SELLING YOUR COMPANY: IS THE PRICE YOU ARE GETTING REALLY GUARANTEED ?

You have been negotiating the purchase price of your company for weeks, sometimes months. The figure is finally settled, put in black and white in the share purchase agreement (the “SPA”), and you are about to sign with a sense of a job well done. One question deserves to be asked before signing, not after: will you keep the price you negotiated, or could part of it still be clawed back after closing?

The honest answer is that it depends far more on the rest of the SPA than on the figure itself.

I-               The stated price is not necessarily the final price

A SPA does more than document an amount and payment terms. Above all, it organizes an allocation of risks between the seller and the buyer for everything that a due diligence will not have fully verified before signing.

This allocation relies on two mechanisms that, together, determine the real fate of the negotiated price. On one hand, the representations and the warranties that the seller grants to the buyer: the absence of hidden litigation, accuracy of the accounts submitted, validity of key commercial contracts, proper ownership of intellectual property, and so on.  On the other hand, the indemnification mechanisms that apply if one of these warranties turns out to be inaccurate after closing.

A seller might well cash a high price on signing day and have to pay back part of it a few months later if a hidden problem surfaces and the warranties were poorly negotiated. Conversely, a buyer might discover they have virtually no recourse if the protections obtained are too weak relative to the risks actually incurred.

II-             How can the purchase price be reduced after the closing?

Four technical parameters determine the seller’s real exposure after closing, and therefore how genuinely final the price received actually is:

• The cap: it sets the maximum amount the seller will have to reimburse in the event of a breach of warranty. It is generally expressed as a percentage of the sale price.

• The "de minimis": it sets the minimum amount above which each individual claim of the buyer  must be indemnified by the seller. In practice, below this threshold, the claim will not be indemnified by the seller.

• The basket: here, the buyer’s various claims are aggregated and can only be indemnified by the seller once the agreed amount (the overall threshold) has been exceeded. All claims are put into a basket, and as soon as it is full, they can be indemnified (either in full or only for the amount exceeding this threshold, depending on what has been negotiated).

• The duration: it sets the date beyond which each warranty ceases to be enforceable.

If, during the due diligence process the buyer identified a risk whose occurrence and amount is uncertain (a risk of competition or environment law penalty for example), such a risk will be the subject of a specific indemnity, most often without a threshold or  cap. The buyer will be entitled to be indemnified from the first euro.

III-               How can you secure the price you negotiated?

The risk can be managed, provided it is treated as a genuine negotiation topic in its own right, on par with the price itself.

The first rule is to align the risks identified during the due diligence process with the warranties to be included in the SPA. The less a matter has been verified during the due diligence process, the stronger the corresponding warranty needs to be to compensate for that blind spot. Conversely, a point that has already been well documented may justify a lighter warranty. It is often this lack of coordination between the two exercises, more than any dishonesty on the seller’s part, that explains the unpleasant surprises discovered after a sale.

The second rule is to check that the cap, the de minimis, the basket and the duration of the warranties genuinely correspond to the scale of the risks identified, and not to a market practice disconnected from your specific deal, even though such a standard can provide a useful starting framework.

Finally, on mid-sized deals as well as larger transactions, warranty & indemnity (W&I) insurance makes it possible to transfer this risk to an insurer rather than leaving the seller to bear the risk alone for several years. Once largely reserved for larger transactions, this tool has become significantly more widespread and deserves consideration as soon as the level of warranty coverage becomes a sticking point in negotiations.

For an executive selling their business for the first time, this is often a late discovery: they expected to negotiate only on the purchase price and instead find themselves spending most of their negotiating time on clauses they had barely noticed when skimming the draft agreement. The right instinct is simple: never treat a purchase price as secured until you have checked, clause by clause, what could still affect it after the closing.

 KEY TAKEAWAYS

• The purchase price is truly final only if the warranties adequately protect both parties.

• The general warranty regime (cap, de minimis, basket, duration) is designed, by construction, to cover only risks unknown at the time of signing.

• A risk identified during the due diligence process, whose occurrence and amount are uncertain, should be covered by a dedicated specific indemnity, generally without a cap or threshold.

• The due diligence process and the negotiation of the warranties should progress in parallel with one another, to avoid a known risk being poorly covered.

• W&I insurance makes it possible to transfer the residual (unknown) risk to an insurer, without leaving the seller exposed for years.

NEHA Law advises entrepreneurs and investors on decisions having an impact on the control of their company. Selling or buying a company in Luxembourg or in France, Feel free to reach out