4.9THE PURCHASE CONSIDERATION
The consideration to be paid for the shares in the target company can be satisfied in a number of ways, each of which is addressed below.
The payment of a fixed amount of cash upon completion is the simplest and most frequently encountered method of performing the purchaser's obligation to discharge the purchase price. The Share Purchase Agreement will state the amount of the consideration and the manner of payment, usually by way of bankers draft or inter-bank transfer to the seller’s solicitors.
4.9.2Issue of Shares by the Purchaser or a member of the Purchaser's Group
The purchaser may have insufficient cash funds from internal sources or borrowings to be able to satisfy the consideration, in which case it may wish to satisfy the consideration by an issue of its own shares to the sellers, which may be retained by the sellers or passed on to institutional investors as part of the sale, often by what is known as a "vendor placing". The satisfaction of the consideration for a takeover of a company by the allotment of listed shares or other securities of the purchaser is frequently encountered where the purchaser's shares or securities are listed on a stock exchange or are about to be listed. Given that a private company is not permitted to invite the public to subscribe for shares or make a public offering or its securities, such share for share takeovers are only encountered where the purchaser is a public company whose shares are listed on a stock exchange.
The sellers will have a preference for receiving cash rather than shares in the purchaser, and will be concerned with entering into a share for share sale by reason of the risks associated with acquiring shares whose value will be subject to market change, and the additional complexity, delay and increased professional costs which will result from the equity issue. The sellers will also require an appropriate right to rescind the Share Purchase Agreement if the purchaser's share price falls below an agreed minimum level prior to completion. A consideration of the legal and procedural issues relating to the issue of the consideration, shares and any placing thereof is outside the scope of this Chapter. However, one particular legal issue, which calls for mention in the context of a share for share sale, is Section 30 of the Companies (Amendment) Act, 1983.
Section 30 of the Companies (Amendment) Act, 1983 imposes stringent restrictions on the circumstances in which a public company may allot shares where the consideration for the allotment is other than cash. Subject to the exception referred to below, a public limited company may not allot shares without the consideration for those shares being independently valued within a period of six months prior to the allotment and copy of the valuer's report being sent to the allottees. Failure by the purchaser to comply with Section 30 results in a considerable risk for the sellers due to the fact that if they have not received a report or there has been some other contravention of the relevant provisions and they were aware of the contravention, the sellers are liable to pay to the purchaser an amount equal to the nominal value of the shares together with any premium and interest at the prescribed rate.
The majority of mergers and takeovers are however exempt from Section 30. The exemption is available for arrangements providing for the allotment of shares in a company, on terms that the whole or part of the consideration for the shares is to be provided by the transfer to that company of all or some of the shares of a particular class in the offeror. In order to qualify for the exemption the arrangement must be available to all holders of the shares of the target company. Thus if the option to acquire shares in the acquiring company (as opposed to cash) is only available to some of the shareholders this will disqualify the arrangement from the exception. This is one area where the risk lies principally with the sellers who must satisfy themselves that the exception applies. If the sellers are not satisfied that the exception applies the sellers would be best advised to require the purchaser to follow the valuation procedure prescribed by Section 30.
The acquisition of a company through a share for share exchange offers stamp duty and capital duty advantages for the purchaser in that, subject to the satisfaction of the various conditions referred to in Section 80 and 119 of the Stamp Duties Consolidation Act, 1999, the 1% charge to stamp duty on a transfer of shares and the 1% charge to companies’ capital duty on a allotment of shares can be avoided.
In the unlikely event that, as a result of a share for share sale, the sellers will be acquiring shares in a private company, the sellers will, in effect, become the holders of a smaller equity stake in the purchaser's group, and therefore all parties will be shareholders in a combined legal entity, as in a joint venture. Accordingly, the parties will need to address the issues which arise on the creation of a joint venture and may require a shareholders' agreement to address the parties' rights concerning issues such as board representation, veto rights, continued employment of the sellers and exit mechanisms. 18
4.9.3Loan Notes/Debt Securities
As an alternative to cash or equity, the purchaser may issue loan notes, debt securities or debentures to the sellers as consideration for all or some of their shares. Whilst there are many forms and nomenclature for such instruments, they all fall within the definition of a debenture within the meaning of Section 2 (1) of the Companies Act, 1963, i.e. "debenture stock, bonds and any other securities of a company whether constituting a charge on the assets of the company or not". All debentures share the common characteristic of comprising a written instrument on foot of which a company acknowledges a debt. In its typical form a debenture will consist of a promise by a company to pay an agreed sum on an agreed date, which may or may not be secured over the assets of the company.
The principal advantage of receiving consideration in the form of a debenture, from a seller's perspective, was that any capital gain arising on the disposal of the seller's shares was available for rollover relief ie. deferred, until the payment of cash was received under the debenture. However, Finance Act 2003 has very significantly reduced these deferral opportunities for debentures issued on or after 4 December 2002. - s584 TCA 97. The seller will, of course, need to make a commercial assessment as to the purchaser's ability to discharge its obligations under the debenture and, where necessary, obtain appropriate security or guarantee from the purchaser’s parent company, controlling shareholders or a third party financial institution.
