The Stock Purchase Agreement is the pivotal document in the equity closing package. It defines the terms under which shares are purchased and the rights that are assigned to them. All the other documents in this package hinge off of this one:

The key elements of this agreement are:

  • It sets the stock price, and by definition of the capitalization table, the enterprise valuation. The cap table details the fully diluted company ownership structure. And, the share price times the fully diluted company stock is the enterprise valuation, also know as the “market cap.”
  • It sets the conversion of Preferred Shares to Common Shares in the event of a change of control of the company, meaning a liquidation or initial public offering.
  • It sets the date of the closing and directs the company to issue share certificates, including how the certificates should be labeled, at that time.
  • It sets the terms for how many additional shares of stock may be sold after the initial closing, called a “rolling closing” if appropriate. This means, if the company is asked to “oversubscribe” the round, the initial investors must approve such action.
  • It explicitly states the designated use of funds is absolute and the company may not spend these invested funds on other activities or assets unless the investors approve such action.
  • It sets definitions for tax codes, intellectual property, key employees, what other agreements shall be put in place (typically those from above), the securities act that governs the transaction, the shares, etc.
  • It sets out certain representations and warranties on behalf of the company including the fact the corporation is duly authorized, in good standing, and authorized to make the shares and sell them.
    • It validates all required securities fillings have been done.
    • It sets out the total capitalization of the company including options and warrants that may be used as stock incentive programs and how they may be issued.
    • It forces the company to warrant that there is no pending litigation against the company now or in the reasonably foreseeable future.
    • It forces the company to warrant that all intellectual property is owned by the company without encumbrance and no material sublicenses exist now or in the reasonably foreseeable future.
    • It forces the company to warrant that there are no undisclosed liabilities (especially regarding members of management, officers, or directors) that exceed a threshold at the time of the closing or tax liabilities.
    • It forces the company to warrant that all property is reported and free of encumbrance.
    • It forces the company to warrant their financial statements are factual and no changes to contracts, liabilities, or assets has occurred since diligence was completed.
    • It forces the company to warrant appropriate insurance is in force and all required permits and licenses are valid.
    • It forces the company to warrant that employees and contractors are not conflicted or a flight risk. This is a protection for the investor. If these warranties are false, then the investor has a legal right to rescind his/her investment in the company.
  • In similar fashion, it forces the investor to opine that he/she is authorized to make the purchase, is doing so for their own benefit, and has reviewed the information provided by the company in assessing their own risk to prevent “buyers remorse” to protect the company.
    • It forces the investor to warrant he/she understands this is private stock and does not have an immediate market.
    • It forces the investor to opine he/she is an accredited investor and that no “general solicitation” has taken place (the dividing line between securities exemptions between traditional private equity sales and “crowdfunding”).
    • It forces the investor to opine that he/she is not conflicted, and all information provided to the company is factual.
  • It sets a maximum compensation, including benefits, employees and contractors may receive without requesting approval of the shareholders. (=* The SPA forces the company to disclose it financial projections and business plan have been provided to the investor.• The SPA set forth the Board of Directors at the time of the closing including any Board seats that will be occupied by the investor.
  • It forces the company to disclose if any “finders fees” have been paid and clearly defined the expenses of the investor that the company will pay, typically for legal costs in performing diligence on the closing documents.
  • It defines where and how any disputes will be arbitrated or litigated.
  • The SPA provides for certain investor protections including the level of debt the company may seek without approval of the shareholders,

It is an admittedly cumbersome document, and an even bigger compilation of closing documents, but this is the industry standard for preferred equity. The utility of this agreement is in the standardization of the terms. This means the company should not have any issues wit successive professional rounds of equity financing and protects both the company and investor.

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