One of the biggest surprises that business sellers experience is when they first review the definitive purchase agreement presented by the buyer and encounter the Reps and Warranties section. The reactions range from shock, to fear, to disbelief to, “no way am I signing this”. As the Eagles song says, “Well I’ve got some news for you and you’ll soon find out its true……” Below is a Reps and Warranties Section for a transaction we recently completed. As you can see, it is extensive and far-reaching.
Warranties and Representations of Seller
Except as set forth in the correspondingly numbered Section of the Disclosure Schedules, Seller represents and warrants to Purchaser that the statements contained in this Article 4 are true and correct as of the date hereof.
Organization and Good Standing of Seller. Seller is an individual residing in the state of XXXXX, and has full power and authority to own, operate or lease the properties and assets now owned, operated or leased by him and to carry on the Business as currently conducted. Section 4.01 of the Disclosure Schedules sets forth each jurisdiction in which Seller is licensed or qualified to do business, and Seller is duly licensed or qualified to do business and is in good standing in each jurisdiction in which the ownership of the Purchased Assets or the operation of the Business as currently conducted makes such licensing or qualification necessary.
Authorization. Seller has full power and authority to enter into this Agreement and the Ancillary Documents to which Seller is a party, to carry out his obligations hereunder and thereunder and to consummate the transactions contemplated hereby and thereby. The execution and delivery by Seller of this Agreement and any Ancillary Document to which Seller is a party, the performance by Seller of his obligations hereunder and thereunder and the consummation by Seller of the transactions contemplated hereby and thereby have been duly authorized by Seller. This Agreement has been duly executed and delivered by Seller, and (assuming due authorization, execution and delivery by Purchaser) this Agreement constitutes a legal, valid and binding obligation of Seller enforceable against Seller in accordance with its terms. When each Ancillary Document to which Seller is or will be a party has been duly executed and delivered by Seller (assuming due authorization, execution and delivery by each other party thereto), such Ancillary Document will constitute a legal and binding obligation of Seller enforceable against it in accordance with its terms.
Ownership and Sufficiency of Purchased Assets. Seller has good title to the Purchased Assets being transferred to Purchaser, free and clear of all encumbrances, security interests, liens, charges, conditional sales agreements or claims by any person of any kind, whether known or unknown, except the Assumed Liabilities. None of the Purchased Assets are subject to any commitment or other arrangement for their sale or use by Seller or third parties. The Purchased Assets constitute all of the Purchased Assets of the Seller used in the Business and are in good condition and are sufficient to permit the conduct of the Business as it has and will be conducted up to the Closing and constitute all of the rights, property and assets necessary to conduct the Business as currently conducted.
Litigation and Adverse Claims. There are no actions, suits, arbitrations, regulatory proceedings or other litigation, pending or, to the knowledge of Seller, threatened against Seller or any of its employees or agents in their capacity as such, or any of its properties or businesses. Seller is not subject to any order, judgment, decree, injunction, or consent order of or with any court or other governmental agency.
Restrictions on Transfer. Seller is not subject to any agreement, judgment or decree, restriction or instrument of any kind which would prevent the consummation of any of the transactions provided in this Agreement, terminate or modify any agreement to which Seller is a party, or prevent the execution of this Agreement.
Financial Statements. Complete copies of the unaudited financial statements consisting of the income statements of the Business for the periods ending December 31 in each of the years 2019, 2018 and 2017 (the “Unaudited Financial Statements”), and unaudited financial statements consisting of the income statement of the Business for the period ending December 8, 2020 (the “Interim Financial Statements” and together with the Unaudited Financial Statements, the “Financial Statements”), as well as sole proprietorship tax information for the years 2017, 2018, and 2019, have been delivered to Purchaser. The Financial Statements have been prepared in accordance with Seller’s customary accounting practices applied on a consistent basis throughout the periods involved, subject, in the case of the Interim Financial Statements, to normal and recurring year-end adjustments (the effect of which will not be materially adverse). The Financial Statements are based on and are consistent with the books and records of the Seller’s customary non-GAAP accounting practices with respect to the Financial Statements detailed herein shall be detailed in Exhibit J and fairly reflect the financial condition of the Business.
Seller has no Liabilities with respect to the Business, except those which have been incurred in the ordinary course of business consistent with past practice and which are not, individually or in the aggregate, material in amount.
