Guaranteed safety
You’re in the process of buying another company to expand your business. However, you’re concerned that the seller might have made their business look better than it really is. How can you buy yourself some protection?
Pre-purchase
You’ve had your eye on a competitor for some time. Finally, they’ve agreed to sell and naturally have made their business sound as attractive as possible. What if, in reality, there are some rather unpleasant problems just waiting to see the light of day? It’s not like taking back a leaking washing machine is it? As the director responsible, you want to know how to build some protection for your company into the deal.
Tip 1. Agree with the seller that you and your advisors will prepare the purchase document. This means you can ask the questions you want.
Tip 2. If time is available, prepare a list of enquiries (known as preliminary information) that the seller must answer (similar to the process used when buying a house). You can then use the responses to ensure the purchase agreement is tailored accordingly (in your favour).
What about warranties?
The sale/purchase agreement will include warranties. What are they? Simply, they provide the buyer with some assurance as to the state of the business being acquired. If a warranty is breached, you’re able to take legal action.
Legal time. However, it might be a costly business. The practice of producing a schedule of warranties that runs to 30 or 40 pages is becoming commonplace. Arguments about the scope of each one means only one thing - higher legal bills. And anyway, relying on a warranty isn’t a 100% safe strategy. This is because of the practice of giving a so-called disclosure letter by the seller.
Disclosure letter
If the seller isn’t prepared to agree a particular warranty, i.e. they won’t guarantee one part of the business they’re selling, they won’t amend the warranty, they’ll just disclose against it (via a disclosure letter). The warranty is then read in conjunction with the disclosure and only if this is untrue will they be liable for a breach of warranty.
What to watch for
Value. The seller will usually seek to limit their liability for a breach of warranty claim by negotiating a maximum amount of the purchase price that will have to be repaid. It’s normal to agree a percentage figure. Unlimited liability for breach of warranty is rare so don’t think of the exercise as leading to an open cheque book.
Time. The period in which claims have to be notified is limited. A two or three year period is normal. However, in respect of tax claims it’s likely to be extended to six years to match the period of time the Taxman has to bring proceedings for the recovery of tax.
Note. The claim only has to be notified within the agreed period. It may take many months or even years thereafter to finally settle the liability.
Tip. If you’re concerned that a particular warranty plus disclosure just aren’t good enough, ask for retention of the purchase price. This means you hold back some of the money until you’re satisfied nothing unpleasant is about to crawl out of the woodwork. As the buyer, you’re in a strong position to insist on this. Even the threat of retention may result in the seller agreeing a better warranty.
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