Contracts are meant to protect you, and for a purchase agreement, there are requirements to help you achieve protection in your business transaction. Reps and warranties in M&A are an example of great tools that will reduce considerably the possibility of entering a bad deal. Although representations and warranties are essential, your contract should also include other clauses that give both parties assurance that the sale is going to be transparent and mutually beneficial.
These are the five clauses that every purchase agreement should include so parties can be legally protected.
Reps, or representations, are the statements that each party agrees to in the M&A transaction. They are promises of the current situation regarding the business sale. Representations in contracts are very important because they help create a remedy in case the other side was not honest about something.
If you are buying a business, you want assurances in writing from the seller about certain aspects of how the business is running. While the buyer should do their own due diligence, there is extra pressure if you have in writing that the seller actually told the buyer certain information.
Some issues addressed by representations may be the following:
- Financial statements
- Capitalization and ownership
- Intellectual property
- Real property
An example of a representation in Mergers and Acquisitions would be the business seller claiming the company’s equipment is in perfect condition and does not need to be repaired or renewed.
The warranties are the assurances that each party in a transaction makes. Representations and warranties are usually confused, and they are sometimes lumped into the same section, but they are not the same. The difference between reps and warranties is that representations are the statements made by a party before the M&A, whereas warranties involve statements after the transaction.
We deal with warranties on a day-to-day basis when we buy things like cars and other items. On the other hand, sellers may try to “disclaim” warranties to avoid being responsible for any future problems a buyer may experience.
In a business purchase, you will want to be clear about what you and the other side are promising about the quality and nature of the company.
As an example, a warranty could state that after the business transaction, the company is going to operate normally and will remain compliant with the law.
Contingencies are the conditions in the contract to protect you if are ever unsure about how certain events might play out. Contingencies are important if you do not want to enter a deal unless other events happen first.
For example, if you are in a business purchase, having a financing contingency is essential just in case you are not able to pay for the business. In M&A, you also want to have a due diligence contingency where, as a buyer, you are not obligated to buy unless the results of due diligence are satisfactory.
On the flip side, if you are a seller, you want the contingencies to be as narrow and specific as possible so that the buyer cannot too easily back out of the deal. If the contingencies are too vague, then a lost deal can result in an opportunity cost for other deals that came by.
Covenants are the promises each side makes as part of the contract. For some contracts, covenants are as easy as one party buying something and the other party paying for it. But in most business deals, it’s important to take the time to know exactly what you need from the other side and get those promises in writing.
For example, if you are buying a business, you may ask the seller for help to transition the business for a few months. Or if you are entering into a long-term relationship with another party, you may ask that they carry certain insurance.
Do not ever assume that the other party just knows what you require and will assume what they will do. If you want something done by the other side, get it in writing.
If you are entering into a business transaction, it’s crucial that you involve an M&A lawyer from the beginning of your negotiations. An experienced business attorney will be capable of drafting a purchase agreement with the specific reps, warrants, contingencies, and covenants that will protect you and propitiate a smooth sale.