A securities purchase agreement is used when one or more investors make a minority investment in a company. The agreement sets out the parties' understanding regarding the purchase of securities in the company by the investors, while other agreements document the parties' ongoing contractual relationship. The purchase agreement is structurally similar to, but still significantly distinct from, an acquisition agreement (such as a stock purchase, asset acquisition or merger agreement) used when acquiring control over a target company, even one that is privately owned.

One of the ways in which the two types of agreements differ is in the scope of the company's indemnification obligations to the buyers. The following discussion describes the negotiation issues involved with the indemnification provisions in a private equity securities purchase agreement and how those provisions differ from an acquisition agreement for control of a company. It is taken from the drafting notes to Practical Law Corporate & Securities' newest resource, Standard Document, Securities Purchase Agreement.

The indemnification provisions allocate the risk of losses between the parties, whether they are losses arising out of a breach of a representation, warranty or covenant or a specific liability. The indemnification provisions should be read in conjunction with the representations, warranties, disclosure schedules and covenants to determine the full scope of what is covered. Most indemnification claims are brought by the investor against the company (or other existing stockholders in a recapitalization transaction), so the investor has a greater interest in the indemnity.

The risk of loss to an investor is somewhat different than the risk of loss to a buyer in an acquisition transaction and the indemnification provisions used in a growth-equity investment partially reflect this dynamic (for example, see the discussion in Standard Document, Securities Purchase Agreement: Drafting Note, Pro Rata Indemnification and Gross Ups). In an acquisition transaction, the risk of loss to the buyer is typically direct. A buyer acquiring all of the stock or assets in a business from a seller is often directly and completely responsible for any losses due to liabilities of the company that give rise to a breach of the purchase agreement. Because the sellers no longer own the company, they are not affected by losses of the company absent an indemnity claim. For example, if following the closing, the company (or the buyer in an asset deal) has a liability arise to a third party relating to a pre-closing period that results in a breach (such as an undisclosed liability), the company (or the buyer) is responsible for that loss directly. The indemnification in an acquisition functions to make the company (or the buyer) whole from the sellers for this direct loss.

In a growth-equity investment with a direct purchase of securities by the investor, however, the investor's risk of loss can be thought of as indirect in many cases. The investor acquires an ownership interest in the company while the company is otherwise unaffected (there is no change of control or asset sale). Following the investment, the company is owned by the investor and its other existing stockholders. Therefore, any losses due to third-party liabilities of the company that give rise to a breach of the purchase agreement are typically the direct responsibility of the company (and not the investor). The investor's loss is therefore indirect, as a result of its ownership in the company and the loss in equity value due to the liability.

The indemnification in a growth-equity investment functions to make the investor whole from the company (and indirectly its existing stockholders) for this loss in equity value, rather than from the direct third-party loss giving rise to the claim. If the growth-equity investment is a recapitalization transaction that contemplates existing stockholder liquidity, the risk of loss is similar to an acquisition transaction and the indemnification provisions look more like the M&A indemnity model.

Indemnification provisions in a growth-equity investment vary, with no "one size fits all" approach. The structure of the transaction as well as the negotiation leverage of the parties influence the nature of the indemnification. For instance, whether the investment is structured to include existing stockholder liquidity with the proceeds (as opposed to the company retaining all of the proceeds of the investment) affects the structure and content of the indemnification provisions. In general, however, the provisions used in a growth-equity investment range from:

While growth-equity investments do at times take the venture-capital approach of silence on contractual indemnification, this approach is usually limited to a small minority of growth-equity transactions. On the other hand, full contractual indemnification, including the procedural provisions for the defense of third-party claims, is typically limited to transactions where existing stockholders are receiving all the proceeds of the investment in a recapitalization or other liquidity structure (see Standard Document, Securities Purchase Agreement: Drafting Note, Indemnification by Existing Stockholders). This is because those transactions are more like an acquisition transaction where a seller is walking away with the proceeds without any further interest in the company. While the indemnification provisions in a securities purchase agreement for a growth-equity investment typically end up somewhere in between these two approaches, most growth-equity investment indemnification provisions follow more closely the M&A model than the venture-capital model.

This securities purchase agreement assumes that the company is receiving all the proceeds of the investment. As a result, the agreement reflects a standard indemnification provision for a direct growth-equity investment, including an express contractual indemnification provision that is similar to, but more limited than, the indemnity provision included in an M&A acquisition agreement. However, each transaction is different and the agreement should be tailored to the specific circumstances and needs of the particular transaction and parties.

Agreements with contractual indemnification obligations sometimes contain various procedures the parties must follow regarding an indemnity claim. These procedures primarily relate to:

This securities purchase agreement does not include these type of procedures. Because it assumes that the company is receiving all the proceeds of the investment and exclusively providing the indemnity, the third-party claim procedures are not appropriate. Those procedures typically are used in an acquisition or a growth-equity investment where the use of proceeds is similar to an acquisition (paid to a selling stockholder) and, as a result, the selling stockholders receiving liquidity in the transaction provide indemnification. In those cases, the indemnifying parties often want to have the option to assume control of the third-party claim because they are responsible for the indemnity obligation. The procedures deal with how and under what circumstances that is appropriate. When a minority investor and the company are the only parties involved, the company will always handle any third-party claims because those claims are brought against the company and there are no procedures to work out (because the company is the indemnifying party).

Similarly, as with many stock purchase agreements used in an acquisition, many securities purchase agreements do not contain detailed procedures for direct claims. Often, the complexity is not needed in this context and the procedures place notice requirements and other obligations on the investor that investors do not always find appealing. However, the company may ask for these procedures and they are sometimes included, particularly if there is stockholder liquidity and those stockholders have indemnity obligations. In those cases, if the third-party claim procedures are included, the direct-claim procedures may be as well.