Selling Your Business: Six Critical M&A Decisions, Part 6
For many business owners, signing the transaction documents feels like the finish line.
The buyer has been selected. Due diligence has been completed. The purchase price has been negotiated. The definitive agreements have been signed.
The deal is done.
Or so it appears.
In reality, one of the most important aspects of any transaction concerns what happens after closing if something turns out not to be true.
What if a material contract was not properly disclosed?
What if intellectual property rights do not belong to the company as expected?
What if a previously unknown liability emerges after closing?
These are precisely the questions that representations and warranties are designed to address.
Although they sit at the heart of virtually every share purchase agreement, representations and warranties are often misunderstood by sellers. Many view them as legal boilerplate or technical drafting that matters primarily to lawyers.
In reality, they are one of the principal mechanisms through which transaction risk is allocated between buyer and seller.
Understanding that allocation is one of the most important aspects of any sale process.
Representations and Warranties Are About Risk Allocation
At their core, representations and warranties are statements made by the seller regarding the business being sold.
They may address matters such as:
- ownership of the shares;
- financial information;
- material contracts;
- employees;
- litigation;
- intellectual property;
- regulatory compliance;
- tax matters.
However, representations and warranties are not designed to guarantee the future performance of the business.
Nor are they intended to suggest that a business is risk-free.
Every business carries risk.
The purpose of representations and warranties is to allocate responsibility for certain facts and circumstances existing at the time of the transaction.
Viewed through that lens, they become easier to understand.
The buyer is effectively asking:
Can I rely on these statements when deciding to acquire the business?
The seller is effectively responding:
Subject to the agreed disclosures and limitations, yes.
Why Due Diligence and Warranties Are Closely Connected
Many sellers view due diligence and warranty negotiations as separate stages of the transaction.
In reality, they are closely connected.
Due diligence is the process through which the buyer investigates the business.
Representations and warranties are the mechanism through which the parties allocate the risks that remain after that investigation has been completed.
In many respects, they are two sides of the same coin.
The buyer investigates.
The seller discloses.
The transaction documents allocate the remaining risk.
This is one reason why well-prepared businesses often experience smoother negotiations.
When information is organised, issues are identified early and material risks are properly disclosed, warranty discussions tend to become more focused and predictable.
Conversely, surprises discovered late in the process frequently lead to more difficult negotiations and increased requests for contractual protection.
The Objective Is Not to Eliminate Every Risk
One of the most common misconceptions in M&A is that every risk must ultimately sit with either the buyer or the seller.
Successful transactions rarely work that way.
The objective is not to eliminate every risk.
The objective is to allocate risk appropriately.
Some risks can be investigated through due diligence.
Some risks can be specifically addressed through contractual provisions.
Some risks are accepted by the buyer as part of acquiring the business.
The most successful transactions are generally not those in which one party transfers all risk to the other.
They are those in which risk is allocated in a manner that both parties regard as commercially reasonable.
That is ultimately what allows transactions to proceed.
What Sellers Are Really Promising
When founders first encounter extensive warranty schedules, they sometimes assume that buyers are seeking guarantees regarding every aspect of the business.
That is not usually the case.
The real purpose is more practical.
The buyer wants comfort that the picture presented during the sale process is broadly accurate.
If a seller states that the company owns its intellectual property, the buyer expects that statement to be true.
If the seller confirms that there is no material litigation, the buyer expects that statement to be accurate.
If the seller discloses significant customer dependencies, regulatory issues or ongoing disputes, the buyer can evaluate those matters and make an informed investment decision.
In other words, the objective is not perfection.
It is transparency.
The most difficult warranty disputes often arise not because a business had risks, but because those risks were not identified, disclosed or understood during the transaction process.
Disclosure Often Matters More Than Sellers Realise
Experienced dealmakers know that the quality of the disclosure process often influences post-closing risk more than the wording of individual warranties.
This may seem counterintuitive.
After all, transaction negotiations often focus heavily on the precise wording of contractual provisions.
Yet in practice, a well-organised and transparent disclosure process frequently provides more protection than subtle drafting changes.
A buyer who has been properly informed about a particular issue is generally less likely to argue later that the issue was unknown.
Conversely, information that remains incomplete, unclear or undisclosed often becomes a source of post-closing disagreement.
For sellers, this is an important lesson.
The disclosure process should not be viewed as an administrative exercise.
It is one of the central risk-management tools available in any transaction.
Startups and Growth Companies Face Different Warranty Challenges
For startups and growth companies, warranty discussions often focus on different issues than those encountered in traditional SME transactions.
While financial performance remains important, buyers frequently devote particular attention to matters such as:
- ownership of intellectual property;
- software development arrangements;
- open-source software usage;
- employee participation plans;
- data protection and cybersecurity;
- financing rounds and investor rights;
- regulatory compliance.
In many growth businesses, a substantial portion of enterprise value may be linked to technology, intellectual property or future growth opportunities.
As a result, buyers often seek greater certainty regarding these areas.
Founders are sometimes surprised to discover that buyers are less interested in how innovative a technology is than in whether the company can clearly demonstrate ownership of it.
The lesson is similar to the one discussed throughout this series.
Good preparation creates options.
Poor preparation creates negotiations.
Warranty Claims Are Rare, But They Matter
One concern occasionally expressed by sellers is the fear that every transaction will inevitably lead to post-closing disputes.
In reality, that is not the case.
The vast majority of transactions do not result in significant warranty claims.
Most buyers acquire businesses because they want to own and grow them, not because they hope to pursue litigation against the sellers.
That said, warranty claims can become highly significant when they do arise.
A material undisclosed liability, ownership issue or regulatory problem can have substantial economic consequences.
For that reason, even though claims may be relatively uncommon, the allocation of risk remains an important part of the transaction process.
The objective is not to assume that problems will occur.
The objective is to ensure that the parties have agreed how those problems will be addressed if they do.
The Best Protection Is Preparation
There is a common theme running through every article in this series.
Preparation matters.
It matters when preparing a business for sale.
It matters when selecting buyers.
It matters during due diligence.
And it matters when negotiating representations and warranties.
The strongest sellers rarely begin preparing for warranty negotiations when the share purchase agreement arrives.
They begin much earlier.
Good corporate governance.
Accurate records.
Clear ownership of intellectual property.
Properly maintained contracts.
A well-organised cap table.
Robust compliance procedures.
All of these measures reduce transaction risk long before any buyer enters the picture.
In many respects, the best warranty negotiation is the one that starts years before the sale process begins.
Conclusion
Representations and warranties are often viewed as highly technical legal provisions.
In reality, they perform a much more practical function.
They determine how certain risks are allocated between buyer and seller after closing.
For sellers, the key insight is straightforward.
Representations and warranties are not primarily about legal drafting.
They are about transparency, disclosure and risk allocation.
The businesses that navigate this process most successfully are rarely those with no risks.
They are the businesses that understand those risks, manage them appropriately and disclose them effectively.
Because in M&A, the strongest protection is rarely found in the wording of the agreement alone.
It is found in the quality of the business, the integrity of its records and the preparation that takes place long before the agreement is signed.
This blog post is for discussion and general information purposes only and should not be considered as legal advice.