Agreements are often composed of a one or two core agreements
and multiple sub-agreements. Larger transactions are often
associated with larger number of sub-agreements and as well
as an increased page count. Here are the more common such
Asset Purchase Agreements
As their titles indicate,
a stock purchase agreement is an agreement to purchase the stock
of a company and an asset purchase agreement is an agreement to
purchase its assets.
The decision to purchase
stock versus assets is usually driven by tax and liability considerations.
The stock purchase agreement is more useful than the asset purchase
agreement when you are purchasing a portion of a business for
investment purposes as opposed to buying the entire business.
The asset purchase agreement is best when there may be hidden
or visible liabilities that you want to avoid. You can leave those
with the original corporation.
The major elements
of both types of agreements are dedicated payment terms, warranties,
indemnifications, and conditions to closing. Whether purchasing
stock or assets, a buyer will still want substantially the same
warranties on assets and other aspects of the business.
If you own an interest
in a privately-held business, you need the ability to sell it
in a predictable and orderly fashion. You also want to make sure
that other shareholders are unable to divert profits, salaries
and other benefits of ownership to themselves. If this happens,
it reduces the value of the interest.
Even if you own a
majority interest in a company, you want some control over who
other shareholders sell their stock to. The purpose of shareholder
agreements is to address all these problems.
can include the following types of provisions:
- A right of first
refusal on the sale of company shares.
- A right of appraisal
in the event of forced sales.
- Participation rights
in the sales of stock by other shareholders.
- Veto rights over
compensation and disbursements to other shareholders.
- Veto rights over
specified corporate actions or transactions.
- The right to be
represented on the board of directors.
Do you know the difference
between shareholder agreements and partnership agreements? Not
that much. The major difference is that partnerships differ in
structure from corporations.
Both agreements deal
with substantially the same concerns: control and extraction of
the benefits. It is just that the structure of the partnership
causes these concerns to play themselves out in a different set
of issues. The provisions of a Partnership Agreement will address:
- Control of the
- Distribution of
- Ability to dispose
of partnership interests.
and Debt Instruments
An option is the right
to purchase stock at a pre-agreed price. Both the price and the
number of shares can be fixed or determined by formulas. The formula
can be based on earnings or revenue. It can also be based on some
measure of the option holder's performance. For example, the option
holder might be a distributor of the company's products. The exercise
price of the option might vary depending on how much product the
option holder sells. Most options must be exercised within a fixed
period of time or the right terminates.
When options are
granted to employees, they normally vest over a period of time.
Employees that leave the company before vesting is complete lose
the unvested portion of the option.
Once the shares are
purchased under an option, the new shareholder will have the same
need to be protected by a shareholder agreement as any other shareholder.
Usually, these issues are neglected until the shares are purchased.
Unfortunately, if they are not addressed at the time the option
is issued, they are difficult to negotiate later. We will talk
about shareholder agreements later on.
Options to purchase
stock can be issued by any shareholder who owns the stock. In
fact, they can even be issued by someone who doesn't own the stock.
However, issuing an option without the stock to back it up can
be dangerous. If the option is exercised, you will have to scramble
to get the stock necessary to deliver to the option holder.
A warrant is identical
to an option except that it is issued by the corporate issuer
of the stock to which the holder is entitled to purchase. This
distinction has become blurred over the years as a result of primarily
as a result of the use of the term "stock options" for
the common practice of granting "warrants" to employees.
The issuing corporation
can issue the warrant out of treasury stock or it can merely authorize
new stock. When you accept a warrant, it is generally prudent
to require that the corporation's board of directors authorize
and set aside shares of the corporation's stock to be dedicated
to fulfilling the option on its exercise.
is debt that can be exchanged for stock. The exchange rate may
be fixed or determined by a formula. The formulas that you can
use are the same ones you would use with a formula option. It
can be based on earnings or revenue, or on some measure of the
option holder's performance.
It is possible that
the debt will never be converted to equity. The exchange of the
debt for stock can be triggered by any of the following:
- The election of
the debt holder.
- The election of
the issuing company.
- The occurrence
of specified events such as a public offering.
The need for shareholder
protections such as those provided in a shareholder agreement
applies to convertible debt in the same way it applies to options.
gives their holders the right to sell stock to the issuing company.
There are many variations
of (a) what can trigger this right, and (b) the formula that controls
the price at which the corporation must buy its the shares.
These are notes that
promise to pay their holders a sum of money, usually with interest.
The money may be paid in a lump sum or in a series of payments
over the life of the note.
The note can be secured
with property. If it is secured, it can limit the holder's recourse
to the property, thereby protecting the issue from any further
We will next look
at Credit & Security Agreements. Keep in mind that promissory
notes often contain many of the same provisions you will find
in Credit & Security Agreements.
A letter of credit
is a promise by a bank to pay a specified amount of money to the
holder of the letter of credit. In order to receive the money,
the holder must present whatever documents that the letter of
credit specifies to the bank.
