Representations and Warranties

Representations and warranties are contractual statements made by the seller in an acquisition definitive agreement about the state of the business. Also called R&W or "reps and warranties," they describe the business at signing and closing, with breach triggering indemnification obligations to the other party. Buyers also give some reps, though to a lesser extent. R&W are typically the largest single section in a definitive agreement by page count and one of the most-negotiated. They are the seller's commitment that what the buyer thinks they're buying is what they're actually buying.

The major categories of seller reps in a typical M&A deal: organizational (the company exists, is in good standing, has authority to enter the agreement), capitalization (the cap table is accurate, all securities have been validly issued, no undisclosed options or warrants), financial statements (financials are accurate and prepared per GAAP, no undisclosed liabilities, accurate accounts receivable), assets and properties (the company owns or properly licenses everything it uses, no liens), intellectual property (the IP is properly owned and registered, no infringement claims, all employees have signed proper assignment agreements), contracts (key contracts are accurately disclosed, no defaults, no change-of-control triggers that could affect the deal), employees and benefits (no undisclosed compensation arrangements, employment classifications are correct, benefit plans are compliant), compliance with laws (no regulatory violations, all required licenses, tax compliance), litigation (all material litigation disclosed), and operational (no material adverse change since the last financial statement, no events outside the ordinary course). The two structural variables that determine how much risk the reps actually carry: survival period (how long after closing can the buyer make indemnification claims for rep breaches; typically 12 to 24 months for general reps, longer for fundamental reps like ownership, often indefinite for tax and fraud) and indemnification caps (typically 10 to 30 percent of deal value for general reps, sometimes 100 percent of deal value for fundamental rep breaches). The R&W insurance market: most modern mid-market and larger deals now use representations and warranties insurance to backstop seller indemnification, allowing tighter survival periods and lower escrows in exchange for an insurance premium of roughly 2 to 4 percent of policy limit.

What founders get wrong: Signing definitive agreements without scrutinizing the reps line by line, then getting hit with indemnification claims years later for things the disclosure schedules should have specifically carved out. Every rep is a future liability if it turns out to be wrong; the disclosure schedule is the seller's only protection. Hire a real M&A lawyer for the reps section specifically; it's where the money is.

Related: Definitive Agreement · Escrow Holdback · Due Diligence · Acquisition

FAQ

What are representations and warranties?
Contractual statements made by the seller (and sometimes buyer) in an acquisition definitive agreement about the state of the business at signing and closing. Breach triggers indemnification obligations to the other party. Typically the largest single section in a definitive agreement by page count.

What categories of reps are typical in M&A?
Organizational, capitalization, financial statements, assets and properties, intellectual property, contracts, employees and benefits, compliance with laws, litigation, tax, and operational (no material adverse change since last financial statement). The exact list depends on the business, but these categories appear in most deals.

What is R&W insurance?
Representations and warranties insurance is a policy that backstops the seller's indemnification obligations to the buyer for rep breaches, allowing tighter survival periods and lower escrows in exchange for an insurance premium of roughly 2 to 4 percent of policy limit. Most mid-market and larger modern deals use it.