Whilst, as a buyer, you would normally prefer to buy the assets of the business rather than the shares in the company that owns that business, it may be that only the shares in the company are for sale.
Warranties and Due Diligence
Under English law the principle of caveat emptor ("buyer beware") prevails, which means that the buyer will acquire a company with all its liabilities, whether they are known or unknown, and so the information provided will allow the buyer to decide whether the business is, in fact, suitable for acquisition, how it will fit within the buyer's existing company structure and identify any 'skeletons in the closet'. As a result of the process, the buyer may want to negotiate a reduction of the sale price or walk away from the deal altogether. Any potential problems or liabilities should come to light and the seller has a duty to make fair disclosure to any question put to it by the buyer. The buyer will want protection against risk as well as against those areas that it was not possible to investigate fully during the due diligence process, which will be built into the final agreement in the form of warranties and indemnities.
Warranties are assurances given by the seller to the buyer that the company being acquired is in the condition described. They will be broken down into specific areas such as land and buildings, employees and IT. If the statements prove to be incorrect at a later stage, then the buyer will be entitled to sue the seller for a breach of warranty if the company value is reduced as a result. The seller has the opportunity to disclose information against them (in a disclosure letter), thereby alerting the buyer to any potential problems but also protecting the seller from claims if information has been sufficiently disclosed.
Indemnities are guarantees by the seller to reimburse the buyer for certain types of liability on a pound-for-pound basis and provide stronger protection. The most usual forms of indemnities are in respect of tax not provided for in the last audited accounts and not arising out of corporation tax on normal trading profits since the last balance sheet date. These will often be included in a tax deed (which may be incorporated into the final share purchase agreement or may be a standalone document). However, indemnities can also be used to cover risks such as unresolved litigation, environmental liabilities, doubtful book debts, or product liability claims in relation to products sold before completion.
The due diligence process will be more detailed and longer for share purchases than for asset purchases because of the greater risk assumed in the former. The buyer will instruct solicitors and accountants to carry out legal and financial due diligence respectively. Each will usually prepare a report which will influence the structure of the deal and the final form of the agreement. There will be some degree of overlap between the two and this may result in tension if a seller is unprepared for the task. A seller is not obliged by law to answer due diligence questions but obviously they will have an incentive to co-operate with the buyer's advisers and a buyer should be wary if this is not the case.
Other Points in the Share Sale Agreement
The share sale agreement will also address other key conditions including the price, any necessary reorganisation of the business or share capital and matters such as the position of any directors remaining with the company after completion. The price of the shares is usually set by reference to the latest audited accounts, with the period since the accounts date generally covered by management accounts.
From the tax point of view, the position for sellers is generally more advantageous if they sell the shares in the company, but specific advice should be sought from professional advisers. In addition, sales of shares may allow the seller to benefit from tax relief. You will need to assess the likely tax position and take it into account in ensuring that the price is satisfactory for your purposes. Stamp duty is payable on share transfers at 0.5% where the consideration is £1,000 or more.