Keeping Company Sale Proceeds: Indemnification-Related Provisions

In the vast majority of sales of privately held emerging companies, the indemnification-related provisions are the most important outside of the purchase price itself—these provisions often determine whether the seller may hold on to the amount paid by the buyer.  I say “indemnification-related” as it is typically not the indemnification provisions themselves that are most important.  Rather, it is the provisions that define and limit the rights to indemnification, determine how damages are calculated, and state when the rights can be exercised.

For example, the upper limit of the amount of indemnification damages that a seller is responsible for in the event that there is an indemnification claim (commonly referred to as the “cap”), is often more important to the seller than the indemnification language itself, which can be written fairly broadly.

While the indemnification-related provisions are important, they are relatively complex and interrelated.  A negotiating “win” in one area for a seller, such as a low cap on the amount of indemnification damages available to a purchaser, can be negated by a negotiating “loss” in another area, such as broad exclusions from the cap.  Because of how these provisions are interrelated, we usually review and negotiate them in their entirety.

Here is an outline of indemnification-related issues that are often negotiated in a company-sale transaction:

  • Survival of representations and duration to make indemnification claims
    • Duration of survival of “fundamental” representations
    • Duration of survival of other representations
    • Time period to make indemnification claims
    • Exclusions from any of the above
  • Sandbagging
    • Anti-sandbagging provisions
    • Pro-sandbagging provisions
    • Silent
    • Nonreliance provisions
  • Indemnification as the exclusive remedy
    • Covering all transaction-related documents
    • Exceptions to the exclusive remedy
  • Cap
    • Amount
    • Exclusions
  • Basket
    • Amount
    • Exclusions
    • Deductible or first dollar
  • Materiality Scrape
    • None
    • Single
      • Breach
      • Damages
    • Double
  • Indemnification damage reduction
    • Tax benefits to buyer
    • Items covered by insurance
    • Buyer obligation to mitigate losses

As indemnification and related provisions are complex and sometimes difficult to understand, they are frequently glossed over by those who do not have the background (or patience) to take the time to understand them.  These provisions, however, can have a significant impact on the financial end result of the sale transaction.  Having a comprehensive negotiating strategy when negotiating indemnification-related provisions is often crucial to a successful sale transaction.

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