While there is a plethora of matters which require contemplation when purchasing or selling shares in a company, the issue of consideration will be at the forefront of any such list. This can be a topic of hot discussion between parties, and as such we have set out a review of the alternative structures consideration can take.

Forms of consideration
As there is a variety of forms consideration can take, the initial decision to be made between the parties is which form the transaction will adopt. As with all matters within the share purchase documentation, this is a matter for negotiation between the parties; which options will be chosen will be dependent upon the relative negotiation strength of the parties and their respective priorities. In general, there are three forms of consideration.

Cash
This can be the most straightforward form of consideration, as it entails assigning a cash value to the share capital being purchased, in much the same way as everyday transactions. Such consideration can provide certainty as to the value being provided for each share, and may therefore be the preferred option.

Shares
With shares as consideration, the seller will be issued shares within the buyer’s own company. From the point of view of buyer, this may be the preferred option if you do not have the necessary free cash to fund the purchase, or you want to take advantage of merger relief, which enables you to avoid the need to assign any premium gained from the transaction into a separate share premium account. As for a seller, shares may offer you the option to retain some element of control over the company you are selling, as well as offering certain tax advantages under the Taxation of Chargeable Gains Act 1992 (there is the potential to spread the gain made from the sale of the company over a number of years).

It is important, however, to assess the disadvantages of using shares as consideration, as these may prove detrimental to the parties. For an acquiring company, you will need to assess your articles of association to see if the transfer or issuing of shares for a share purchase is restricted; if so, in the absence of a change in the articles of association, share consideration will be inappropriate. For a seller, the primary concern regarding share consideration will be its adequacy; will the shares issued in the acquiring company actually reflect the value of the shares sold?

The various advantages and disadvantages of share consideration mentioned within this section are only key examples; others will be relevant to your particular sale and will therefore need to be assessed.

Debt Instrument
It is possible for a share purchase to be effected by the seller being granted debt in the buyer, which is typically evidenced by a loan note held by the buyer. A loan note instrument will determine the terms of the debt, and as such this will be an additional matter to negotiate between the parties over and above the share purchase agreement.

Once again, there are numerous advantages and disadvantages of electing to use this form of consideration. For the buyer, one advantage is that there is no requirement for cash reserves at the payment date, but equally the company will be subject to a debt sitting on its balance sheet, which may be prevented by its articles of association and in any event will impact upon its financial status.

As for the seller, the advantage is that they will rank alongside other creditors in the event of insolvency of the buyer, which would put them in a stronger position than had they been a shareholder under a share swap. However, the seller will not receive cash at the point of sale, and while the loan note provides security that payment will be made at some point, this security is only as robust as the balance sheet of the acquiring company.

Amount of consideration
Having settled on a form of consideration, it will then be necessary to establish the value of the consideration.

Pre-determined and fixed price
If possible, agreeing a price in advance between the parties provides certainty and clarity for both the buyer and seller. This is generally derived from the last set of completion accounts available to the buyer.

Price adjustments
Although it is far simpler, for both parties, to have a pre-determined price, this may be inappropriate in the circumstances, and the share purchase agreement may need to provide for an adjustment mechanism.

One way in which this can be implemented is through completion accounts. As the price is generally derived from the last set of statutory accounts available, there may have been a change in the financial position of the target company in the interim for which needs to be accounted. Drawing up completion accounts at completion will provide a clearer picture of the financial status of the company at completion, and the price can be adjusted to take into account any divergence between the sets of accounts.

Alternatively, if a buyer is in a particularly strong negotiating position, it may be possible to state that there will be no payment until a certain event transpires, such as the target company turning a profit (any such provision is called an ‘earn-out’). This could clearly prove detrimental to the seller, who may never receive the full purchase price if the company never makes a profit. Serious thought must be had before entering into any agreement under which the timings are such as this.

As for the seller protecting themselves with regards to the amount of consideration, they may be concerned that their company has been undervalued, and as such have lost out in the transaction. One form of protection for such a seller is an anti-embarrassment provision, which ensures the seller will gain a portion of any proceeds in a subsequent sale which exceed the initial sale price for a specified period after the initial sale.

Other consideration considerations
Over and above the forms of consideration as detailed above, further elements must be decided in order to arrive at the final consideration structure for the share purchase.

Timing of payment
Whereas most share purchase agreements will provide for consideration on completion, there are alternatives to this practice.

One such alternative is a deferred payment structure, under which the buyer will pay instalments at various dates following completion until the full purchase price is discharged.

Security
Security for the purchase price tends to only be relevant in situations of deferred consideration. Imposing security on the purchase price will enable the seller to take priority in the case of insolvency for the buyer, and will provide additional assurance of payment. There are a number of forms security can take, such as a charge or debenture, and this will be a matter for negotiation between the parties. Security may also take the form of guarantees.

Depending upon which of the above are agreed between the parties, the relevant matters need to be accurately reflected within the share purchase agreement. If you are considering selling or buying a company and would like to speak to someone in our corporate department to discuss the above, please contact either Yavan Brar at Yavan.Brar@herrington-carmichael.com or on 0118 977 4045. Alternatively please contact Matthew Lea at matthew.lea@herrington-carmichael.com or on 0118 977 4045.

This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to a particular matter.