The “Representations and Warranties” section is standard in an acquisition agreement. It is also where the bulk of the negotiating time is spent between the purchasing and selling parties. Recall that “reps” are assurances one party gives to the other. For the entrepreneur who is making his first sale of the company, the “reps” might seem as being ridiculously onerous. Sometimes, an entrepreneur might feel that the reps section is a sign that the purchaser doesn’t trust the entrepreneur.
Though it certainly could be true that a purchaser might not trust the seller, there are other legitimate business reasons the purchaser might ask for reps. Here are some.
To get disclosure from your business
The reps you make force you to disclose things about your business. The purchaser might request this either because he does not trust the seller or, less cynically, the seller might be busy, disorganized, or forgetful. By putting all the reps to be included in one part of the agreement, the seller is forced to go through his business and examine it carefully. This can actually be a good exercise for the entrepreneur as it gives him an opportunity to take stock of his company.
Also, one man’s non-issue is another man’s problem. Just because you don’t see any issues with a certain rep, doesn’t mean it’s not a problem for purchaser. This will often lead into further negotiations. Speaking of which…
To gain ammunition in negotiations.
See above. If purchaser discovers anything he doesn’t like, that issue might be subject to heavy negotiating.
To set up an excuse to walk away.
Sometimes a guy will make up an excuse to break up with a girl so he doesn’t look like the bad guy. Sometimes purchasers do this as well. To take a less cynical view on things: if a purchaser discovers something as part of his due diligence that makes the deal a bad business proposition, he wants a way to back out. And he would be fully justified in doing so. Unlike the guy who broke up with the girl.
Set up grounds for indemnification
If a deal has closed and it turns out a certain rep was not true, the purchaser would likely want a way to get indemnified, reimbursed, or otherwise held harmless against the seller. For example, if the seller reps there is no contingent liability as part of the purchase agreement but it turns out there is indeed a contingent liability, the purchaser wants the seller to take the financial hit of the liability.
Since so much time is spent on the reps and warranties, upfront disclosure to your attorney about your company is critical so that your attorney can work on a negotiation strategy.
(photo courtesy of: http://flic.kr/p/9dz1WF)