All Tax Returns required to be filed by Seller for any Tax period prior to Closing have been, or will be, timely filed. Such Tax Returns are, or will be, true, complete and correct in all respects. All Taxes due and owing by Seller (whether or not shown on any Tax Return) have been, or will be, timely paid.
Seller has withheld and paid each Tax required to have been withheld and paid in connection with amounts paid or owing to any employee, independent contractor, creditor, customer, or other party, and complied with all information reporting and backup withholding provisions of applicable Law.
No extensions or waivers of statutes of limitations have been given or requested with respect to any Taxes of Seller.
All deficiencies asserted, or assessments made, against Seller as a result of any examinations by any taxing authority have been fully paid.
Seller is not a party to any Action by any taxing authority. There are no pending or threatened Actions by any taxing authority.
There are no Encumbrances for Taxes upon any of the Purchased Assets nor, to Seller’s Knowledge, is any taxing authority in the process of imposing any Encumbrances for Taxes on any of the Purchased Assets (other than for current Taxes not yet due and payable).
Seller is not a “foreign person” as that term is used in Treasury Regulations Section 1.1445-2.
The operations of Seller with respect to the Business and the Purchased Assets are currently and have been in compliance with all Environmental Laws. Seller has not received from any Person, with respect to the Business or the Purchased Assets, any: (i) Environmental Notice or Environmental Claim; or (ii) written request for information pursuant to Environmental Law, which, in each case, either remains pending or unresolved, or is the source of ongoing obligations or requirements as of the Closing Date.
Section 4.10(a) of the Disclosure Schedules contains a correct, current and complete list of: (i) all Intellectual Property Registrations used in, arising out of, or relating to the Business as currently and formerly conducted, specifying as to each, as applicable: the title, mark, or design; the jurisdiction by or in which it has been issued, registered or filed; the patent, registration or application serial number; the issue, registration or filing date; and the current status; (ii) all unregistered Trademarks included in the Intellectual Property Assets; (iii) all proprietary Software included in the Intellectual Property Assets; and (iv) all other Intellectual Property Assets that are used or held for use in the conduct of the Business as currently conducted. All required filings and fees related to the Intellectual Property Registrations have been timely filed with and paid to the relevant Governmental Authorities and authorized registrars, and all Intellectual Property Registrations are otherwise in good standing. Seller has provided Purchaser with true and complete copies of file histories, documents, certificates, office actions, correspondence and other materials related to all Intellectual Property Registrations.
Section 4.10(b) of the Disclosure Schedules contains a correct, current and complete list of all Intellectual Property Agreements, specifying for each the date, title and parties thereto. Seller has provided Purchaser with true and complete copies (or in the case of any oral agreements, a complete and correct written description) of all such Intellectual Property Agreements, including all modifications, amendments and supplements thereto and waivers thereunder. Each Intellectual Property Agreement is valid and binding on Seller in accordance with its terms and is in full force and effect. Neither Seller nor any other party thereto is, or is alleged to be, in breach of or default under, or has provided or received any notice of breach of, default under, or intention to terminate (including by non-renewal), any Intellectual Property Agreement.
Seller is the sole and exclusive legal and beneficial, and with respect to the Intellectual Property Registrations, record, owner of all right, title and interest in and to the Intellectual Property Assets, and has the valid and enforceable right to use all other Intellectual Property used or held for use in the Business as currently conducted, in each case, free and clear of Encumbrances. Seller has entered into binding, valid and enforceable written Contracts with each current and former employee and independent contractor who is or was involved in or has contributed to the invention, creation, or development of any Intellectual Property during the course of employment or engagement with Seller whereby such employee or independent contractor: (i) acknowledges Seller’s exclusive ownership of all Intellectual Property Assets invented, created or developed by such employee or independent contractor within the scope of his or her employment or engagement with Seller; (ii) grants to Seller a present, irrevocable assignment of any ownership interest such employee or independent contractor may have in or to such Intellectual Property; and (iii) irrevocably waives any right or interest, including any moral rights, regarding such Intellectual Property, to the extent permitted by applicable Law. Seller has provided Purchaser with true and complete copies of all such Contracts.
Neither the execution, delivery or performance of this Agreement, nor the consummation of the transactions contemplated hereunder, will result in the loss or impairment of or payment of any additional amounts with respect to, nor require the consent of any other Person in respect of, the Purchaser’s right to own or use any Intellectual Property Assets or any Intellectual Property subject to any Intellectual Property Agreement.