4.9.4Variable Consideration and Completion Accounts
The parties may agree that the purchase consideration (whether payable in cash, shares, loan notes or otherwise) is to be determined by reference to the financial position of the target company at a date, frequently by reference to the net asset value or profitability of the target company at a date subsequent to the date when the latest audited financial statements of the target company were prepared. In the majority of cases the financial position of the target company will be determined as at the completion date, by reference to a set of completion accounts prepared as at that date. Usually the target company's auditors will prepare completion accounts in accordance with provisions contained in the Share Purchase Agreement . These provisions will address various issues including those referred to below.
(a) The bases and principles upon which the completion accounts are to be prepared and, in particular, any departures from those used in the preparation of the latest audited financial statements.
(b) The auditor's rights of access to records and the management of the target company and the timing of the preparation of the draft completion accounts.
(c) An entitlement of the parties to dispute the draft completion accounts and the timing mechanism whereby the parties can resolve the dispute, failing which the dispute shall be referred to an independent firm of accountants agreed between the parties or nominated by an independent third party such as the President of the Institute of Chartered Accountants or the Law Society of Ireland. The clause will then prescribe the manner whereby the firm of chartered accountants will make an expert determination of the issue in dispute, the costs thereof and the issue of a final set of completion accounts.
The Share Purchase Agreement will also contain provisions for the determination of the final amount of the consideration following the issue of conclusive completion accounts. Given that the parties will have agreed in advance of the execution of the Share Purchase Agreement, a provisional value of the target company and the consideration to be paid on completion, the Agreement will provide for a method whereby the provisional amount of consideration will be adjusted upwards or downwards, depending on the issue of the final form of completion accounts. Clearly, any adjustment will require either the sellers to repay to the purchaser part of the provisional consideration or for the purchaser to pay over to the sellers an additional sum. In order to provide appropriate security in relation to such adjustments, the parties may agree that part of the estimated amount of the consideration be placed into an escrow account held jointly by the solicitors for both parties or by an independent third party, usually a financial institution, pending a conclusive determination.
The parties may agree that the sellers should receive an additional payment of consideration contingent upon the financial performance of the target company during a period subsequent to completion, often known as an "earn-out". The length of such period may be dependent on whether the sellers are to continue to be employed by the target company following completion. The Share Purchase Agreement will, in such a case, usually provide for a fixed amount of consideration to be paid on completion and an additional amount of contingent consideration determined by reference to the target company's future financial performance as determined by subsequent audited financial statements of the target company, usually as a percentage thereof. Whether or not the amount of contingent consideration would be subject to an upper ceiling would be a matter for negotiation.
Where contingent consideration is to form part of the purchase price, similar provisions to those outlined in paragraph 4.9.4 above in relation to variable consideration and the preparation and finalisation of completion accounts will need to be included in the Share Purchase Agreement. In addition, the sellers will require a range of protections so that they can exercise control over the manner in which the company will operate during the “earn-out” period in order that the purchaser can not unfairly manipulate the company, its business and the presentation of its financial performance in the financial statements. If the sellers are to remain in employment, and to hold office as directors, the sellers may accept less extensive provisions concerning such matters provided that their contracts of employment provide appropriate security of tenure during the earn-out period.
The inter-relationship between the right of the sellers to receive payment of the contingent consideration in accordance with the Agreement and the desire of the purchaser to be able to withhold the whole or part thereof in the event of a warranty claim often gives rise to extensive negotiations between the parties.
Earn-outs give rise to capital gains tax issues for sellers, which are considered in Chapter 3.
The parties may agree that notwithstanding the seller's entitlement to the consideration (whether fixed or variable) part thereof will not be paid over until a later date, perhaps by instalments. The issues relating to withholding, considered above, equally apply. The subject of deferred consideration as a form of security is considered in paragraph 13.5.21 of Chapter 13.
4.9.7Withholding Taxes Applicable to the Payment of the Consideration
Section 980 of the Taxes Consolidation Act, 1997 imposes an obligation on the purchaser of land, mineral exploration rights and certain other assets (including a company whose value or the greater part of whose value is derived from such assets), to withhold 15 percent of the purchase consideration, unless the seller furnishes on or before completion a clearance issued by the Revenue Commissioners in Form CG50A. In practice, the financial advisers of the target company will often be required to issue an opinion as to whether or not the target company is within the scope of this provision. If the purchaser is in any doubt as to whether the provision applies, it should require the seller to furnish a clearance on or before completion. It is important to note that if the provision applies and the purchaser has not been furnished with a clearance at the time of completion it will be liable to account to the Revenue Commissioners for 15 per cent of the consideration. It is considered that a clearance furnished subsequent to completion cannot override the statutory liability to account. Accordingly, it is imperative from all parties' perspectives that where the section is applicable, the entire purchase consideration should not be paid over to the seller in the absence of a Revenue clearance.