What is a Stock Purchase Agreement and how important is it?

So, you have decided to buy some stock in an exciting new startup and want to know what’s next? That’s where a Stock Purchase Agreement comes in.

What is a Stock Purchase Agreement?

A Stock Purchase Agreement, or SPA as it’s often known, is simply a document that sets out the terms and conditions of a purchase of stock in a company. It describes the agreement between the buyer and the seller, and other key holders (more on that later). It is a binding contract that clearly states the terms of the deal, thus providing contractual protections for all parties who have an interest in the sale.

The seller could be the company or one or more existing shareholders, and the buyer could be a new investor or an existing shareholder. When a company issues new shares to raise capital or ownership of existing shares is transferred, a SPA is often used.

A SPA lists important information relating to the stock purchase such as the names of the company, buyer, and seller, the number and value of the shares, the location of the transaction, warranties and representations of the buyer and seller, and disclosure of potential issues that may be relevant to the sale such as key holder rights, employee considerations, benefits, and bonuses.

SPAs can take many forms, and the specific structure of a particular SPA will depend on the requirements of the company, the founders, the advisors, and the investors. A flexible SPA structure is one that defines a short, simple agreement that is then supported by schedules, exhibits, and attachments containing the various details applicable to the transaction.

Steps to File

For the SPA to be legally binding, it must be signed by both the buyer and the seller. For more rigorous legal standing, a witness or notary may also sign.

Copies of the signed document must be made and retained by the buyer, the seller, and the company (note the company may also be the seller, for example in a capital raise).

Once payment has been made, the seller must transfer to the buyer share certificates representing the stock in the company. Depending on the specific transaction, the share certificates may be physical, digital, or managed on a register. Again, depending on the nature and structure of the transaction, the share certificates may be held by an agent on behalf of the buyer.

Depending on the company structure and charter, the SPA may need to be registered with the Securities and Exchange Commission.

Types of Stock

A SPA could be used in the transaction of various types of stock, including Limited Liability Companies, Corporations, and Partnerships.

Stock Purchase Agreement Key Provisions

There are a number of key provisions that should be included in a SPA, including:

• Definitions: This section is extremely important because it defines terms that are used throughout the agreement. Capitalized terms have a specific meaning that may be different from non-capitalized words.
• Details of the transaction: Here is where the number of shares and the share price is recorded, and any adjustments to the purchase price that may have been made from prior discussions. Also included here should be information regarding share certificates, legal considerations , and any relevant agreements such as to do with employees or escrow.
• Warranties and Representations: Often split into two sections, one for the buyer and one for the seller, this section sets out statements from each party relating to the purchase. On the buyer side, this might be as simple as the buyer promising to pay money for the stock. On the seller side, particularly if it’s the company selling the stock (rather than an existing shareholder), this section might include statements and facts relating to the status, operation, and performance of the business.
• Covenants and Closing Conditions: This section describes the promises that the buyer and seller make to each other committing to what they will and won’t do between the time of signing the agreement and completing the transaction.
• Indemnifications: Here is where the compensation rights are documented in the event that one of the parties to the agreement breaches the contract.
• Termination: This details the rights of both parties to terminate the agreement.
• General Provisions: A section outlining any miscellaneous provisions that apply to the agreement.

Is a Stock Purchase Agreement Important?

Absolutely, a SPA is important! Putting all the terms of a sale into a binding contract ensures all parties are protected and that they have full knowledge and disclosure of all the relevant terms that could have an impact on the transaction.

Stock Purchase Agreement Template Breakdown — Part 1

To help build your understanding of a SPA, you can download a Stock Purchase Agreement template from organizations such as Series Seed. Shown below are some screenshots of the first few sections of the Series Seed template, with some key terms highlighted followed by some context and explanation. We’ll continue our breakdown and explanation of the SPA template in future posts, so keep an eye out for them! In the meantime, if you have any questions or find something in the template that you’re not sure of, please reach out here.