All of the Intellectual Property Assets are valid and enforceable, and all Intellectual Property Registrations are subsisting and in full force and effect. Seller has taken all reasonable and necessary steps to maintain and enforce the Intellectual Property Assets and to preserve the confidentiality of all Trade Secrets included in the Intellectual Property Assets, including by requiring all Persons having access thereto to execute binding, written non-disclosure agreements.
To Seller’s Knowledge, the conduct of the Business as currently and formerly conducted, including the use of the Intellectual Property Assets and the Intellectual Property licensed under the Intellectual Property Agreements in connection therewith, and the products, processes, and services of the Business have not infringed, misappropriated, or otherwise violated. To Seller’s Knowledge, no Person has infringed, misappropriated, or otherwise violated any Intellectual Property Assets or the Intellectual Property licensed under the Intellectual Property Agreements.
There are no Actions (including any opposition, cancellation, revocation, review, or other proceeding) settled, pending or threatened (including in the form of offers to obtain a license): (i) alleging any infringement, misappropriation, or other violation of the Intellectual Property of any Person by Seller in the conduct of the Business; (ii) challenging the validity, enforceability, registrability, patentability, or ownership of any Intellectual Property Assets; or (iii) by Seller or any other Person alleging any infringement, misappropriation, or violation by any Person of any Intellectual Property Assets. Seller is not aware of any facts or circumstances that could reasonably be expected to give rise to any such Action. Seller is not subject to any outstanding or prospective Governmental Order (including any motion or petition therefor) that does or could reasonably be expected to restrict or impair the use of any Intellectual Property Assets.
Section 4.11 of the Disclosure Schedules lists each of the following Contracts (x) by which any of the Purchased Assets are bound or affected or (y) to which Seller is a party or by which it is bound in connection with the Business or the Purchased Assets (such Contracts and all Intellectual Property Agreements set forth in Section 4.11 of the Disclosure Schedules, being “Material Contracts”):
all Contracts involving aggregate consideration in excess of $25,000 and which, in each case, cannot be cancelled without penalty or without more than 90 days’ notice;
all Contracts that require Seller to purchase or sell a stated portion of the requirements or outputs of the Business or that contain “take or pay” provisions;
all Contracts that provide for the indemnification of any Person or the assumption of any Tax, environmental or other Liability of any Person;
all Contracts that relate to the acquisition or disposition of any business, a material amount of stock or assets of any other Person or any real property (whether by merger, sale of stock, sale of assets or otherwise);
all broker, distributor, dealer, manufacturer’s representative, franchise, agency, sales promotion, market research, marketing consulting and advertising Contracts;
all employment agreements and Contracts with independent contractors or consultants (or similar arrangements) and which are not cancellable without material penalty or without more than 90 days’ notice;
except for Contracts relating to trade receivables, all Contracts relating to indebtedness (including, without limitation, guarantees);
all Contracts with any Governmental Authority (“Government Contracts”);
all Contracts that limit or purport to limit the ability of Seller to compete in any line of business or with any Person or in any geographic area or during any period of time;
all joint venture, partnership or similar Contracts;
all Contracts for the sale of any of the Purchased Assets or for the grant to any Person of any option, right of first refusal or preferential or similar right to purchase any of the Purchased Assets;
all powers of attorney with respect to the Business or any Purchased Asset;
all collective bargaining agreements or Contracts with any Union; and
all other Contracts that are material to the Purchased Assets or the operation of the Business and not previously disclosed pursuant to this Section 4.11.
Each Material Contract is valid and binding on Seller in accordance with its terms and is in full force and effect. None of Seller or, to Seller’s knowledge, any other party thereto is in breach of or default under (or is alleged to be in breach of or default under) in any material respect, or has provided or received any notice of any intention to terminate, any Material Contract. Except as set forth in Section 4.11 of the Disclosure Schedules, no event or circumstance has occurred that, with notice or lapse of time or both, would constitute an event of default under any Material Contract or result in a termination thereof or would cause or permit the acceleration or other changes of any right or obligation or the loss of any benefit thereunder. Complete and correct copies of each Material Contract (including all modifications, amendments and supplements thereto and waivers thereunder) have been made available to Purchaser. There are no material disputes pending or threatened under any Contract included in the Purchased Assets.
