What is a company ownership transfer agreement?
Company Ownership Transfer Agreements have a very specific purpose in business transactions. At their most basic level, they are a contract or document of intent between a seller and buyer of a business. They are not commonly referred to by this name, but instead often called Letter of Intent or Memorandum of Understanding (MOU).
The primary purpose of such an agreement is to facilitate the sale of a business or transaction . It essentially sets the stage for the closing of the sale through the following:
• A description of the business being sold
• A name and other identity (or identities) of the buyer and seller
• The basic terms of the planned transaction and purchase (e.g., price)
• No obligation for the seller to sell or the buyer to purchase the terms listed above should the selling process continue, or effectively, the terms have not been fully agreed upon between the parties
Horizons has written extensively about these and other types of business transactions under the category of Merger and Acquisition.
The components of the agreement
A company ownership transfer agreement is a binding legal contract that sets out all details of the transfer of a business. Typically, the agreement needs to cover the parties involved, assets being transferred, conditions of sale, warranties, indemnities, schedules and guarantee, among other things.
Parties. The parties are usually the vendor and purchaser of the business or property.
Assets to be transferred. The agreement should set out clearly what property is being sold and transferred.
Conditions. These are basically all components of the agreement that have to be satisfied before the transaction can close. Among other things, conditions are often used to pass the risk of a third party or government approval for the transaction.
Warranties. A warranty is a statement of fact made by the vendor in a sales transaction and an indemnity is an assurance made by the vendor that, if a certain event occurs, they will be liable for the loss or harm that results. For example, the vendor may warrant that all items sold are in good working order and indemnify the purchaser for any repairs that need to be made in a certain period of time after sale.
Checklist to follow when preparing an ownership transfer agreement
Drafting an ownership transfer agreement involves several successive steps. Each step builds upon the previous step, such that a chain that is only as strong as its weakest link will not form until all of the links (or steps) are in place.
Step 1: Who is Getting What
The first phase of ownership transfer agreement drafting is to identify exactly what will be transferred, and in what proportions. Some companies for whom the agreement is being drafted have significant numbers of different forms of ownership interests, including common, preferred and debt securities. The parties will frequently be best served by specifying the particular class of securities to be offered, or acquired, based upon the present state of ownership in the corporation and the ultimate goals of the shareholders.
Step 2: The Transfer Process
Once the specific securities to be transferred are identified, the transfer procedure must be determined. Will the proposed transaction be accomplished by a single purchase and sale transaction? Alternatively, will there be multiple purchasers who acquire varying portions of the class of securities? Which of the company’s owners will be the sellers? How will the closing of the purchase or sales transaction be completed? Those are just a few examples of the procedures that will likely need to be identified and described in the ownership transfer agreement.
Step 3: Fund Requirements
In many cases, there will be significant capital requirements associated with the acquisition of company ownership. How much capital is required to complete the ownership transfer? Where will the funds be sourced? Will the funds come from a financial institution? Alternatively, will the funds be supplied by a third party or related company? Those are just a few examples of questions that will need to be considered in the drafting process.
Step 4: Closing and Funding
There is a strong interrelationship between the fund requirements for a transfer of ownership and the ultimate closing. Funds to complete the transfer cannot be deployed until closing, and closing cannot be timed until a reliable picture has developed regarding the amounts necessary to complete the ownership transfer and the sources of that funding.
Step 5: State Rules
It is not unusual for some states to impose various ownership transfer requirements on corporations. If a company intends to conduct business in multiple states (it is not uncommon for companies to develop a basic presence in neighboring states), the geographic area of operation will need to be addressed during the drafting process to determine whether multiple filings will be necessary, or whether a single filing will service the company’s needs. Generally speaking, the more a company diversifies its business geographically, the more complicated its ownership transfer will be, and the more likely it will be to require more than a single filing.
Legal implications
Legal considerations relating to the transfer of a company’s ownership will include whether a shareholder or legally recognised interest group has priority over another when it comes to a legal share transfer. A legal adviser should also be consulted as to what, if any, governmental approvals are required prior to a transfer and ensure those are obtained.
