What are representations and warranties and which ones am I making?
Takeaway: "Reps and warranties" are a series of legally binding promises you make to your investors about the state of your company; a breach of these promises can give your investors the right to sue the company for damages.
In every venture financing, the Stock Purchase Agreement will contain a long and detailed section called "Representations and Warranties." This section can be intimidating, as it is a long list of formal legal statements that the company is required to make to the investors. These are not just casual promises; they are legally binding assertions of fact about your company's legal, financial, and operational health.
If any of these statements are later found to be materially false, it can constitute a breach of the financing agreement, giving the investors a legal claim against the company. For this reason, it is critical that you and your legal counsel review every single representation and warranty to ensure it is true and accurate.
The Purpose of Reps & Warranties
Reps & warranties serve two primary purposes:
A Diligence Tool: They force the company to formally disclose any known issues. The process of reviewing the reps & warranties with your lawyer is a form of self-diligence, as it requires you to confirm the status of everything from your corporate records to your intellectual property ownership.
A Risk Allocation Mechanism: They allocate the risk of any unknown problems to the company. If a hidden liability emerges after the financing that contradicts one of the reps & warranties, the investors are protected because they relied on your statement that the problem did not exist.
Standard Reps & Warranties in a Series A
While the list can be long, it is highly standardized. The company will be asked to represent and warrant facts about:
Corporate Organization: That the company is a duly organized Delaware C-Corporation in good standing.
Capitalization: That the cap table provided to the investors is complete and accurate.
Authorization: That the company has the full legal authority to enter into the financing and issue the stock.
Intellectual Property: That the company owns or has the right to use all the IP necessary for its business and that it is not infringing on the IP of any third party.
Financial Statements: That the financial statements provided to the investors are accurate and have been prepared in accordance with GAAP.
Compliance with Laws: That the company is in compliance with all applicable laws and regulations.
Litigation: That there is no pending or threatened litigation against the company.
The Role of the "Disclosure Schedule"
No company is perfect. It is common that one of the standard representations may not be 100% accurate. For example, the company may be involved in a minor, pending legal dispute. You cannot simply sign a representation that there is "no litigation."
The solution is the Disclosure Schedule. This is a separate document that is part of the financing agreement where you can list any exceptions to the reps & warranties. By formally disclosing an issue on this schedule, you are preventing the investors from later claiming that you breached your warranty on that specific matter. The process of preparing the Disclosure Schedule with your lawyer is a critical part of the diligence process.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.