Representations and warranties are the part of a sale agreement where you make statements of fact about the business, and agree that if they turn out to be wrong the buyer has a claim. They are usually the longest section and the most negotiated, and for a seller they are where the risk of the deal continues after the money has arrived.
Representations and warranties: what you are actually promising
What are reps and warranties: statements that the accounts are accurate, that the contracts listed are all of them, that there is no litigation you have not mentioned, that taxes have been filed, that you own what you are selling, that employees are as described, and dozens more depending on the business. Each one is a promise with money behind it. Reps and warrants, as it is often shortened, are not a formality: they are the mechanism by which a buyer transfers the risk of unknown problems back to the seller.
Disclosure is the seller's protection
The disclosure schedule is where a seller says, in effect, this warranty is true except for the following. Anything properly disclosed cannot later be claimed on, which makes disclosure the single most important defensive exercise in the whole transaction. It is also tedious, which is why it gets rushed, and rushing it is how sellers end up exposed on something they knew about and assumed the buyer did too. Assume nothing is known unless it is written in the schedule.
Limits, survival and insurance
Sellers negotiate caps on total liability, thresholds below which no claim can be brought, and survival periods after which warranties expire. Those three terms decide what your real exposure is, far more than the wording of any individual warranty. Reps and warranties insurance is a policy, usually bought on larger deals, that covers warranty claims so the seller's exposure can be reduced and more of the price paid at closing. Whether it is available and worth it at your size is a question for your adviser, but knowing the option exists is worth having before the negotiation.
Questions people ask about reps and warranties
What are reps and warranties?
Statements of fact about the business that you promise are true, with money behind them. If one is wrong, the buyer has a claim, which is how unknown risk transfers back to the seller.
How does a seller limit warranty exposure?
Through disclosure, and through negotiated caps, thresholds and survival periods. Anything properly disclosed cannot be claimed on, which makes the disclosure schedule the key defensive document.
What is reps and warranties insurance?
A policy covering warranty claims, usually seen on larger deals, which can reduce a seller's exposure and allow more of the price to be paid at closing.