Classification: Deal Driver
Section: Representations and Warranties of Seller
Negotiation Time: Minimal
Transaction Costs: Insignificant
Major Impact: Deal Value and Risk Management
What is This? The Representations and Warranties of Seller portion of the Agreement is used to save the Buyer time and money. Rather than require the Buyer to go through third parties to find certain information, the Seller provides the information and must reimburse the Buyer for any Losses it suffers if the information is false or misleading. Here, the Seller provides information regarding the Business’s Accounts Receivable.
The Middle Ground: The typical representations in this section include: (1) Accounts Receivable figures are based on legitimate transactions that are consistent with past practice; (2) the amounts are not disputed by the person or business on the other side of the transaction; and (3) the amounts will be collectible within some standard time frame, taking into consideration the company’s “bad debt allowance” that has been computed based on prior experience.
Purpose: The Accounts Receivable portion of the balance sheet indicates the strength of a company’s incoming cash flow and provides the Business with some assurance that it will be able to pay future debts. It is an essential component of the working capital calculation, which is often directly tied to the valuation of the Business. Therefore, it has a significant impact on the final Purchase Price. Additionally, if a company has sold its Accounts Receivable to another company (called a “factoring relationship”), that can have a substantial negative effect on a company’s value.
Buyer Preference: The Buyer wants to include the middle ground term as a baseline representation and may want to include additional receivables accounts if they make up a significant portion of the business.
Seller Preference: Since Accounts Receivable is an item on the Balance Sheet, the Seller wants to exclude this representation on the grounds that it is covered by the Financial Statements representation. In lieu of complete removal, the Seller may try to remove the language referencing collectability of Accounts Receivable since the ability to collect payment within a set time frame relies largely on the actions of third parties over which the Seller has little or no control.
Differences in a Stock Sale Transaction Structure: None.
We want The Middle Ground to be an ongoing dialogue for and resource to the lower middle market M&A community. The outline above is generally applicable, but there is always specific case law and nuance around certain industries that can be useful in helping buyers and sellers come together. If you are a lawyer or deal professional, we encourage you to add your perspective below.