Friday, 25 January 2013

Warranties & Indemnities – A Basic Guide If You Sell Your Business

What Are Warranties & Indemnities For?

If you choose to sell your business and manage to find a Buyer, once the Buyer has reviewed all of the information provided in the Due Diligence bundle, they will assess with their advisors the areas that they perceive are a risk, or that there is potential for a future liability to arise from.  Acquiring Companies is naturally a risky process, and Business Owners who are risk adverse will never be successful in growing through this method.  However, as every successful Business person would agree, if there is potential to limit your risk then it would be foolish for this route not to be taken.

Warranties are included within the Sales or Business Purchase Agreement, and are basically comments stating the current standing of the Company, protecting the Buyer from any ‘skeletons founds in the closet’ once they have taken ownership.  Warranties are usually generalised to cover the Buyer for standards areas, such as ‘The Company has no outstanding HMRC liabilities’ or ‘The Company currently does not have any outstanding grievance claims from previous/current staff’.

Within the contract the Warranties will be defined to cover a set period of time, and are usually capped at a maximum amount equivalent to the purchase price paid for the Company.  During Due Diligence if the Buyer finds out about a potentially liability or area of concern, and they wish to specifically protect themselves against this, then they will include details of this under the Indemnities.  For example “Should any claims arise in relation to the CVA then the full amount payable will be borne by the Vendors including any legal costs or interest” or “Should Mr James be successful in their claim of unlawful dismissal against the Company then the full compensation and legal costs will be borne by the Vendor”.

How Can A Broker Help In This Instance?

Having the correct advice in this situation is crucial for Vendors, as warranties and indemnities can be up to the financial consideration you received for the Company, and can be in place for up to 7 years after the sale.  This means that 7 years after you have sold your Company, and in reality either spent or invested the money elsewhere, you could be taken to court and forced to pay back the money you received if you have breached the warranties or indemnities within the contract you signed.  The key thing in place to protect Vendors from this scenario is the ‘Disclosure Letter’, a document which allows you to detail any areas of the Company that may breach the stated warranties for the Buyer to review before purchasing the Company.  This allows you the opportunity to make the Buyer fully aware of any issues before signing the contract, meaning they cannot come back and look to claim against these points in the future.

Obviously any disclosures that are made need to be made in full, and there is the risk of the Buyer walking away at this stage if they find out information that they are not willing to proceed with.  Understanding the Company, and honestly reviewing the areas that Buyers may see as a concern or want to warrant against at the outset, is one of the most important things to review when you sell your business, and talking through with professionals can save time, costs and emotional stress at a later stage.  Once your advisor or broker is aware of any potential issues then these will be raised with a Buyer at the appropriate stage, ensuring that these issues are factored into any deal and form part of negotiations, and removing any ‘last minute’ surprises for either party to ensure the sale concludes.

Adam Croft, Senior Business Broker

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