Letters of credit
are useful because of the flexibility you have in determining
what these documents can be. They can be shipping documents, warehouse
receipts, inspection reports, or third party certifications that
specified events have occurred. By carefully selecting what documents
a letter of credit requires, you can design a letter of credit
to guarantee almost any type of transaction.
In practice, letters
of credit are used only to guarantee payment obligations. When
the guaranteed performance involves more complex performance obligations
like the performance of construction contractors, performance
bonds are usually used. They are issued by insurance companies.
When the holder of
a letter of credit exercises it and the bank disburses the money,
the procuring party must reimburse the bank. Banks are required
to unwaveringly honor their letters of credit without compromise.
They are prohibited from looking at any discrepancies or problems
in the underlying transaction between the holder and the procuring
Small banks and foreign
banks can not always be relied upon to do what they are supposed
to do. If you hold a letter of credit from such a bank, it is
often advisable to get it "confirmed" by a major money center
bank. A confirming bank must honor the letter of credit as if
it were its own. A money center will be careful to comply with
its obligations and disburse the money when it is presented with
the letter of credit and the required documentation. Without the
confirming bank, the procurer may be able to delay or prevent
the issuing bank from honoring the letter of credit.
A small or foreign
bank may permit itself to be influenced by an important local
customer. A major money center bank can't afford to sully its
banking reputation by permitting a customer to influence its decision
to honor a letter of credit. Its reputation as a reliable issuer
of letters or credit is too important to its ability to function
as a money center bank.
& Security Agreements
These agreements contain
provisions that help ensure payment of debt. In most instances,
the debt will be represented by a promissory note.
These agreements will
usually secure the debt with a lien on the debtor's property.
In addition, they will include details on payment terms, what
constitutes an event of default, rights to accelerate payments
in the event of default, rights to ongoing financial information,
and other creditor rights.
These agreements can
also include operational restrictions such as negative covenants
prohibiting specified actions and affirmative covenants requiring
specified actions. These covenants can also control any activity
that may impair the debtor's ability to pay. For example they
can impose restrictions on compensation paid to shareholders,
additional debt, and the disposition of property. They can also
require maintenance of specified financial ratios such as debt
to equity ratios.
A revenue participation
agreement entitles its holder to be paid a stream of revenue based
on some measure of a corporation's performance. The revenue stream
can be based on gross revenue, gross profits, net profits, compensation
and dividends paid to shareholders, or some other measure.
When structuring a
deal where you will participate in the success of a privately
held company, revenue participation agreements are usually preferable
to obtaining a direct minority interest in the company.
These are agreements
that control terms of employment. They usually contain provisions
relating to duration of employment, employee compensation, employee
benefits and perquisites, employee duties, rights to terminate,
and termination pay.
Employers often assume
that it is possible for an employment agreement to force an employee
to work for an agreed period of time. This is neither legal or
practical. It went out with indentured servitude. You can't force
performance from an employee who does not want to work for you.
are effective only as a carrot to encourage an employee to stay.
Here's an idea. If you combine an employment agreement with a
non-compete agreement and a proprietary rights agreement, you
can often provide an employee with strong encouragement to stay.
prohibit one party from competing with another. They are often
called "non-compete" agreements. The scope of restricted activities
will vary from agreement to agreement. Sometimes, the restricted
parties will have an obligation to periodically report on their
Ease of enforcement
varies substantially from situation to situation. A non-compete
agreement arising out of an employment relationship can be difficult
to enforce. A non-compete agreed to as part of the sale of a business
is much easier to enforce.
Even an employment
related non-compete agreement, though can be made enforceable
by adding provisions that make the impact of enforcement less
burdensome on the employee. For instance, you can provide an employee
who must forgo employment as a result of the agreement a reasonable
consulting fee during the period of non-competition.
In assessing enforceability,
courts require that the restrictions be reasonable. They look
at the nature of the relationship, the bargaining power of the
parties, the scope of the relationship, the length of time the
restrictions remain in place, and the geographical reach of the
restrictions. The determination of reasonableness is made on a
case by case basis. It can be controlled in large part by the
predisposition of the judge to particular legal theories or fact
One of the most effective
tools for assuring compliance with non-compete restrictions is
the right to withhold money owed to the restricted party.
These agreements control
ownership and rights to proprietary rights that are developed
or acquired during the course of a relationship. These proprietary
rights can include patents, trademarks, copyrights, and trade
Believe it or not,
these agreements can even reach out and control proprietary rights
that come into existence after the end of the relationship.
The relationship can
be other than an employment relationship. It can be a relationship
with an independent contractor, a partner, a shareholder, a vendor,
or a customer.
and Corporate Guarantees
These are agreements
to guarantee the performance of another party under a separate
agreement. The guarantor is often an owner of the company whose
performance is being guaranteed.
the guarantor is an independent third party that is compensated
for providing the guarantee. Guarantors are frequently compensated
with equity, warrants, options, and/or revenue participation agreements.
They will often insist that an owner of the company co-guarantee
Enforcement of a guarantee
can be made subject to numerous types of pre-conditions. Also,
the liability of the guarantor can be limited to a specified amount.
This last condition is one of the most frequently negotiated elements
of a guarantee.