Representations and Warranties

  • Peter Lynch

Representations and Warranties

Whether you are aware of it or not, you have likely entered into a transaction where representations and warranties were made. This weekend, for example, I purchased a Craftsman hand-held power tool. It came with a 3-year limited warranty (“For three years from the date of sale, the product is warranted against defects in material or workmanship.”), which gave me the confidence to make the purchase. And that is precisely the purpose of this section in a stock purchase agreement. Except that you are buying a company instead of a power tool, and this same logic must be applied to a highly unique operating entity. Also, millions of dollars are at stake. 

What are representations and warranties? Think of the representations in this section as promises that certain statements about the company are true, and think of the warranties as a promise to protect the buyer in the event that these statements are not true.

In the event that a representation made is inaccurate, the buyer knows that they can be made whole for the associated loss (we will cover this in detail under Indemnification).

Representations and Warranties of the Buyer

This section of the purchase agreement contains statements of fact and assurances made by the Buyer that must be true and correct as of the closing date.

In an aggressively summarized format, the Seller is looking to have the following confirmed:

  1. That the Buyer has the authority to enter into the purchase agreement and make the acquisition.
  2. That the Buyer is duly organized, validly existing and in good standing.
  3. That there are not additional brokers that will benefit from the transaction beyond what is stated in the purchase agreement.
  4. That the Buyer has sufficient knowledge of the Company and is acquiring the securities of the Company for its own account.
  5. That the Buyer has sufficient funds to complete the transaction.

In contrast to the Representations and Warranties of the Seller, the Representations and Warranties of the Buyer are more limited and primarily focus on fundamental representations and warranties. This is largely because the single greatest concern from the Seller’s perspective is the Buyer’s ability to pay the purchase price. As such, there is generally very little negotiation that takes place as it relates to this section of the purchase agreement.

Representations and Warranties of the Seller

This section of the stock purchase agreement contains statements of fact and assurances made by the Seller that must be true and correct as of the closing date. In an aggressively summarized format, the Buyer is looking to have the following confirmed:

  1. That the Seller has the authority to enter into the purchase agreement and sell the securities described, and that the share count and capitalization represented are accurate.
  2. That the Company is duly organized, validly existing and in good standing.
  3. That the financial statements provided are complete and correct and fairly present the financial condition of the Company.
  4. That there are no undisclosed liabilities.
  5. That the company has all required permits and operates within the boundaries of the law.
  6. That taxes have been paid and returns have been filed.
  7. That Seller has provided information regarding the Company’s litigation matters, employee matters, as well as the material contracts of the Company.

Summarized even further into one sentence: The Buyer needs to know that the Company’s key assets are covered, that it can legally operate and that the Buyer is protected from potential liabilities that might have been the Seller’s responsibility or that grew under Seller’s ownership.

Beyond this summarized format, the Representations and Warranties of the Seller or the Company can cover somewhere between 20 and 50 separate topics.

Focus of the Article: The type of business being acquired and the industry it operates in will have a big impact on which representations and warranties are of focus. For example, a manufacturer of lead-acid batteries for forklifts will be more focused on compliance with labor and environmental laws and the permits required to operate. In contrast, the acquisition of a business that has developed proprietary technology, say a database to manage hospital patients and predict outcomes, will place an emphasis on representations and warranties surrounding intellectual property.

Additional Content:

The ASM+ PRO tier includes a mini course titled Stock Purchase Agreement that contains hypothetical language detailing how these articles might appear in a stock purchase agreement.