While Representations and Warranties and Indemnification are Essential in an Acquisition, There’s No Substitute for Thorough Due Diligence When Buying a Business
When you buy a used car do you rely exclusively on the seller’s warranty or do you have the vehicle checked out by your mechanic before buying it? I would always prefer to have a used car checked out by my mechanic before I buy it so any issues can be resolved up front and any claims or controversies avoided. If the used car is a “Lemon”, I don’t want to buy it no matter how strong the warranty!
So, too, when I buy a home. If I am making an offer on a home, I want the most detailed and thorough home inspector available to go through the home before the closing. No matter how strong the warranty, I like to be aware of all issues and problems before closing. I would like to address and resolve all issues/problems pre-closing rather than rely on a warranty post-closing. And if the home is too troubled, has too many issues/problems, I don’t want it.
And so it is with buying an operating business. Yes, I recommend a comprehensive purchase agreement complete with representations, warranties, disclosure schedules, and indemnification provisions should there be a breach of representation or warranty. I can help with all of this.
But let’s conduct comprehensive due diligence as to all important aspects of the business and transaction up front. Why? Better to identify any and all issues/problems up front, and to address them up-front, pre-closing, than to discover them later and be faced with making a claim agreement against the seller. And of course if the business is too troubled, don’t buy it!
I am reminded of one client’s experience from some years ago. The client had me draft and negotiate an “iron clad” purchase agreement but the client didn’t want to invest in having me or others assist with the due diligence.
Imagine the clients’ disappointment when he learned, post-closing, that he had a very strong claim against the seller under the purchase agreement, as he wanted, but he needed to file suit to recover the moneys and in the meantime had to operate the acquired business with hundreds of thousands less in working capital than he had hoped.
A warranty is a wonderful thing, but is no substitute for checking out what you are buying ahead of time! When buying a business, make sure you or a professional does their due diligence.