While Representations, Warranties and Indemnification are Essential in an Purchase Agreement, There's No Substitute for Thorough Due Diligence When Buying a Business
When you buy a used car do you rely exclusively on the seller's warranty, or do you have the vehicle checked out by your mechanic before buying it? I always prefer to have a used car inspected by my mechanic before I buy it, so any issues can be resolved up front and any claims or controversies avoided. If the used car is a "lemon," I don't want to buy it no matter how strong the warranty!
So, too, when I buy a home. If I am making an offer on a home, I hire the most detail-oriented and thorough home inspector available to go through the home before the closing. No matter how strong the warranty, I want to be aware of all issues and problems before closing. I would like to address and resolve all issues and problems pre-closing rather than rely on a warranty post-closing. And if the home is too troubled and has too many problems, I don't want it.
And so it is with buying an operating business. When proceeding with a business merger or acquisition, I recommend a comprehensive purchase agreement complete with representations, warranties, disclosure schedules, and indemnification provisions should there be a breach of representation or warranty.
But conduct comprehensive due diligence as to all important aspects of the business and transaction up front. Why? It is better to identify all problems up front. Issues should be addressed pre-closing, rather discovering them later and be faced with making a claim under the purchase agreement against the seller. Of course, if the business is too troubled, don't buy it!
I am reminded of one client's experience from some years ago. The client had me draft and negotiate an "ironclad" purchase agreement, but the client didn't want to pay me or others to assist with the due diligence.
Imagine the client's disappointment when he learned, post-closing, that he had a very strong claim against the seller under that ironclad purchase agreement, as he wanted, but he needed to file suit to recover on that claim and in the meantime had to operate the acquired business with hundreds of thousands dollars less in working capital than he had anticipated.
A warranty is a wonderful thing, but it is no substitute for thoroughly investigating the company you are buying ahead of time! When buying a business, make sure you or a professional does the due diligence.