THE ZWEIG LETTER | OCTOBER 31, 2011, ISSUE 933
F & A A D V I S O R
Reps and warranties They are a necessary evil, though often not met in full. I n almost every M&A deal that I have partaken, the seller has made certain representations and warranties about the business or asset they are selling. The seller typically guarantees that an asset or company has certain characteristics, will perform to a mini- mum level or guarantees that nothing negative will occur. Many of the stan- dard representations and warranties are basic guarantees to ensure the sell- er has not knowingly committed any fraud or malfeasance. For example, you have clear title to the assets, you have paid all your taxes, you are a duly formed legal entity, etc. The standard M&A convention is that the buyer drafts the definitive pur- chase agreement. The buyer’s attorney works with his or her client to draft reps and warranties in a way that mit- igates the transactional risk. For all firms involved in designing structures, a significant amount of time and ef- fort will be put into drafting language concerning liabilities for past projects. The buyer will likely spend quite a bit of time in due diligence going over the firm’s insurance policies and their con- tracts in order to understand any con- tingent risks that the buyer may end up with. Every firm and deal is differ- ent, so you are not likely to see the same set of reps and warranties, even in similar deals. This primarily has to do with how the seller approached their business. A firm that designs locks and dams is likely to have a to- tally different set of reps and warran- ties than a firm doing lighting design for retail clients. The business model is different, as are their clients, which af- fects the risk profile to the purchaser. People make guarantees all the time; however, they do not make any dif- ference unless there is a consequence for failing to live up to your word. If
a salesperson guarantees a product will work, but will not back it up in writ- ing – it is hollow. Reps and warranties typically come with a methodology for the buyer to get a portion of their money back if the sell- ing firm did not perform to
is grim, though, especially in today’s risk-averse environment. The fact of the matter is that the discount that a seller would impose on a firm selling without reps and warranties is so high that no one would undertake such an endeavor. As a seller, you have to come to terms that even after the deal is done, you will have some risk for months, if not years, after a deal is closed. This can be a tough pill for some sellers to swal- low; however, it is the inevitable real- ity of today’s M&A environment. Hav- ing a strong deal attorney and invest- ment banker can help negotiate a bet- ter deal for the seller, though the days of handing the keys over for cash are over, except in instances of extreme distress. W. Hobson Hogan is a ZweigWhite principal specializing in mergers and acquisitions, finance and strategic planning. Contact him at email@example.com. ZweigWhite Merger & Acquisiton Survey: Is your firm considering a merger, an acquisition or a sale? Or have you recently completed a merger or acquisition transaction? If so, then you’ll want to see the survey results in the 2011 Merger & Acquisition Survey of Architecture, Engineering, Planning & Environmental Consulting Firms. The 21st edition of this comprehensive report includes all the latest data on the state of merger and acquisition activity in the design and environmental consulting industry. Whether you want to get a projected value for your own firm or one you’re looking to buy, or you want to find out how the details of the deal you recently made compare to other similar deals, this report has the answers you need. For more information or to buy a copy, call 800-466-6275 or log on to www.zweigwhite.com/zw-1052.aspx.
the terms of the purchase agreement. One of the most important parts of an M&A negotiation is coming to an agreement on the reps and warran- ties and the financial consequences of those. The liability of the sellers is typ- ically capped. In most cases, the worst- case scenario is that a buyer cannot claim more than what they purchased a firm for. If a firm or asset has a sig- nificant environmental liability and a low purchase price, there may be a case for a cap that is more than the pur- chase price. However, this is not likely to occur in an A/E/P firm. Often times in a transaction, the buy- er will hold back a portion of the pur- chase price and put those funds into escrow. The buyer has a defined peri- od of time to make a claim against the seller to deduct the money from the escrow account. JP Morgan Treasury Services recently released their annual survey on escrow activity in M&A. The survey revealed that only 21 percent of all M&A deals last year paid the full es- crow account to the seller and financial buyers never paid the entire escrow amount. The average claim was for 45 percent of the escrow account, which accounts for 74 percent of the original claim. These are pretty shocking statistics, considering the prevalence of hold- backs. If you are a seller, you should understand that there is a strong like- lihood that you will not get all of the escrow. There is likely to be a job that turns south or claim that arises out of nowhere. The alternative of mak- ing no representations or warranties
One of the most important parts of an M&A negotiation is coming to an agreement on the reps and warranties and the financial consequences of those. The liability of the sellers is typically capped. In most cases, the worst-case scenario is that a buyer cannot claim more than what they purchased a firm for.
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