Acquisitions can be unpredictable—you never know exactly what you’ll get once you open that box of chocolates! Even in an asset purchase (rather than a merger or stock sale), hidden liabilities or unforeseen issues may arise. For instance, the seller could be insolvent, exposing the transaction to claims from creditors under bulk sales or fraudulent conveyance laws.
Similarly, you might not acquire all the assets you expected, whether through poor structuring or overlooked shared resources in a merger or stock purchase.
However, you can mitigate these risks through careful planning and the right tools. Below is an overview of key mechanisms that experienced M&A attorneys use to protect buyers.
1. Due Diligence
Due diligence is the first line of defense. It involves thoroughly examining the business you intend to acquire, akin to checking under the hood of a car before purchase. Legal due diligence entails reviewing, among other things:
- Organizational documents
- Material contracts
- Permits and government filings
- Real estate instruments
- Intellectual property records
- Financial statements
- Employee benefits plans
- Pending litigation
- Environmental reports
This process often occurs before signing agreements and includes inspections of facilities, data room access and meetings with key personnel. The findings inform deal structure and terms, helping ensure you’re buying what you expect.
2. Representations and Warranties
Representations and warranties (or “reps and warranties”) are factual statements in transaction agreements made by the seller about the business. If these statements prove false, they provide grounds for recourse, such as refusal to close the deal or post-closing remedies.
These may cover:
- Ownership and capitalization
- Compliance with laws
- Material contracts
- Tax matters
- Intellectual property
- Environmental compliance
- Financial health
Tailoring these provisions to your deal is crucial. They not only clarify what you’re buying but also incentivize the seller to ensure their accuracy.
3. Pre-Closing Covenants
In deals with a gap period between signing and closing, pre-closing covenants reduce risks by requiring the seller to:
- Provide access to records and facilities for continued evaluation.
- Operate the business in the ordinary course to preserve its condition.
- Notify you of any material developments affecting the transaction.
These commitments help maintain the value of the business and protect you from unexpected changes before closing.
4. Certifications
At closing, parties typically exchange officer’s certificates and secretary’s certificates:
- Officer’s certificates affirm that representations and warranties remain accurate and pre-closing covenants have been fulfilled.
- Secretary’s certificates verify that those signing on behalf of the company are authorized to do so.
These certifications provide an added layer of assurance and create additional grounds for redress if breaches are later discovered.
5. Legal Opinions
Although less common today, legal opinions from the seller’s counsel can offer added assurance on matters such as:
- Proper formation and good standing of the target.
- Compliance with securities laws for stock issuances.
- Absence of undisclosed litigation.
These opinions, while adding cost, may be valuable in higher-risk transactions.
6. Conditions to Closing and Termination Rights
Your transaction agreement will include conditions precedent that must be satisfied before closing, such as:
- Accuracy of representations and warranties.
- Fulfillment of pre-closing covenants.
- Absence of material adverse changes in the business.
If these conditions are unmet, you can terminate the agreement, avoiding unintended liabilities.
7. Indemnification Rights
Indemnification clauses ensure that if the seller breaches representations, warranties, or covenants, you can recover losses. These rights incentivize the seller to uphold their commitments and provide a mechanism for addressing issues discovered post-closing.
8. Post-Closing Covenants
Finally, post-closing covenants address ongoing concerns, such as:
- Transfer of inadvertently omitted assets.
- Transition services to support operations during the handover.
- “Further action” provisions requiring parties to cooperate in resolving unforeseen issues.
These agreements help ensure the deal’s intentions are fully realized, even after the transaction is complete.
Acquiring a business is a complex process filled with potential risks, but a well-planned strategy, thorough due diligence, and robust contractual protections can significantly mitigate these concerns. Each of the tools outlined above plays a vital role in ensuring you acquire only the assets and liabilities you intend. For tailored advice and support in your M&A transactions, consult with experienced legal professionals and business consultants who can help safeguard your interests and maximize the value of your investment.
