Are you afraid that some information will jeopardize the sale of your company?
There are tons of possible risks a buyer has when purchasing your company. Representations and warranties are your stamp of approval and given word that what you have disclosed is EVERYTHING you know. However, it can be nerve-wracking to open up your doors and show someone all your skeletons, especially when this person or company is making an offer that could be the biggest transaction you ever do. That retirement plan is right in front of you. The beach, the holiday home… everything!
So to share something that might paint your company in a bad light may seem like the last thing you want to do, but if there is one take-away from this article it has to be the phrase “they’ll find out eventually”. Let’s get this clear from the outset.
Absolutely no business is perfect. Most people do know that, so it really is stupid to pretend otherwise, not to mention illegal (more on that later). And by not declaring something first up, you could ruin the whole deal at the 11th hour. It just figures that a problem is more likely to be worked around if it is known from the beginning of negotiations… no one likes nasty surprises.
In fact, having a plan and a system to overcome the challenges in your business is actually a sellable concept, but only if you have acknowledged the challenges in the first place.
Those challenges that keep you up at night – the ones you only share with your closest executive(s) and advisors… they are exactly what the potential buyer is looking to know and fully understand.
Share any and all information!
There are no online reviews of your private business; there are no prospectuses that can be read like a public company. The buyer is relying on you and your team to be fully transparent with the good AND the bad of you business.
The buyer is looking for any gotch-yas. You have to ask yourself if it was you buying the business: what would want to know?
The due diligence period will extract most of the information that the buyer needs, but there is no way they can get to know your company like you do in such a short period. Therefore, the representations and warranties are a tool (CYA) to cover any unknown liabilities.
Representations and Warranties:
Reps and warranties are statements of fact on every aspect of the business, i.e. taxes, contracts, ownership, finances, legal issues, intellectual property, etc. that the buyer discloses. You are representing that all the facts you are giving about the past are true and warrantying the information you have given into the future.
Rep and warranty examples:
- Largest client is about to cancel / contract is almost up
- Patent on crucial technology is about to expire
- Economic or policy changes about to take place that could change the business climate
- Pending lawsuits
- Tax liens
What happens if I don’t share all the information or something happens?
If something should happen after the completion of the acquisition that affects the future cash flow of the business and it was foreseeable and not disclosed then the buyer has a legal right for compensation.
These are some of the ways a buyer can be compensated:
- Payment out of an escrow account that was setup ahead of time, usually a specific dollar amount or percentage of the total purchase
- Payment via an insurance claim from a Representations & Warranties insurance policy
- Legal action
What happens if something happens that I didn’t know about?
If something happens after the sale that you didn’t see coming or that was a normal business risk, there should be no grounds for a claim against the reps and warranties.
Key Take-aways:
- NO SURPRISES!
- Share everything
- Be clean, concise, and confident with your information
- Be able, and willing, to walk away
- Take out R&W insurance if it makes sense
- Limit the claw-back number only to an amount you are comfortable with if it were to take place
Conclusion
Make sure that when you draft the representation and warranties document it is VERY CLEAR on what is covered and not covered. This can be the turning point when the buyer uses their experience to push the price down, negotiate better terms (i.e. a higher percentage of an earn-out or bigger escrow) or walk away completely.
Make sure to keep control and don’t let the attorneys drive the whole process… sometimes it is best to cover it all as businessmen in person and then capture it in writing, exactly like you talked about.
Check out the Top 14 Seller Mistakes Infographic:
