How to Read a Sale and Purchase AgreementMedium

The price is the first page. The second half of the price is everything after it — and the disclosure letter is what the warranties are actually worth.

5 min read · 919 words

Why the price is not the price

A sale and purchase agreement opens with a number. Almost nothing else in the document is decoration.

The headline figure is adjusted afterwards for the cash, debt and working capital actually present when the business changes hands. It is reduced by claims under the warranties. It may be increased by an earn-out. And it is conditional on things that have not happened yet.

So the document has two halves. The first says what is being bought and for how much. The second says who bears which risks — and the second half is negotiated harder, because it is where the rest of the money is.

The transaction is the private share purchase, and the alternative structure is an asset purchase, where much of this works differently.

1. What is actually being sold

Shares, or assets. If shares, the buyer inherits the company and everything it has ever done, including liabilities nobody has found. If assets, only what is listed transfers — cleaner to own and far harder to execute, because every contract needing consent is somebody else's veto.

Then check the perimeter: which subsidiaries, which jurisdictions, and what is being excluded and left behind.

2. The price mechanism, which is a real choice

• Completion accounts. The price is adjusted after closing for cash, debt and working capital measured on the day. Fair, and it produces months of argument about definitions — particularly what counts as debt-like, where pensions, deferred consideration and unusual provisions are fought over one by one.
• Locked box. The price is fixed by reference to a historical balance sheet, and the seller undertakes that no value has leaked out since. Certain from signing, and the buyer takes the trading risk from that earlier date.

Read the definition of working capital and the target level. A target set above the business's normal level hands money to the seller, and it is set by negotiation rather than by arithmetic.

3. Conditions, and the long stop date

• Regulatory conditions — merger control, foreign investment, sector approvals. Not negotiable away; the negotiation is who bears the risk if one is refused, and whether a fee is payable.
• Third-party consents — customers, landlords, lenders. The slowest counterparty sets the timetable.
• The long stop date, after which either side may walk away. This is the real deadline, and it is what an arbitrage spread discounts to.
• Material adverse change, allowing the buyer out if something serious happens. Present in most agreements, invoked rarely, and successfully invoked more rarely still.

4. Warranties, and what they are for

Two jobs, and the second is the surprise. They allocate risk: a claim can be made if a warranty is untrue. But their more important function is disclosure — a seller asked to warrant something must either warrant it or disclose why it cannot, and that process surfaces more than diligence usually does.

Which is why the warranty schedule and the disclosure letter have to be read side by side. The schedule says what the buyer asked for; the letter says what it actually got.

5. The limitations, which are the real negotiation

A warranty without limits is unusable, so every agreement caps them:

• A cap on total liability, usually a fraction of the price — with a separate, higher cap for title and capacity, which go to whether the seller could sell at all.
• A de minimis, below which individual claims are ignored, and a basket that total claims must exceed before anything is payable.
• Time limits: short for commercial warranties, long for tax, because tax authorities have their own clocks.
• Knowledge qualifiers — "so far as the seller is aware". Whose awareness, and whether anybody was required to go and look, changes the meaning entirely.
• Exclusions for anything disclosed, provided for in the accounts, or within the buyer's knowledge.

6. Indemnities, which are different from warranties

A warranty is a statement, and a claim requires proving loss. An indemnity is a promise to pay for a specific identified thing — a known tax exposure, a live piece of litigation, a contaminated site — usually pound for pound and often outside the general caps.

Where diligence found something specific, this is where it lands. The move from "warranty" to "indemnity" for a particular issue is one of the clearest signals in the whole negotiation.

7. Who stands behind the promises

• Escrow or retention — part of the price held back against claims.
• Warranty and indemnity insurance — an insurer stands behind the warranties instead of the seller, so a fund can distribute the whole price. Read the policy's own exclusions as carefully as the agreement.
• A guarantee from a parent, where the selling entity is a shell.

A seller with no covenant strength and no insurance has given warranties that are worth reading and not worth much.

8. What happens between signing and completion

Covenants about how the business may be run while everybody waits: no unusual transactions, no dividends beyond an agreed level, no changes to key contracts. They are ordinary and they are also the period in which the buyer has committed and cannot easily withdraw.

The four questions to leave with

1. What does the disclosure letter carve out of the warranties?
2. What is the cap, and is it a number the seller could actually pay?
3. Which condition is most likely to fail, and who bears the cost if it does?
4. What did diligence find that turned into an indemnity?