M+A: Progressive sale of equity

Progressive sale of equity

In cases where the buyer is in a strong bargaining positon it may negotiate a deal to allow it to acquire the seller’s shares in the target company in stages.  A buyer in this position will generally seek to acquire a stake in the target company that represents something in excess of 50% and generally less than 75% of the target’s issued voting shares (which will also carry the right to capital and income). One factor that influences this decision (and also determines the content of any shareholders agreement that is made in connection with the sale agreement) is the question of control of the target company’s board post completion.  This is particular so if the buyer wishes to consolidate the target company with other entities in its group for tax consolidation purposes.

The terms of the transaction document, which is made at the date of the initial share sale, determines whether the buyer can be compelled to acquire the seller’s remaining shareholding in the target company, or whether the seller is destined to remain a minority shareholder.

Why buy shares in stages?

The commercial motivations from a buyer’s perspective to progressively buy the seller’s shares in the target company are as follows:

  1. the initial outlay of money to acquire the target’s shares is less. Evidently, acquiring a 51% stake is initially more affordable than acquiring a 100% stake;
  2. it should ensure that the seller and its associates (who are often key officers of the target company) continue to be fully engaged in the target company’s business and are appropriately compensated for their ongoing effort to build the business and maximise its profitability post completion of the initial share sale transaction; and
  3. the buyer may feel it is ameliorating its risk (being the risk associated with its investment in the target company) because the seller is not departing the business following the sale of the first tranche of shares.  From a legal perspective this can make it easier to manage conflicts of interest and prevent harmful competition post completion by someone who would otherwise be the departing owner/operator.

What transaction documents are typically required?

Each transaction is obviously unique, but we would normally expect a transaction of this kind to involve the following key transaction documents:

  • share sale agreement;
  • shareholders agreement;
  • Call option agreement or a Put and call option agreement; and
  • Executive service agreement.

In our experience most people who have spent time in business have encountered share sale agreements, shareholders agreements and executive service agreements.  However not everyone has come across option agreements.

Option agreements

Option agreements are regarded by Australian law as either:

  • an irrevocable offer (in return for consideration, A continues to offer B something, and to not revoke it for a stated period of time); or
  • as a conditional contract (A enters into a contract with B permitting B to do something).

A put option is an option to sell. The grantor of the option is the potential buyer and it gives the option to the potential seller. The seller or grantee of the option is the person who has the right to exercise it. In this case it entitles the grantee to sell the property (eg shares in the target company) that it owns to the grantor.

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