The phased transfer of shares

Not every takeover takes place in a single transaction. The parties may choose to structure the entire transaction in phases. The buyer acquires shares from the seller at various points in the future and pays for the shares acquired at those times. This is known as a phased takeover of a company.

The reasons for this are understandable. It allows the buyer to spread their investment risk or to wait until certain financial milestones have been achieved. It also enables the seller, provided the company achieves good results, to secure a higher purchase price.

Although this can offer practical solutions, it also entails a more complex acquisition structure. Without clear agreements, the period between the first and final share transfers creates a gap regarding the rights and obligations between the parties. This article examines in more detail the warranties and indemnities, governance and a potential impasse between the parties.

Warranties and indemnities

In a ‘normal’ acquisition, the seller provides warranties on the date of signing the purchase agreement, which apply on the date of transfer of the shares (also known as the “Completion Date”). The shares are then transferred in a single instalment on the Completion Date.

However, if the shares are purchased and acquired by the buyer in separate tranches, the buyer could be left empty-handed if the company’s situation has deteriorated in the meantime.

One solution may be to include warranties in the purchase agreement covering the various transfer dates. In doing so, the seller immediately guarantees that the warranties are ‘valid’ on the future Completion Dates. This gives the buyer a further means of recourse to claim damages from the seller should the seller fail to comply with the warranties in respect of subsequent tranches.

In our practice, we have assisted clients on numerous occasions with such phased acquisitions and are therefore well versed in the correct drafting and negotiation of the warranties and indemnities that these more complex acquisition structures entail.

Governance

Another obvious issue is the distribution of power until all shares have been transferred. After the first tranche, the buyer is, in fact, a co-shareholder with the seller. Depending on the transaction, it may vary whether one party holds a majority and, if so, which party holds that majority. The seller may still formally hold the majority of control, but at the same time be aware that they are on their way out. Conversely, the buyer may hold the upper hand in terms of control, which could lead to the seller’s interests being compromised.

This creates a fundamental tension: which decisions may the board of the target company take independently during the interim period? This question arises all the more when the buyer joins the board immediately. Major investments, securing new financing, dismissing key employees or paying a dividend: all these decisions can influence the value of the shares in the remaining tranches. If these decisions are not set out in a contract, the buyer has little recourse.

The solution lies in setting out the arrangements precisely in the shareholders’ agreement; after all, both the buyer and the seller are shareholders in the company. The focus here will be, in particular, on an exhaustive list of decisions requiring shareholder approval, specific veto rights and what should happen in the event of a deadlock.

Here too, we regularly advise parties on the best way to structure governance in the shareholders’ agreement right up to the final Completion Date (and possibly beyond). In our experience, this is a subject of much negotiation, as the seller is generally reluctant to relinquish too much control. The buyer, for its part, does not wish to leave too much to the seller’s discretion, so that it can also protect its own interests, with a view to ultimately acquiring full ownership of the company.

Pricing of tranches

Although the valuation of the subsequent tranches is usually discussed in broad terms in advance, it is one of the most important elements of this acquisition structure. There are various approaches, but broadly speaking these boil down to the following three:

· Fixed price: the price for all tranches is set immediately upon signing. This makes things simple, but neither party bears the risk (or the benefits) of market developments or operational results in a proportionate manner.

· Formula-based: the price is calculated on the basis of a financial metric (for example, an EBITDA multiple or a revenue multiple) at the time of the next Completion Date. This is in line with market practice, but creates an incentive for the seller to manipulate results and for the buyer to influence decisions that lower the metric.

· Fair market value determined by a third party: an independent valuation expert determines the price on the various Completion Dates. This appears to be the most neutral approach, but in practice may lead to disputes regarding the expert’s terms of reference or the methodology used.

Whichever method is chosen, the contractual arrangements require great precision.

Conclusion

A phased acquisition is a useful tool for bridging a valuation gap or allowing a buyer to come on board gradually. However, the legal complexity of the interim period should not be underestimated and is substantially greater than in a traditional one-off acquisition.

Experience shows that most problems do not arise in the final tranche, but in the period leading up to it: when the balance of power has shifted and interests diverge.

Questions

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