Navigating Indemnity Terms in Business Acquisitions

I've never shared this tip publicly, but it's arguably the most important legal deal point when buying a business.

When negotiating your LOI, you face a tough choice:

1. Keep indemnity terms vague to give yourself flexibility to negotiate.

2. Be very specific to avoid losing the deal later but risk losing some negotiating leverage.

As the buyer, the choice is yours. Here’s what we see:

Leaving it vague looks like this:

"The Definitive Agreements would be in a form customary for transactions of this type and would include, in addition to those matters specifically set forth in this letter, customary representations, warranties, covenants, conditions precedent to Closing, and indemnities."

If you choose this path, you give your lawyer the ability to negotiate better-than-market terms.

What's market in indemnification? - 10 to 20% recovery caps for ordinary reps, with 12 to 24 months survival - Purchase price cap for fundamental reps, covenants, and fraud, with statute of limitations survival.

Being very specific in the LOI looks like this:

"The Definitive Agreements would be in a form customary for transactions of this type and would include, in addition to those matters specifically set forth in this letter, customary representations, warranties, covenants, conditions precedent to Closing, and indemnities. Ordinary representations and warranties shall survive for a period of 18 months following the Closing Date, while fundamental representations, covenants, and any matters involving fraud shall survive for the applicable statute of limitations period. The indemnification obligations for breaches of ordinary representations and warranties shall be capped at 10% of the Purchase Price, whereas the indemnification obligations for breaches of fundamental representations, covenants, and any matters involving fraud shall be capped at the total Purchase Price. Any indemnity amounts owed to the Buyer shall be offset against amounts due under the Promissory Note."

In 60 to 70% of transactions we handle, the seller's counsel is not an M&A-trained lawyer and does not know market terms. This allows us to push the limits of what's market. In those deals, we ask for 5 years of uncapped indemnity with no temporal limitations. This can mean millions of dollars in additional recovery possibilities after closing.

The risk here is that the seller's counsel might demand extreme protections for the seller, like no rep survival at all. This can (and should) kill your deal. This happens in about 5% of cases. It's rare, but it does happen. So, as a buyer, you've got a choice to make!

The information provided in this post is for general informational purposes only and does not constitute legal advice. No attorney-client relationship is formed by reading or responding to this post. If you need legal advice, please contact a licensed attorney directly.

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