If you’re a business owner who’s thinking of selling up, you’ll need to familiarise yourself with the legal procedure involved, commonly known as the merger and acquisition process.
The main document involved in this process is the share purchase agreement under which, you, as the seller, will make certain promises to the buyer known as representations and warranties. For example, you may state that the company owns all its assets outright, there are no outstanding loans, and the business isn’t in breach of any laws or regulations.
If any of these claims are false, your buyer will have a claim against you, potentially for their money back. So, where these statements are only partially true (for example, if there’s a mortgage on your premises and you have a line of credit at the bank), you are entitled to ‘qualify’ them in a disclosure letter.
Because the disclosure letter is one of the most important and contested documents in an M&A, you must get this professionally drafted.
Read on to find out more.
Jump to:
- What is a disclosure letter?
- Why is disclosure important when selling your business?
- Why are warranties important when selling your business?
- What’s included in a disclosure letter?
- How missing disclosures could affect your business sale
- How to write a disclosure letter – can I draft one myself?
- What to do if you need help with a disclosure letter
What is a disclosure letter?
A disclosure letter is a formal document given by the seller of a business as part of the sale process. In it, the seller tells the buyer facts about the business that might affect the buyer’s decision to purchase, or the value of the company.
More specifically, the seller sets out any information that contradicts the promises and statements (representations and warranties) made to the buyer in the sale and purchase agreement.
Why is disclosure important when selling your business?
Disclosure is important when selling your business firstly because it prevents the buyer from coming to you for damages should one of the representations and warranties you made during the sale turn out to be not 100% true. In the letter, you specifically identify each warranty that is untrue, partially true, or provide further details.
If, for example, you are stating that the company owns all the IPR needed to run its business, but you license certain software that’s integral to your operations, you’ll spell this out in the disclosure letter. It’s then up to the buyer to do further investigations to make sure this license will transfer to it on completion.
Even though the buyer will jump all over the company as part of its due diligence, you can’t assume that because you’ve shown them everything you’ll be protected from a claim if one of your warranties turns out to be untrue. To be fully transparent, you should put all qualifications in the disclosure letter.
For larger companies, due diligence will be a major affair. Usually, the seller will set up a ‘data room’ either physically or virtually where its documents and records can be inspected by the buyer. For smaller and less complex companies, due diligence may be less formal although no less important.
Lastly, the disclosure letter has a major role in the sale negotiations. If the disclosure letter reveals issues that are new to the buyer, it can, for example:
- ask the buyer to sort the issue out before or after completion
- ask the buyer for an indemnity to compensate it for any costs that might arise from the issue
- ask for a reduction in the purchase price
- accept the disclosure and go ahead anyway
- withdraw from the sale
Why are warranties important when selling your business?
Warranties are important to the buyer because they shift risk from them (‘buyer beware’) back to the seller. It’s open to the buyer to ask the seller to give them warranties about any part of its business operations, from ownership of assets to outstanding lawsuits.
Warranties are important to you, as the seller, as they enable you to give the buyer full and frank information about your company. Provided you fully disclose any qualifications to the warranties, you can rely upon this disclosure as your defence against a claim for breach of warranty.
What’s included in a disclosure letter?
As we’ve seen, the disclosure letter is where the seller tells the buyer about any discrepancies in the statements it’s making to them as part of the sale. The disclosure letter then protects the seller against claims from the buyer for those discrepancies.
Disclosure against warranties
The disclosure letter will describe, warranty by warranty, any matter that’s inconsistent with that warranty. This comprises:
General disclosures
These apply to all the warranties. They generally refer to things that are easily obtainable from public records and desktop research, and of which the buyer is probably already aware. For example, the general disclosures might refer to all the information in the data room, all publically available information and all information disclosed in its accounts.
Specific disclosures
These apply to certain warranties, in particular. For example, if the seller has warranted that it complies with all laws that apply to it, but it’s been late filing its accounts or has been guilty of a technical breach of a regulation, this will be a specific disclosure against that warranty in the sale agreement.
Here are some examples of how to tackle warranties:
- Warranty: “the company is not involved in any legal proceedings that could affect the value of the shares”. If that’s true, then you don’t need to make any disclosure in the disclosure letter.
- If in fact, you have an outstanding dispute with a major customer that could cost the company millions if a court ruled against it, then you’ll need to declare that in the disclosure letter.
The golden rule of disclosure letters for the seller
If in doubt about whether to put something in the disclosure letter, err on the side of caution and put it in.
How missing disclosures could affect your business sale
You may be tempted to leave due diligence and disclosure to your legal team, but this would be a huge mistake. You and your staff need to be fully involved and provide the buyer with all information it could find useful, up to and including the signing date.
Breach of warranty claims
Any missing or inaccurate disclosures can come back to bite you in the form of breach of warranty claims potentially leading to big financial losses or, in a worst-case scenario, the deal being unwound. Make sure you read and understand every part of the disclosure letter and are happy that you can stand by every statement in it.
Loss of confidence in the sale
Inaccuracies that come to light pre-sale can lead to your buyer losing confidence in you, the business and the sale. This can cause extra costs and delays, and potentially the collapse of the sale itself.
How to write a disclosure letter – can I draft one myself?
Yes and no.
Generally, the first draft of the disclosure letter can be put together by someone with in-depth knowledge of the business, including the operations, risks, downsides and anything else the buyer needs to know. This could be you, your in-house lawyer, accountant or director of operations, for example. While this process can be time-consuming, mistakes can be extremely costly, so be thorough.
Once this first draft is complete, get external legal advice to ask further questions, translate your draft into appropriate legal language and prepare the final draft for signature.
What to do if you need help with a disclosure letter
We can help you prepare a watertight disclosure letter that will protect you against future claims from your buyer. Here are the kinds of issues we’ll be looking out for:
- We’ll make sure that any disclosures you make are full, accurate and clear, and in line with the requirements of the sale and purchase agreement
- We’ll make sure that any documents that are confidential and that you as a seller are legally entitled to withhold are kept back from the buyer
- We can advise on the risks involved in unlawfully withholding information from the buyer, including potential criminal penalties, misrepresentation and exposure to liability under the warranties and indemnities
Our corporate team will be able to guide you every step of the way from preparing for sale to the post-acquisition filings and obligations. We can provide experience, guidance and knowledge on the warranties and indemnities and the detailed disclosure process to ensure you are making the best choices for you and your business.
