How to sell your business
Part 3 - Warranties and indemnities
Warranties and indemnities
This is the third article in our four-part series outlining the process of selling your business with a focus on the importance of warranties, indemnities and disclosure.
In any sale process, the parties’ advisers shall negotiate a Purchase Agreement setting out the key terms of the deal. Importantly, the Purchase Agreement will usually contain assurances given by the seller in relation to the state of the business. These assurances take the form of warranties and indemnities, which give the buyer recourse if an issue arises, and they suffer a loss.
What are warranties?
When a buyer acquires a business, the law provides very little protection if things don’t turn out as the buyer expected. Depending on the nature of the deal, the buyer may be taking on the business “warts and all”, inheriting all the debts, liabilities and problems of the business. For this reason, the buyer usually seeks extensive contractual assurances in the form of warranties given by the seller.
Typically, a buyer will seek assurances that (i) the seller owns the asset(s) they are selling; (ii) there are no disputes affecting the business; (iii) all business and financial information is up to date and accurate; (vi) the business holds all permits and consents required to operate; and (v) the business has been run in compliance with any applicable laws.
The warranties are typically set out in a schedule to the Purchase Agreement and can run on for several pages. It is important that the seller is comfortable giving the warranties as the buyer may be able to sue the seller if any of the warranties turn out to be untrue.
What is disclosure?
Buying a business is not as simple as buying other assets in your day-to-day life and it is unlikely that the seller will be able to confirm that all warranties are true in all respects. Therefore, it is typical for a seller to prepare a Disclosure Letter to inform the buyer of anything that may qualify the warranties.
The purpose of the Disclosure Letter is to ensure the buyer is given “fair disclosure” of any issues that affect the business so the buyer can make an informed decision about entering into the deal. If the seller gives a fair disclosure, and the buyer continues with the deal, the buyer is usually precluded from raising a warranty claim against the seller later down the line.
What are indemnities?
During the sale process, the buyer will have conducted a thorough due diligence exercise which may have identified certain issues affecting the business. In addition, the seller may have brought certain issues to the buyer’s attention in the Disclosure Letter.
Depending on the nature of the issue identified, the buyer may seek additional comfort in the form of an indemnity.
An indemnity is a promise by the seller to reimburse the buyer for a particular liability if it arises. For example, if the seller has disclosed an ongoing dispute involving an employee, the buyer may require an indemnity from the seller for any sums that the employee is awarded by an Employment Tribunal. The indemnity operates to reimburse the buyer on a pound-for-pound basis so that the buyer is not left out of pocket as a consequence of the issue.
Tips for the seller
Well-prepared sellers can mitigate their exposure in terms of the warranties and indemnities by considering the following practical tips:
- Organisation. Ensure all your paperwork and legal compliance is up-to-date and accurate so you can spot risk areas and deal with them early.
- Don’t hold back. Ensure the buyer is fully informed of any issues affecting the business before they sign on the dotted line. Disclosure is a seller’s best line of defence.
- Limitations and controls. Ensure the Purchase Agreement contains a robust set of limitations on your liability (e.g. maximum monetary cap on liability and strict time limits for a buyer to raise a claim).
- Insurance. Consider exploring Warranty and Indemnity Insurance to help you satisfy a claim, should it arise.
Organisation, full disclosure and negotiated limits reduce seller risk when giving warranties and indemnities. These steps preserve value, build buyer confidence and minimise post-completion exposure while enabling a smoother, faster sale process overall.