Selling a business is a complex process that requires careful negotiation between the buyer and seller. As part of this negotiation, both parties must agree on reasonable representations and warranties. Ronald A Fossum Jr. discusses what determines whether a representation or warranty is fair and how to ensure that both parties agree.
What Representations and Warranties Mean
When a business is sold, the seller makes representation and warranties about the company, its past performance, and future prospects. These statements assure the buyer that they are getting what they expect in terms of the quality of the business.
For example, a seller might make a representation that states, “The company has been profitable for three years,” “There is no outstanding litigation against the company,” or “All customer contracts are valid and enforceable.” Representations may also include information about financial projections, contracts, employees, intellectual property, tax liabilities, and regulatory compliance.
The buyer will use these representations to determine what value they assign to the business. Therefore, both parties must agree on reasonable representations and warranties when selling a business.
Why Representations and Warranties are Vital
A buyer will look to the representations and warranties made by the seller as assurance that the business they are buying is in good condition. The representations and warranties also help protect the buyer from any unexpected liabilities or costs after they purchase the company.
Therefore, both parties must agree on reasonable representations and warranties before a sale occurs. It is also crucial that these representations and warranties are accurately reflected in the purchase agreement. If a buyer discovers any discrepancies between the representations they were given and the actual state of the business, it could result in expensive legal proceedings.
How to Reach Fair Representations and Warranties
When both parties agree on reasonable representations and warranties, they should be outlined in detail within the purchase agreement. A qualified attorney should review this agreement to ensure that all the necessary information is included and that both parties agree.
In addition, it may benefit both the buyer and seller to get an independent third-party appraisal of the business before any representations or warranties are made. This can help provide a more accurate assessment of the current state of the industry and can help both parties reach a fair agreement.
Red Flags to Look Out for
Being wary of unusual demands or requests is essential when selling a business. For example, if the buyer is requesting representations and warranties that are overly broad or vague, this could signal a red flag. These kinds of requests may be an attempt by the buyer to reduce their own risk without offering adequate consideration in return.
In addition, if the buyer requests representations beyond what is reasonable for the specific business being bought, this could also be a red flag. For example, suppose the buyer requests representations regarding future performance or revenue projections. In that case, they may be expecting too much assurance from the seller.
Both parties should also be aware of any changes to the representations and warranties made after the signed purchase agreement. If either party makes a material change, this should be documented in writing and agreed upon by both parties before it is finalized.
Final Thoughts
Ronald A Fossum Jr understands that setting reasonable representations and warranties during the sale of a business is a necessary process. It is vital that both the buyer and seller agree on these representations to ensure a fair transaction and to protect against unexpected liabilities down the road. By following these guidelines, buyers, and sellers can rest assured that their sales will be handled fairly and transparently.
