Most of the negotiating hours in a business sale are not spent on price. They are spent on representations and warranties — the seller's formal statements about the company — and on what happens when one of those statements turns out to be wrong. If you are buying or selling a California business, understanding how reps, disclosure schedules, and indemnification fit together is the difference between reading the purchase agreement and actually knowing what you signed.
What reps and warranties actually are
A representation is a statement of fact about the business as of a specific date: the financial statements are accurate, the company owns its assets, taxes have been paid, there is no undisclosed litigation, the contracts listed are all the material ones. A warranty is a promise that the statement is true. In modern purchase agreements the two travel together, and the practical point is the same: the seller is putting facts on the record, and the buyer is paying a price that assumes those facts are true.
Reps serve two functions. First, they force disclosure — a seller confronted with forty pages of detailed statements must either confirm each one or disclose the exceptions. Second, they allocate risk. If a rep is false and the buyer suffers a loss, the indemnification provisions decide who pays. In effect, the reps are a private insurance policy written into the contract, with the seller as the insurer.
Disclosure schedules: where the real story lives
Almost every rep is qualified by a disclosure schedule — the attachment where the seller lists exceptions. The rep says "there is no pending litigation except as set forth on Schedule 3.12," and Schedule 3.12 tells the truth. Buyers should read the schedules as carefully as the agreement itself, because that is where the actual risks appear. Sellers should treat schedule preparation as serious drafting work, not a clerical task: an accurate, complete schedule is the seller's best protection, since a disclosed item generally cannot support an indemnification claim later.
The knowledge and materiality battle
Two qualifiers do most of the risk-shifting work:
- Knowledge qualifiers. "To Seller's knowledge, no customer intends to terminate" shifts the risk of unknown problems to the buyer. An unqualified rep keeps that risk on the seller. Expect negotiation over which reps get the qualifier and whose knowledge counts — often a defined list of officers, sometimes with a duty of reasonable inquiry.
- Materiality qualifiers. "In all material respects" softens a rep so trivial inaccuracies do not create claims. Buyers often push back with a "materiality scrape," which reads those qualifiers out when calculating damages.
Neither side should treat these as boilerplate. A single word — "knowledge" in the wrong place — can move six or seven figures of risk.
Survival, baskets, and caps
Indemnification terms decide how long reps last and how much they are worth:
- Survival periods. In private deals, general reps commonly survive twelve to twenty-four months after closing. Fundamental reps — ownership of the shares, authority to sell, capitalization — typically survive far longer, and tax reps often track the assessment statutes.
- Baskets. A basket is a threshold below which the seller does not pay. With a deductible basket, the buyer absorbs losses up to the threshold and recovers only the excess; with a tipping (first-dollar) basket, once losses cross the threshold the seller pays from dollar one. Baskets in private middle-market deals are often in the range of one-half to one percent of the purchase price.
- Caps. The cap is the seller's maximum exposure for general rep breaches — frequently ten percent or so of the purchase price in the private market, though it varies with deal size and leverage. Fundamental reps are usually carved out and may have exposure up to the full purchase price; fraud is typically uncapped.
An escrow or holdback commonly backstops these obligations, and representation and warranty insurance increasingly replaces part of the seller's exposure in larger deals.
Why this matters before the LOI
By the time the purchase agreement is being marked up, leverage has largely been set. Sellers who prepare — clean records, accurate financials, complete schedules — give fewer reps trouble and negotiate from strength; the groundwork described in our guide to preparing a business for sale pays off precisely here. Buyers who invest in diligence know which reps to push on and which exceptions matter. Either way, the reps-and-indemnification package deserves experienced M&A counsel, because it is where the deal's real economics hide. Sellers should also expect the package to interact with contract issues surfaced in diligence — change-of-control clauses, unsigned agreements, and consent requirements all show up in the reps.
Talk to a California business attorney
Whether you are selling your company or acquiring one, the reps and indemnification terms will decide who bears the risk after closing — and they are negotiable. Schedule a free consultation or call (949) 418-2113.
This article is attorney advertising and provides general information only. It is not legal advice and does not create an attorney–client relationship. Facts matter; consult a lawyer about your specific situation.
