Welcome back to the Hunter Business Law Mergers and Acquisitions blog series. On our first installment, we discussed the differences between a stock sale and an asset sale. The second installment addressed the differences between an M&A broker and an M&A advisor. This blog will discuss the nuances of baskets and caps within the M&A context.
When an entrepreneur is ready to sell his or her business, common sense dictates that they should attempt to limit their post-closing legal liability as much as possible. That is precisely what the caps do: They establish a ceiling on the seller’s legal exposure regarding issues on their financial statements or contingent liabilities at the time of the sale.
Let’s say the seller represents certain warranties that post sale, the buyer argues are not accurate. If these alleged misrepresentations cause a financial loss to the buyer, the seller may be on the hook, depending on the totality of the circumstances. And because sometimes, mistakes or unforeseen events do happen, it’s always sound advice to place certain types of limits on the seller’s responsibility, while still assuaging the buyer’s concerns.
There are several types of baskets in an M&A.
A basket deductible is an amount that’s established during the process of acquiring a business. Typically, the seller will prefer a higher deductible, because that would mean having a lower risk of exposure to losses. If a loss subsequent to the sale is lesser than the amount established in the purchase agreement, the buyer will be responsible for it.
A tipping basket also delineates an amount that would trigger the seller’s responsibility; except that this type of basket exposes the seller to a larger financial burden. For example, if a purchase agreement includes a basket deductible of $100,000.00, and the buyer suffers a $150,000.00 loss, the seller would be responsible for paying out the additional $50,000.00.
However, under a tipping basket scenario, the seller would be responsible for the entire $150,000.00 amount.
The exact period of time can be negotiated by the parties and included in the purchase agreement. The parties can also establish an escrow in which the seller would deposit funds in the amount of his or her agreed upon liability cap. Such funds would remain in escrow until the indemnification period ends.
Deciding which terms are best for your business will depend on your individual circumstances. Every single business is different, and what may be a great idea for one, may be fatal for another one. The best way to make an informed decision is by consulting with an experienced business lawyer. Hunter Business Law is here to help you.
This Blog was written by Hunter Business Law Founder, Attorney Sheryl Hunter. View her profile HERE.
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