The image shown above is the first page of the Series Seed SPA template. Highlighted terms are discussed below:

• Key Holders are investors named in the share register who hold a large number of shares or hold stock with particular rights or stock options.
• Capitalized terms are used in the agreement to denote defined terms. This is very important, because those capitalized words have a specific meaning as described in the definitions section.
• Exhibit A (see below) lists out the defined terms. It’s important not to just gloss over these, because they do have specific meaning that could have an impact on the transaction. For example, if someone wrote “purchase price” to represent their understanding of an agreed amount, it may have a different value to the defined “Purchase Price”.
• Exhibit B sets out the agreement terms. This section will be covered in future articles.
• Schedule 1 (see below) is a table listing all the shareholders and key holders including their name, contact details, stock ownership, rights, and options.
• Purchase Price states the agreed price per share that applies to the transaction.
• Agrees to be bound by the obligations means the Agreement is a legally binding contract, where the buyer and seller are promising to each do what they say they will do in the agreement.
• Full and entire understanding and agreement means this agreement is the only document that sets out the understanding and terms of the stock purchase, and supersedes and overrides any prior discussions, understanding, or other agreements, either verbal or written. So, once a SPA is signed, neither party can enforce any prior agreement. The agreement itself is quite short and straightforward — it basically says the seller agrees to sell the stock, and the buyer agrees to buy the stock. However, the terms, conditions, schedules, and exhibits are of course important because they do form part of the agreement.

The image shown above is the second page of the Series Seed SPA template, being Exhibit A which defines the terms in the agreement. This is representative of what might generally be included in an agreement but will vary depending on the specific nature and details of the SPA that applies to a particular stock purchase.

The image shown above is the third section of the Series Seed SPA template. Highlighted terms are discussed below:

• Schedule of purchasers & key holders lists all the individuals and entities in the share register who own shares, and the key holders with a large number of shares or stock with particular rights or stock options.
• Indebtedness Cancellation refers to conversion of a convertible note, when the debt owed to a lender via a convertible note converts to equity via a stock issue.

Schedule B and the remainder of the SPA template will be covered in future articles, so keep an eye out for them on our blog!

Pros and Cons of Stock Purchase Agreements

Pros of a SPA include the following:

• It clearly sets out in writing the terms and conditions of the stock purchase, which can prevent any misunderstandings or disagreements.
• It details specific information about the stock transfer, including warranties, dispute resolution measures, allocation of costs, etc.
• It is a binding agreement that ensures the stock transfer will proceed.
• The buyer and seller can review the agreement and get a clear understanding of the transaction in advance.
• It provides a clear mechanism for resolving disputes.
• Companies and existing shareholders can include specific terms and conditions into a SPA to protect themselves against potential issues that are important to them, for example including a “right of first refusal” clause that gives existing shareholders the right to purchase any shares on offer before they are offered on the open market.

Just about the only cons of a SPA are the time, effort, and cost involved for an entity’s founder to set one up, and the complexity of the document for investors to understand. But any entity worthy of investment deserves setting up a SPA, for the reasons noted above. As for the complexity of the agreements, there are many educational resources such as this article that can go a long way in supporting investors to grow their knowledge of SPAs, which are an important element of their portfolio.

Do I Need a Lawyer to Complete a Stock Purchase Agreement?

As with any investment, doing your due diligence is critical. The need for your own legal advice or assistance to fill out a SPA depends on your own level of skill, experience, competence, and confidence, along with the advisory services you may have access to as part of the purchase.

If you are just starting out on your investor journey and feel that a high level of protection is required for the stock purchase, then it may be advisable to obtain your own legal counsel.

If you’d like to know more about investing in startups, you can find more information here on how to start angel investing and how to find opportunities for angel investing on Propel(x).

This article is for informational purposes only. We do not provide legal, financial, or tax advice and investors should consult their advisors prior to making any investment. The template documents provided in this article are from Series Seed and are used solely for educational purposes and should not be relied upon in any other manner.

As with any investment, past performance is no guarantee of future performance, and any investment decision must balance the risk against the potential return. Private investments are highly illiquid and risky and are not suitable for all investors. There is no guarantee that a liquidity event will ever take place.

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Originally published at https://www.propelx.com on December 1, 2022.