For many entrepreneurs, selling their business is the culmination of years of hard work. The contract has been signed, the price agreed upon and the future beckons. But what many sellers don't realize: even after the transfer, they can be sued for years to come.
The cause? Warranties.
Case study
An entrepreneur sells a business. The purchase agreement contains a guarantee that "all contracts are correct, complete and not misleading. A year later, the buyer discovers that deviating and/or additional agreements have been made about a large purchase contract during the term by, for example, the contract manager or the sales department.
The buyer claims damages insofar as less favorable agreements are not evident from the original contract. And if the warranty breach affects EBITDA, the buyer applies the same market multiple to the loss amount as he used in calculating the purchase price for the business.
In short, the seller thought he was "done," but still ends up in a legal dispute.
What are guarantees?
Guarantees are statements by the seller about the state of the business, for example:
- Financial statements and management figures provide an accurate and complete picture;
- The company complies with all the laws and regulations that apply to it;
- All contracts are correct, complete and not misleading and are fulfilled according to their wording.
Often sounds standard, but their scope is wide. If it turns out afterwards that a warranty is incorrect, the buyer can make a claim, sometimes for substantial sums of money.
Three misunderstandings
1) 'These are standard clauses, I don't need to look at them'.
Standard texts are usually in favor of the buyer (drafted by the buyer's lawyer). Always check critically what the scope is and whether they fit your business.
2) 'After the sale, I'm rid of everything'.
Not true: guarantees usually apply for several years after the transfer. Ranging from 12 months to infinity, and as soon as a buyer invokes a guarantee within a period of (for example) 12 months (by 1 short bill), the legal proceedings concerning it can last for many years.
3) 'My business is decent, so this doesn't affect me'
Even a well-run business has imperfections. Especially small details can give rise to claims, and you cannot possibly know all that your employees have done or promised.
How do I limit my risk?
- Limit the scope: make guarantees concrete, for example with a contract list.
- Work with disclosure: record discrepancies in an appendix and agree that what the buyer knows, he cannot claim.
- Negotiate: only give guarantees for things that fall outside the normal entrepreneurial risk, agree maximums and deadlines for claims.
- Get tested: an experienced M&A lawyer sees the open ends and eliminates these risks.
Conclusion
When sell a business, it's not just about the price, but also the legal terms. Warranties are not a formality: they determine whether you are still at risk after the deal. Those who get this right not only sell a business, but also the concerns that come with it.
