So, you’re back and ready to dive deeper into Representations & Warranties! Welcome. And if that sentence seems strange, you missed last month, where we explored why representations and warranties are important and how they act as your insurance policy in M&A transactions. It’s a good read.
Now we know why representations and warranties are important. Now let’s talk about how to use them and which representations and warranties are important.
Due Diligence Informs Our Representations & Warranties
Representations & warranties don’t exist in a vacuum. And they aren’t meaningless boilerplate. They protect our deal by ensuring that key facts are true. Because our reps & warranties are tied to key facts, we must very carefully and intentionally design them around key facts. How do we know which facts are critical? We learn this through due diligence..
Before you close on a house, you hire an inspector. They crawl through the attic, test the electrical panels, run the water, and poke at anything that looks suspicious. That inspection is your due diligence. What you learn from the inspection determines what promises you need from the seller.
Maybe the inspector finds water stains on the ceiling. Now you need the seller to confirm in writing whether there’s been water damage and whether it’s been properly repaired. Maybe the electrical panel looks outdated. Now you need a representation that all systems are up to code. Maybe that addition over the garage looks a little off. Now you need confirmation that all permits were properly obtained.
The inspection reveals the questions; the seller’s answers become the representations (statements of fact) and warranties (promises that a fact will remain true).
The same principle applies when buying a business. Due diligence uncovers what you need to know about the business you’re buying. Representations and warranties put the seller on the hook for the answers.
The Standard Checklist
Let’s begin with the basics. Every M&A deal includes a baseline set of representations and warranties. Think of these as the equivalent of confirming the house has running water and electricity. These are fundamentals that matter in virtually every transaction.
Organization and Authority: The company is properly formed and in good standing, and the seller has the authority to sell the business.
Financial Statements: The financials fairly present the company’s condition with no hidden liabilities.
No Conflicts: The sale doesn’t violate existing contracts or laws.
Assets: The company owns its assets free of liens.
Contracts: All material contracts are disclosed and in good standing.
Compliance: The business has proper licenses and follows applicable laws.
Litigation: There’s no pending or threatened lawsuits.
Employees: Employee information is accurate and employment laws are followed.
Intellectual Property: IP is owned or properly licensed.
Taxes: All taxes have been filed and paid.
These are your table stakes. Every deal has them. But if you think checking these boxes is enough, Present You is likely putting Future You in a very tough spot.
When Due Diligence Demands More
The real protection from representations and warranties comes from crafting specific ones based on what you discover. A skilled M&A lawyer doesn’t just hand you a template. We dig into what your due diligence uncovered and build reps that address those specific concerns. Let’s explore some examples. In these we’ll call the company you are buying the “Target”.
The Customer Concentration Concern.
The financials of your Target look great until you realize a significant portion of revenue comes from a small concentration of customers. You need to know that these relationships are in good shape and can transfer to you, or else that revenue may walk out the door after closing. Now you need the seller to represent that a schedule lists all customers exceeding ten percent of revenue over the past three years. For each such customer, the seller confirms that complete copies of all agreements have been provided, customer relationships are in good standing, and the company has received no indication that any major customer plans to reduce or terminate its business. If one of these key customers bails after closing, you have recourse.
The Regulatory Gray Area.
The company operates in a regulated industry but seems casual about compliance. Some licenses are expired, renewal applications are pending, and documentation is inconsistent. You need specific representations that the company holds all required licenses and permits, with a schedule listing each one along with expiration dates and renewal status. You also want confirmation that the company has received no notice of violations, pending investigations, or threatened actions from any regulatory authority. Now you have options. If it turns out the company is operating illegally in some capacity, that’s a breach you can act on. Maybe the potential regulatory breaches are “minor” enough to you that you still want to buy the Target. Now you have full disclosure so you can adjust the price. Or perhaps the deal becomes a sign, then close with remediation of the problems becoming a condition to closing.
The Affiliate Problem.
The Target relies heavily on a few key assets. During due diligence, you learn the owner is a masterful entrepreneur with several successful businesses. It’s possible that Target relies on the seller’s other companies. Maybe one of the affiliated companies owns the real property that the target company uses for operations. Maybe another owns key intellectual property that the target needs. These kinds of arrangements can tether you to the seller for years after closing. And if the Target is dependent on these affiliates, you’re vulnerable to painful price increases down the line.
You need a specific rep identifying transactions between affiliates, with a schedule attached listing each one. You might also negotiate a plan to include the key asset of the affiliate within the sale. This way, you’re protected from essentially renting the business you thought you were buying.
How This Protection Actually Works
Before closing, you conduct due diligence, identify issues, and negotiate with reps addressing what you find. Some problems get fixed before closing. Others get disclosed on schedules as exceptions to the reps, which might adjust the purchase price or deal terms.
At closing: The seller signs the agreement containing all the reps and warranties, promising they’re true as of the closing date and will remain true for a specific period. Often, a portion of the purchase price goes into an escrow account specifically to cover breaches.
After closing, you discover a problem, an undisclosed lawsuit, a departing customer, unpaid taxes, or contamination on the property. You notify the seller of the specific breach and quantify your damages. Depending on the deal terms, you recover from escrow, withhold earnout payments, or pursue direct indemnification. The purchase agreement specifies caps, baskets (minimum claim amounts), and time limits for bringing claims.
This is exactly why specific wording matters. Vague reps are hard to enforce. Specific reps tied directly to your due diligence findings provide real, actionable protection.
How to Use Representations & Warranties Effectively
Be thorough in due diligence. Every issue you uncover informs what reps you need. Don’t rush this phase.
Don’t be shy about specific reps. If something makes you nervous, demand a representation addressing it. The seller can disclose exceptions, but at least you’ll know exactly what you’re buying.
Understand survival periods. Representations don’t last forever. Some might survive for the statute of limitations period; others might only last twelve to eighteen months. Negotiate timeframes that match the risks.
Sellers should understand the flip side of this equation: be completely honest in due diligence because disclosure is your friend, use disclosure schedules strategically to limit liability for known issues, negotiate reasonable survival periods, and cap your exposure through baskets and indemnification limits. A good deal protects both sides.
The Bottom Line
Representations and warranties are not fill-in-the-blank forms. They’re not boilerplate. They’re not interchangeable from deal to deal. They’re carefully crafted statements reflecting the specific business you’re buying, the specific risks your due diligence uncovered, and the specific protections you need. The real value comes from turning what you learned during the due diligence into enforceable commitments from the seller.
Thinking about buying or selling a business? Let’s talk through how to structure reps and warranties that protect your interests without torpedoing your deal. We’ll help you figure out what matters, what doesn’t, and how to bridge the gap between what you’re comfortable with and what the other side needs.
Team Way Law is ready to help!