Customers and Suppliers
Section 4.12(a) of the Disclosure Schedules sets forth with respect to the Business (i) each customer who has paid aggregate consideration to Seller for goods or services rendered in an amount greater than or equal to $50,000 for each of the two most recent fiscal years (collectively, the “Material Customers”); and (ii) the amount of consideration paid by each Material Customer during such periods. Except as set forth in Section 4.12(a) of the Disclosure Schedules, Seller has not received any notice, and has no reason to believe, that any of the Material Customers has ceased, or intends to cease after the Closing, to use the goods or services of the Business or to otherwise terminate or materially reduce its relationship with the Business.
Section 4.12(b) of the Disclosure Schedules sets forth with respect to the Business (i) each supplier to whom Seller has paid consideration for goods or services rendered in an amount greater than or equal to $50,000 for each of the two most recent fiscal years (collectively, the “Material Suppliers”); and (ii) the amount of purchases from each Material Supplier during such periods. Except as set forth in Section 4.12(b) of the Disclosure Schedules, Seller has not received any notice, and has no reason to believe, that any of the Material Suppliers has ceased, or intends to cease, to supply goods or services to the Business or to otherwise terminate or materially reduce its relationship with the Business.
Compliance With Laws
Seller has complied, and is now complying, with all Laws applicable to the conduct of the Business as currently conducted or the ownership and use of the Purchased Assets.
Except as set forth on Schedule 4.14, no broker, finder or investment banker is entitled to any brokerage, finder’s or other fee or commission in connection with the transactions contemplated by this Agreement or any Ancillary Document based upon arrangements made by or on behalf of Seller.
No representation or warranty by Seller in this Agreement and no statement contained in the Disclosure Schedules to this Agreement and the Seller’s Closing Certificate contains any untrue statement of a material fact, or omits to state a material fact necessary to make the statements contained therein, in light of the circumstances in which they are made, not misleading. End or Reps and Warranties Section
This is one of the areas of the contract where there is very little wiggle room for negotiations on the part of the seller. The instructions of the larger company’s transaction team are to protect the mother ship. They do not want to acquire unknown liabilities that could put the buying company in financial or legal difficulty. They will ask for the Reps and Warranties to last for long periods, often including language such as, “will last for the statute of limitations or six years, whichever is longer”. We generally are able to negotiate the period down to the 3-4 year range. It does not matter what your agreement’s rep and warranty period is on taxes, because the government is not bound by your agreement and will come after you to the full extent of the statute of limitations period.
This language was extracted from a Software Company deal. Please note the extensive attention paid to the full and complete ownership of the intellectual property. I warn our software clients that the buyers will spend the most time in due diligence on this very issue, because this is the value they are buying.
As a Business Seller, you may think this is overkill, but the buyers will stand fast on this issue. A business acquisition is, by its very nature, a risky transaction based on integration with the buying company, synergies, customer churn, employee defections, etc. They will do whatever possible to limit their risk from inherited hidden liabilities and/or misinformation. So as a Seller, focus your energies to negotiating the best price and terms for your sale and to being totally transparent in the due diligence process.
Dave Kauppi is the editor of The Exit Strategist Newsletter and Author of Selling Your Software Company – An Insider’s Guide to Achieving Strategic Value Dave is a Merger and Acquisition Advisor and President with MidMarket Capital, Inc. MMC is a private investment banking, merger & acquisition firm specializing in providing M&A sell side representation to entrepreneurs and middle market corporate clients in information technology, software, high tech, and a variety of industries. Dave began his Merger and Acquisition practice after a twenty-year career within the information technology industry. His varied background includes positions in hardware sales, IT Services (IBM’s Service Bureau Corp. and Comdisco Disaster Recovery), Software Sales, computer leasing, datacom, and Internet. The firm counsels clients in the areas of merger and acquisition and divestitures, achieving strategic value, deal structure and terms, competitive negotiations, and Letter of Intent Consulting. Dave is a Certified Business Intermediary (CBI), is a registered financial services advisor representative and securities agent with a Series 63 license. Dave graduated with a degree in finance from the Wharton School of Business, University of Pennsylvania. For more information or a free consultation please contact Dave Kauppi at (269) 231-5772, email email@example.com or visit our Web page MidMarket Capital, Inc.