An M&A process at a glance (IV): price, purchase agreement, warranties, and indemnities

A successful M&A process (a merger or acquisition of one or more companies) requires more than just agreement on the price. In this blog series, we discuss step-by-step the essential legal phases of an acquisition: from the letter of intent and due diligence to warranties, indemnities, financing, the purchase agreement, and the post-closing period. We share practical insights from our daily practice, aimed at entrepreneurs, investors, and advisors who want to maintain control over the acquisition process. In this fourth installment, we focus on the phase after due diligence, where the purchase agreement is central. 

In this phase, not only is the legal documentation prepared, but the purchase price and risk allocation are also central. Many clients initially focus on the price, but in practice, the actual outcome of a transaction is often determined by how that price is calculated and by the agreements on risk allocation after closing.

Enterprise value is not the same as purchase price

In many share transactions, the enterprise value is discussed first. However, this is not automatically the amount that will ultimately be paid for the shares. To arrive at the equity value, adjustments are often made for cash, debt, net debt, and working capital. It is precisely about these items that discussions often arise in practice.

What exactly falls under debt? What level of working capital is considered "normal" for the business? How are exceptional or incidental items treated? These questions may seem technical, but they often have a direct impact on the final return or investment. Ideally, parties reach agreements on this in the LOI.

Locked box or completion accounts?

An important part of the documentation is the purchase price mechanism. In practice, two models are primarily used: completion accounts and locked box.

With completion accounts, the final purchase price is determined after closing based on the actual financial position at that time. This aligns well with the actual state of affairs but also relatively frequently leads to disputes after closing. With a locked box, the price is fixed earlier in the process based on historical figures. Between that locked box date and closing, agreements apply concerning leakage: which value may or may not be withdrawn from the company.

For sellers, a locked box often provides more price certainty. For buyers, completion accounts may be more attractive if the company is volatile or the financial position can change significantly in the period leading up to closing.

Warranties and indemnities allocate risk

In addition to the price, warranties and indemnities play a central role in the purchase agreement. Warranties relate to the state of the business, such as the accuracy of the financial statements, ownership of shares, validity of contracts, absence of undisclosed claims, and compliance with laws and regulations.

Indemnities are typically used for specific, known risks that have not yet materialized. Think of a concrete discussion with the tax authorities, an ongoing procedure, or a reported labor dispute. While warranties are often formulated generally, indemnities focus on a clearly defined subject.

How is liability limited?

Sellers do not want to remain indefinitely liable after closing. Therefore, much negotiation occurs in the purchase agreement regarding maxima and minima (the so-called caps, de-minimis thresholds, and baskets), expiry periods, and exclusive remedies. Buyers will try to ensure that these limitations do not undermine their protection too much. 

Due diligence also plays a role here, as the seller will not accept liability for everything they have communicated to the buyer during the due diligence process. For buyers, it is important that these communications are sufficiently concrete. Agreements are also made regarding this.

The buyer may also require additional securities

In addition to warranties and indemnities, a buyer may wish for additional securities for compliance with obligations by the seller. This is especially the case if there are doubts about the seller's recoverability after closing, if a part of the purchase price is paid later, or if specific risks are particularly sensitive. In practice, this could include an escrow arrangement or withholding part of the purchase price, a bank or corporate guarantee, or a capital maintenance statement.

For buyers, such securities provide extra comfort if a warranty claim, indemnity claim, or discussion over price adjustment arises later. For sellers, they are often a point of negotiation since they can limit the desire to exit the transaction "clean" after closing. Whether additional security is appropriate depends on the size of the transaction, the risk profile, and the relative negotiating position.

Earn-outs and financing require extra attention

An earn-out can be a useful tool if the buyer and seller have different expectations about the company's future performance. Part of the purchase price is then made contingent on later results or KPIs. In theory, this is an elegant solution; in practice, it is also a well-known source of disputes. The clearer the goals/targets, definitions, and information agreements, the smaller the chance of discussion.

Additionally, in this phase, acquisition financing, W&I insurance, and any external approvals often play a role (more on this in a later blog). These topics can be crucial for the feasibility and timing of the transaction.

The purchase price is thus much more than a document in which agreements are recorded. It is the place where price, protection, and risk allocation come together. We are happy to think along with you, whether you are negotiating as a (strategic or non-strategic) buyer to make an acquisition or whether you are an entrepreneur selling your life's work.