Mergers and Acquisitions For Dummies (82 page)

Buyer represents that his company is a duly organized entity, validly exists, and is in good standing. In other words, Buyer promises that his company is a going-concern.

Buyer has authority and legal right to execute the purchase agreement.

Buyer pays the fees for any intermediary he utilizes during the sale.

Mutual promises between Buyer and Seller

Most purchase agreements have at least a couple of mutual representations and warranties that both sides agree to. These may include

Buyer and Seller agree to refrain from making any public announcement of the deal until after the deal closes.

Buyer and Seller agree on the method to calculate taxes for the pre-closing period.

Both sides take reasonable best efforts to fulfill their obligations of the agreement.

Secure against loss with indemnifications

All the representations and warranties (see the earlier section “Review the representations and warranties”) are meaningless unless one side has some sort of recourse against the other.
Indemnification
means one side is providing security against a loss for the other side. The term you see in legal documents is
hold harmless.
One side agrees to hold the other side harmless in the event something happens (or doesn't happen).

As with the representations and warranties, Seller generally provides Buyer with many more indemnifications than Buyer provides to Seller.

Indemnification is why the Seller usually places some of the proceeds from the sale in an escrow account. In case of a breach of a rep or warranty, the Buyer has recourse to recover damages by obtaining money from escrow.

The purchase agreement defines how long the representations and warranties are in effect. Generally, this period ranges from one to two years.

In addition to time limits, the purchase agreement also spells out the limits on the amount of damages from indemnity. This figure depends on the specifics of your deal, of course. A good rule of thumb is to limit the damages to the amount of money in escrow, but as with all legal issues, speak to your attorney to determine damage limits (as well as indemnity periods) for your deal.

Instead of nickel-and-diming each other with relatively small damage claims, M&A parties often agree not to seek money from each other until the net damages reach a certain amount, called a
basket.
In other words, if the basket is $100,000, Buyer won't ask for reimbursement if he suffers $500 in damages from some sort of breach of representation. However, if the net damages reach that $100,000 threshold, Buyer can seek reimbursement from Seller (usually from the escrow money).

Whether you're buying or selling, don't agree to a limitless indemnity because you may be on the hook for a limitless amount of money.

Agree on how to handle a rep and warranty breach

The purchase agreement defines the process for one party to pursue a claim against the other. Usually, the process involves submitting a written complaint and trying to settle the issue with the other party. If the parties can't settle the issue, the agreement lays out how to settle a dispute, often through mediation or the courts. As with most agreements, the specifics depend of the deal, so talk to your legal advisor.

The purchase agreement defines which state's laws govern the agreement. If the parties fail to agree on which side's home state to use, Delaware is a good compromise because it's considered a business-friendly state and even has a separate court system for business issues.

Get acquainted with the exhibits and schedules

As I note earlier in the chapter, purchase agreements are long, and that doesn't even address the exhibits and schedules. For any given agreement, you may see 50 to 100 exhibits and schedules that run the gamut from the escrow agreement to legal and accounting opinions to employment contacts and a lot more!

Many of these exhibits and schedules are part of Seller's representations and warranties. The burden of producing these schedules falls on the shoulders of Seller. Flip to the earlier section “Review the representations and warranties” for more detail on those promises.