Selling a business: minimising risk through warranties and protections

Selling a business comes with significant risk to the seller and the buyer.

As the seller you should attempt to limit liability under warranties. The most common way of achieving this is by either amending the wording/deleting warranties, or by including express seller protection provisions within the agreement  i.e.:

  • time limits on claims;
  • a maximum financial limit on claims;
  • an aggregate level of claims; and
  • a de minimis limit (a threshold below which claims will be disregarded) in respect of individual claims.

If you are unable to confirm whether a warranty is true, you need to disclose the information which renders the warranty untrue to avoid a breach of warranty claim. To ensure you have “fully and fairly” disclosed the information, you must make specific disclosures within the disclosure letter.

The buyer will carry out due diligence to investigate the target business and highlight areas of risk they may wish to minimise through the form of warranties.  Warranties seek to provide contractual protection for the buyer and are a way of reducing the risks involved, therefore, the warranties will be heavily negotiated.

With transactions involving an earn-out (where  part of the purchase price is determined by the post-completion performance of the company), it is essential for the seller to seek protection to avoid the buyer attempting to reduce the amount of earn-out. Earn-out protection provisions include undertakings from the buyer such as:

  • to carry on the business in the ordinary course and to maximise profits;
  • no attempt to reduce or distort the amount of earn-out;
  • not to divert business; and
  • not to manipulate profits.

As the seller, failure to seek sufficient protection can result in costly claims or a reduction in the earn-out.