How much risk does an indemnity cap leave me with in a business sale?

BDC notes that the seller of a business is not liable for misrepresentations forever, and that liability is typically capped at a certain percentage of the purchase price. A cap helps, but it does not remove the risk. What is left depends on the other terms around it, and you can influence those before you sign.

Disclosure shapes the exposure

BDC explains that in the representations section the vendor formally describes the business and discloses issues it knows about. It says it is hard for a company to give clean representations, so a seller will typically say there is no litigation other than what is disclosed in a schedule. Because BDC ties the compensation to disclosures that turn out to be inaccurate, list known issues carefully with your lawyer.

Time and security

The period in which a buyer can claim is a separate term from the cap. BDC says parties negotiate the compensation a vendor must pay if disclosures are inaccurate, and quotes a lawyer who says that when the market favours vendors, they can drive a hard bargain on capping their liability and limiting how long they are on the hook. BDC also says a buyer will typically want to hold back part of the price as security for a claim. Ask how much of your proceeds would sit in escrow and when it is released.

Questions to put to your lawyer

• Does the cap apply to every kind of claim, or do some fall outside it?
• Who gives the promise, you personally or a company you own?
• When does the claim period start and end?
• Is the holdback the first source of payment or only part of it?