By Tom Vogt
Any business owner selling their company naturally focuses on their net proceeds—the dollars arriving in their bank account when the dust settles. That critical number often decides whether the deal makes sense, but the story does not end at closing. Buyers often propose transaction structures and deal terms that create ways to claw back those hard-earned proceeds. Owners should recognize these risks and carefully negotiate their sale to minimize them.
Watch Your Earn-Out
Having an earn-out means the buyer pays part of the purchase price after closing based on how the business performs. Instead of receiving the full price upfront, the seller earns additional payments if the business hits specific targets.
Any earn-out puts the seller’s proceeds at risk. After closing, the buyer usually controls the business, and the seller may have no say in decisions that affect whether the business meets its earn-out targets. Changes in strategy, personnel, or resource allocation can make these targets harder to achieve.
To protect their proceeds, sellers can negotiate for some post-closing control of the business. The seller should also ensure that earn-out targets are clearly defined and measurable (an example calculation helps). If personnel are key to post-closing success, consider provisions in the transaction documents that protect their employment. If the business is absorbed into buyer’s operations, the seller should consider how to measure its performance in isolation. Finally, the earn-out should include detailed reporting obligations and dispute resolution mechanisms to keep the seller informed.
Disclose Carefully
Transaction documents often contain extensive representations and warranties. These are factual assurances about the business, and the buyer can bring a claim against the seller if they are breached (turn out to be false). Part of the purchase is often held back and put into escrow to secure the seller’s obligation to pay for these breaches.
Negotiating limited representations and warranties is a first line of defense, but careful disclosure can also reduce the seller’s risk of breach. Most deals have a “disclosure schedule” that accompanies the main transaction documents. The disclosure schedule lists specified information (for example, a list of all leases) and any facts that make a representation not fully accurate. Creating the disclosure schedule is a dry task that the bankers or lawyers often manage, but the business team’s careful review is critical. Fully disclosed issues generally cannot result in a post-closing claim, so having complete and accurate disclosures helps protect any escrowed purchase price.
Limit Your Indemnities
Even with meticulous disclosures, post-closing claims can happen. These claims often involve the buyer’s request that the seller indemnify (compensate) them for losses that arise after closing, typically due to breaches of representations, warranties, or agreements in the transaction documents. Indemnification payments may come from a purchase price escrow or holdback first, but additional amounts can come out of the seller’s pocket.
Sellers can protect their proceeds with appropriate limits on the buyer’s indemnification rights. The transaction documents should provide a limited time for buyers to bring claims. Sellers should also consider capping their indemnification risk, often at 10-15% of the purchase price for most types of claims. Deductibles can ensure that buyers only bring claims when their alleged losses become severe. There are many other nuanced limits that sellers and their counsel can propose.
Consider Representations and Warranties Insurance
In recent years, sale transactions increasingly involve representations and warranties insurance (RWI). This is an insurance policy that covers losses arising from breaches of the seller’s representations and warranties. Rather than a buyer seeking indemnification from the seller, the policy covers some or all the buyer’s losses (subject to terms and limits). The parties negotiate who pays the RWI premiums and who covers any losses below the policy’s deductible. RWI can limit the seller’s post-closing risk and avoids the need for escrows and holdbacks, allowing sellers to receive more of the purchase price at closing. In some deals, the RWI becomes the buyer’s sole remedy, and the seller walks away with minimal risk after closing. If a seller expects the buyer to obtain RWI, this should be communicated early in the deal to allow time for underwriting.
These are only a few of the key points that impact whether sellers enjoy their full proceeds after closing—or see them lost through post-closing claims or missed earn-outs. A team of trustworthy professionals, including financial, tax, and legal advisors experienced in negotiating deals, can help business owners minimize their risks and protect their proceeds.
Are you considering selling your business? Contact the M&A team at Tonkon Torp to discuss strategies for structuring and negotiating a successful sale – and making sure you protect the value you’ve built.
Tom Vogt is an attorney in Tonkon Torp’s Business Department with a practice focused on mergers and acquisitions, start-up companies, and corporate governance. He has significant experience leading and negotiating strategic transactions and securities offerings of all sizes for buyers, sellers, and investors.