When obtaining the necessary approvals, realise that not obtaining the necessary approvals can have adverse consequences. Some agreements have been held to be void due to non-compliance with statutory requirements. This also holds true for the transfer of shares. In addition, the transaction must not contravene Competition Act provisions of the Companies Act which includes the Companies Act’s provisions prohibiting insider trading.
If the parties were in business together and held a 50/50 split in ownership for a company, this can lead to a potential deadlock. In this bedlock scenario, one party can effectively be unable to transact on behalf of the company and it may be a worthwhile consideration in the ownership transfer agreement to ensure that the parties take steps to resolve or diffuse the deadlock i.e. an offer or series of offers to purchase the other parties’ shares. This is a relatively standard way to deal with a deadlock situation. It can be beneficial for the excluded party in the sense that they get to exit the company on terms that do not see their shareholding diluted.
From a legal perspective, the parties should consider:
Depending on the complexity of the parties’ relationship, rules and procedures may need to be included in the share transfer agreement.
Common pitfalls in ownership transfers and what to avoid
There are a number of challenges that companies commonly face when negotiating the terms of a company ownership transfer agreement and its related documents. These challenges include disputes over succession planning, the need to balance diverse goals and objectives of shareholders, and the complexities of asset valuation for the purposes of the transfer. The nature of agreements covering owner transfers can make it difficult to navigate these challenges.
Owner Transfer Agreements can be lengthy, dense, and often include technical language that is not easily understood. With the stakes as high as they are during the transfer of company ownership, the consequences of misunderstanding or misinterpreting the issues tied into the agreement can be costly for all parties involved . It is important for companies to address issues in advance, establish clear points of partnership, and work towards a greater understanding of the proposed agreement from all involved parties.
One way to overcome difficult discussions and negotiations during the transfer of company ownership is through mediation. A neutral mediator ensures that all parties involved have a fair opportunity to discuss concerns and complaints as well as outline their goals and objectives for the transfer. This has the potential to resolve problems before they evolve into full-fledge conflicts. It is also valuable to have a legal advisor on hand who specializes in company ownership agreements to provide a wealth of experience that can help to guide the process. These strategies will make it much easier for companies to identify and rectify potential issues within the agreement so that the transfer of ownership can be completed successfully.
Case studies exemplifying the effective use of ownership agreements
To illustrate the principles of a successful transfer of company ownership interest, the following examples can be analyzed: A Company with a Single Shareholder. A single shareholder sells the shares to an independent third party who pays for the shares using installment notes and his personal guarantee. In the process, the seller made certain representations as to the company’s operations and finances. Prior to completing the transfer, the purchaser was provided with audited financial statements and satisfactory verification as to the continued management of the company. The owner provided an indemnity on a competitive price basis. Since the purchaser was independent of the seller, this transaction was completed without any problems. A Company with Multiple Shareholders. An existing shareholder purchases the balance of the company’s shares from the remaining shareholders. As part of the transfer, the price was established based on an independent valuation. The purchaser provided certain representations in respect of the company’s operations and finances. The purchaser arranged financing through the bank for the purchase of the shares, including the sellers’ indemnity on a competitive price basis. The bank evaluated the company and found that the sale was fair and reasonable. The sellers provided an indemnity to the purchaser at no charge. This transfer was simple and effective. A Close Purchase. The shareholders have determined that they want to acquire a company interest and contribute to a new corporate entity. Each of the shareholders may contribute a minimum amount but the balance of the contribution will be based on its proportionate share of the purchase price of the shares, due on terms as established by the shareholders’ agreement. The acquisition is on an equal cost basis.
The importance of seeking professional legal advice
The strategic role of any legal professional is to facilitate an orderly and accurate environment within which all parties can present their case or execute their transactions without hidden agendas or unintelligible language. The domain of ownership transfer agreements and their impact on organizations is no different. It is the responsibility of the legal professional to: The expert assistance of a seasoned legal professional is required to ensure that all parties are privy to the entire scope of the transaction , understand the dynamics at play, realize the strengths and weaknesses of the agreement and are able to capably analyze all written material and not suffer from any contradictory messages, jargon or legalese. Failure to consult with a legal expert increases the risk of negative consequences associated with employment and corporate law.