What representations and warranties will a company have to make in an acquisition?
Takeaway: In an acquisition, the seller must make a comprehensive set of legally binding promises about every aspect of the business; any breach of these "reps and warranties" discovered after closing can result in a significant financial penalty.
When you sell your company, the acquirer is effectively buying it "as-is," but only after you have provided them with a detailed and legally binding "owner's manual" in the form of the representations and warranties (reps & warranties) section of the merger agreement. This is one of the longest and most critical sections of the entire contract.
Reps & warranties are a series of detailed statements of fact that your company makes about its business, legal, and financial condition. If any of these statements are found to be untrue after the deal closes, the buyer has the right to make a legal claim against you and the other selling stockholders to recover their damages.
What Do Reps & Warranties Cover?
The list of reps & warranties is exhaustive. It is designed to cover every conceivable aspect of your business to give the buyer a full and transparent picture of what they are acquiring. The standard list will require you to make factual statements about:
Corporate Matters: That the company is a duly organized corporation, has provided the buyer with a complete and accurate cap table, and has the authority to sign the merger agreement.
Financials: That your historical financial statements are accurate and have been prepared in accordance with GAAP.
Liabilities: That there are no undisclosed debts or liabilities.
Contracts: That the company has provided a list of all its material contracts and that it is not in breach of any of them.
Intellectual Property: That the company owns or has valid licenses to all the IP necessary to run its business and is not infringing on the IP of any third party.
Employees and Benefits: That the company is in compliance with all employment laws and that all employee benefit plans have been properly administered.
Tax: That the company has filed all required tax returns and paid all taxes due.
Litigation: That there is no pending or threatened litigation against the company.
Compliance with Laws: A broad representation that the company is in compliance with all applicable laws and regulations.
The Role of the Disclosure Schedule
It is almost impossible for any company to make all of these representations without any exceptions. The mechanism for handling these exceptions is the Disclosure Schedule. This is a separate, lengthy document where you must list, in painstaking detail, any specific facts or circumstances that are an exception to the general reps & warranties.
For example, if you are involved in a minor pending lawsuit, you must disclose it on the schedule corresponding to the "No Litigation" representation. By formally disclosing an issue, you prevent the buyer from later claiming that you breached your warranty on that specific matter. The process of preparing the Disclosure Schedules is one of the most time-consuming parts of the entire M&A legal 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.