Acquisition Finance: Why Lenders Should Review SPAs Before Funding an Acquisition

Acquisition Finance: Why Lenders Should Never Treat the Share Purchase Agreement as “Someone Else’s Document”

When acting for lenders on acquisition finance transactions, one misconception still crops up from time to time: that the share purchase agreement (SPA) is primarily a matter for the borrower and its corporate advisers.

In reality, some of the biggest lending risks in an acquisition can often be found in the acquisition documents themselves.

At EMW Law, our banking and finance solicitors regularly advise banks, challenger banks and alternative lenders on funding acquisitions ranging from owner-managed businesses through to private equity-backed transactions. While every deal is different, lenders that take the time to properly understand the acquisition documentation are typically in a much stronger position when things do not go according to plan.

Why should a lender care about the SPA?

Put simply, in many acquisition finance deals, the value of the lender’s security and its prospects of repayment are ultimately linked to the business being acquired.

The lender may have excellent security documents, comprehensive guarantees and well-drafted finance documents. However, if the target company turns out not to be worth what everyone thought, or if material liabilities emerge shortly after completion, those protections can only go so far.

That is why lenders should view the SPA, disclosure letter and related acquisition documents as important credit documents rather than just corporate paperwork.

Follow the money

One of the first things we look at is how the purchase price is being structured.

Is all of the consideration being paid on completion? Are there deferred consideration arrangements? Is there an earn-out? Are sellers taking loan notes? Is consideration being adjusted post-completion?

These issues matter because they can affect future cash flow and the borrower’s ability to service debt.

A lender may be comfortable funding an acquisition today, but if substantial future payments become payable to sellers over the next two or three years, that could have a direct impact on liquidity and covenant compliance.

Are the seller protections worth anything?

Most acquisitions include warranties and, in some cases, specific indemnities from the seller.

From a lender’s perspective, these provisions can be extremely valuable. If a significant issue emerges after completion, they may provide the buyer with a route to recover losses.

However, it is important to look beyond the existence of the warranties themselves.

Questions lenders should ask include:

• Are the warranties comprehensive?
• Has liability been heavily restricted?
• Are the claim periods unusually short?
• Have extensive disclosures diluted the protection?
• Most importantly, does the seller actually have the financial resources to meet a claim?

We’ve seen situations where a borrower has excellent legal protections on paper but very limited practical recourse because the seller has distributed sale proceeds shortly after completion.

Watch out for change of control provisions

One area that regularly causes concern is change of control provisions.

A target company may derive a substantial proportion of its revenue from a handful of major customers. If those contracts allow termination following an acquisition, the value of the business could change dramatically overnight.

The same issue can arise in relation to key supplier agreements, licences, franchise arrangements, leases and regulatory consents.

For lenders, understanding whether third-party consents are required before completion can be just as important as reviewing the financial projections.

How will the business operate on day one?

Another practical point is understanding how the target business will function immediately after completion.

Many businesses rely heavily on services provided by the seller’s wider group, including finance, IT, payroll, HR and administrative support.

If those services disappear the day after completion, operational disruption can follow very quickly.

Where appropriate, lenders should ensure that robust transition arrangements are in place and documented before funds are released.

Don’t forget security over acquisition documents

Lenders should also consider whether rights under the acquisition documents form part of their security package.

If the borrower later brings a warranty claim or receives compensation under an indemnity, lenders will generally want those recoveries to sit within the secured asset pool.

This is a relatively straightforward point, but one that can easily be overlooked in the rush to completion.

Acquisition finance is about more than lending documents

For lenders, acquisition finance is ultimately about understanding the transaction as a whole.

The facility agreement and security documents are obviously important, but they only tell part of the story. The acquisition documents often contain the detail that explains where the real risks lie and whether those risks have been appropriately allocated between buyer and seller.

A thorough review of those documents can highlight issues early, shape the finance terms and, ultimately, help avoid problems after completion.

If you’re a lender considering an acquisition finance opportunity, getting the right legal team involved early can often be the difference between a smooth transaction and an expensive surprise.