Key takeaways
- Representations are statements of fact about the business as of the closing date. Warranties are promises that those statements are true. If either is inaccurate, the seller may owe indemnification to the buyer.
- The most heavily negotiated representations are financial statements, taxes, material contracts, intellectual property, employment, and absence of undisclosed liabilities.
- Knowledge qualifiers limit a rep to what the seller actually knew or should have known. Materiality qualifiers limit a rep to matters that have a material adverse effect. Both reduce seller exposure but buyers push back on both.
- Fundamental representations, including organization, authorization, capitalization, and title to assets, typically survive the closing for longer periods and have higher or unlimited liability caps.
- Disclosure schedules are the mechanism by which sellers qualify their representations. A rep that would otherwise be inaccurate is made accurate by disclosing the exception on the schedule. Missing a disclosure is how reps get breached.
18 months
Typical survival period for general representations
36–60 months
Typical survival period for fundamental representations
8–12%
Of closed transactions result in a rep and warranty indemnification claim
$150K–$500K
Typical basket threshold before buyer can make indemnification claims
When a founder signs a purchase agreement, they are making dozens of specific factual statements about the business to the buyer. Those statements, collectively the seller's representations and warranties, are the legal foundation of the buyer's decision to pay the agreed purchase price. If any of them turn out to be inaccurate in a material way, the seller may owe the buyer indemnification for the resulting loss.
Most founders read their reps and warranties without fully registering the risk in each one. They trust their attorneys to negotiate the right language, which is the right approach, but the founder who understands what they are signing is a more effective client and a more credible counterparty in negotiation.
The major representation categories and their risk profile
Major representation categories and what they cover
Organization and authority
The company is validly organized, the seller has authority to sign, and no approval is required that has not been obtained. Low risk if properly organized; high risk if there are undisclosed co-owners, equity holders, or authorization gaps.
Capitalization
The seller owns 100% of the equity being sold, there are no other equity holders, and there are no outstanding options, warrants, or rights to acquire equity. Moderate risk: founders sometimes forget about historical equity grants or informal arrangements.
Financial statements
The financial statements provided to the buyer present fairly the financial condition of the business and were prepared in accordance with GAAP or another specified standard, consistently applied. High risk: the most common source of indemnification claims post-close.
Absence of undisclosed liabilities
There are no liabilities not reflected in the financial statements or disclosed on a schedule. High risk: contingent liabilities, environmental obligations, and informal commitments are frequently undisclosed because the founder was unaware of them.
Tax representations
All tax returns have been filed, all taxes have been paid, there are no pending audits, and there are no positions that would result in additional tax liability. High risk for businesses with multi-state nexus, aggressive deductions, or prior-year positions under examination.
Material contracts
All material contracts are listed on a disclosure schedule, are in full force, and have not been breached. The company is not in default. High risk: founders often have verbal agreements or unsigned contracts that technically breach this rep.
Intellectual property
The company owns or has valid licenses for all IP it uses, there are no infringement claims, and no IP is subject to third-party rights not disclosed. Moderate-to-high risk depending on the business.
Employment and labor
All employees are properly classified, there are no pending labor disputes, and all required benefits have been provided. Moderate risk: contractor misclassification is the most common employment rep issue.
Compliance with laws
The company has operated in compliance with all applicable laws and regulations, and has all required licenses and permits. High risk for businesses in regulated industries.
The financial statements representation and the absence of undisclosed liabilities representation together are the source of more than 60% of post-close indemnification claims, according to SRS Acquiom data. These two reps should receive the most attention from seller's counsel and the most rigorous disclosure schedule preparation.
Fundamental representations vs. general representations
Purchase agreements distinguish between two categories of representation based on their survival period and the associated liability cap.
General representations survive for a defined period after closing, typically 12 to 24 months, and are subject to the general indemnification cap, often 10 to 20 percent of the purchase price. After the survival period expires, the buyer can no longer bring a claim based on those representations.
Fundamental representations cover matters that go to the core of what the buyer purchased: the seller's authority to sell, the capitalization of the company, and title to the assets being transferred. These typically survive for the statute of limitations period, often three to six years, and are subject to a higher cap, sometimes the full purchase price or unlimited.
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Schedule a conversation →Qualifiers that limit seller exposure
Sellers negotiate two types of qualifiers into their representations to limit exposure: knowledge qualifiers and materiality qualifiers.
A knowledge qualifier limits a representation to what the seller actually knew, or what a defined group of key persons knew. Instead of "there are no undisclosed liabilities," the rep reads "to the knowledge of the seller, there are no undisclosed liabilities." If a liability existed but no one at the company knew about it, the knowledge-qualified rep is not breached.
Buyers typically push for a defined knowledge group that includes all senior managers, not just the founder. They also push for a "should have known" standard: the seller is responsible for facts they would have discovered with reasonable inquiry, not just facts they actually knew.
A materiality qualifier limits a representation to matters that have a material adverse effect. Instead of "all contracts are in full force," the rep reads "all material contracts are in full force." Immaterial contract issues that would otherwise breach the rep are excluded.
Knowledge qualifier negotiating positions
Seller preference
Knowledge limited to the founder and named C-suite; actual knowledge only; no "should have known" standard
Buyer preference
Knowledge attributed to all officers, directors, and key managers; "should have known" standard; independent investigation required
Typical middle ground
Knowledge limited to the founder and two to four named senior executives; actual knowledge plus "inquiry that a reasonable person would make in the ordinary course"
Disclosure schedules: how to qualify representations correctly
The disclosure schedules are the seller's primary tool for making representations accurate. If a representation states something that is not completely true, the seller discloses the exception on the relevant schedule. The disclosed exception is then excluded from the scope of the representation.
The most common disclosure schedule mistake is underdisclosure: the seller or their counsel omits an item from a schedule because it seems minor or because the founder was not asked about it directly. Underdisclosed items that later cause a loss are the basis for indemnification claims.
"A founder sold a $16M distribution business and represented that all material contracts were in full force and not subject to any pending termination notice. A major customer had sent an informal email four months before closing expressing dissatisfaction and asking to discuss the contract. The founder recalled the email but did not mention it to counsel, because it was informal and no formal termination notice had been received. Six weeks after closing, the customer terminated the contract. The buyer claimed the contract termination email was a material fact that should have been disclosed. The dispute settled for $900K. The founder's counsel had asked about termination notices, not about informal customer communications."
The lesson is not that founders must disclose everything. It is that the disclosure review process should be thorough: every potentially relevant fact should be surfaced and evaluated by counsel, not filtered by the founder's judgment about what is material.
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Disclaimer: Financial figures and case studies in this article are illustrative, based on representative middle market assumptions, and are not guarantees of outcome. Statistical references are drawn from cited third-party research; individual transaction and operational results vary based on business characteristics, market conditions, and deal structure. This content is for informational purposes only and does not constitute legal, financial, or investment advice. Consult qualified advisors for guidance specific to your situation.
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