable for its own past taxes, so the sellers usually indemnify the buyer for taxes relating to periods before closing, often for as long as the CRA can reassess those periods.
• Specific indemnities for known problems found in due diligence, such as an open audit or a threatened claim, which the buyer will not accept as a mere disclosed exception.

Where there are several sellers, the SPA also states whether their liability is joint and several or limited to each seller's share of the proceeds.

If signing and closing are separated, the SPA governs the gap. The sellers covenant to run the business in the ordinary course, give the buyer access and not take listed actions, such as paying dividends or signing major contracts, without consent. The buyer's obligation to close is subject to conditions precedent, typically the accuracy of the representations at closing, third-party consents, financing and any regulatory approval. Contracts and leases with a change of control clause need attention even though the corporation assigns nothing, because the clause is triggered by the change in ownership.

The closing agenda lists what each side delivers. For a typical Ontario private company, the sellers deliver:

• share certificates endorsed for transfer, or transfer instruments for uncertificated shares, with a directors' resolution approving the transfer where the articles restrict share transfers, as private company articles commonly do;
• an updated securities register and register of individuals with significant control;
• resignations of departing directors and officers, and releases of their claims against the corporation;
• a recent certificate of status showing the corporation is active;
• an officer's certificate confirming that the representations remain true and the covenants have been performed;
• payout letters and PPSA discharges for debt being repaid; and
• the sellers' non-competition and non-solicitation covenants and any consulting or employment agreement.

If a seller is not resident in Canada and the shares are taxable Canadian property, subsection 116(5) of the Income Tax Act can make the buyer liable for tax of 25% of the amount by which its cost exceeds the certificate limit in a section 116 clearance certificate, which means 25% of the full price if no certificate has been issued. Buyers therefore hold back that amount until the certificate arrives. The buyer delivers the price, any escrow agreement and its own officer's certificate.

The two documents share a structure but do different jobs:

The tax and liability trade-offs that drive the choice between the two structures are covered in asset purchase vs. share purchase.

Daniel Okafor and Mei Lin each own 50% of Northline Mechanical Supply Inc., a Mississauga distributor of HVAC parts. Ravi Sandhu's holding company agrees to buy all of the shares for an enterprise value of $4.2 million on a cash-free, debt-free basis, with a working capital peg of $600,000.

At closing the corporation owes its bank $350,000, which is repaid from the proceeds under a payout letter, and estimated working capital is $540,000, so the price falls by $60,000. The equity price is $3,790,000. The SPA puts $420,000 in escrow for 18 months to secure the sellers' indemnities, so Daniel and Mei receive $3,370,000 at closing, split equally. Their lawyers deliver endorsed share certificates, a directors' resolution approving the transfer, resignations, a certificate of status dated the day before closing and an officer's bring-down certificate.

Eleven months later the CRA reassesses the corporation for $38,000 of HST from a period before closing. The SPA's pre-closing tax indemnity is not subject to the basket, so Ravi's company is paid from the escrow without a dispute, and the remaining $382,000 is released to the sellers at 18 months. Because the Northline shares met the qualified small business corporation share tests, Daniel and Mei each claim the lifetime capital gains exemption on part of their gain, a result an asset sale by the corporation would not have produced.