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Working Capital, Works in Progress, Warranties

I’ve seen these three deal points derail more deals than anything else.

Master them, and you’ll join the top 10% of searchers who close better deals—ones that are fair to everyone and actually make it to the finish line. Ignore them, and you risk deals collapsing post-LOI, wasting time and money.

This is part three of our series on the “3 Ws.” Today’s topic: warranties.

Warranties

Does the business you’re buying offer warranties? Many do, and they can become a significant liability.

Imagine buying a commercial electrical business. They offer a one-year warranty on their work—and a three-year warranty on government projects. Six months after closing, a government client demands you redo defective work on a $350,000 project, costing you $95,000 in parts and labor. Without a clear agreement on who handles warranty claims, you’re on the hook.

Worse, sellers sometimes forget warranties exist—or the terms are so poorly worded they create massive problems. Always review marketing materials, proposals, estimates, contracts, and terms. And make sure your M&A lawyer scrutinizes any warranty language.

Warranties range from negligible (“manufacturer’s warranty only”) to risky (“lifetime warranty”).

Asset Purchase vs. Warranty Claims

You might think warranties only matter in a stock purchase, not an asset purchase. After all, you’re buying the assets, not the liabilities, right?

Not so fast. Even in an asset purchase, you’re likely on the hook for warranty claims. Rejecting claims could lead to lawsuits or a damaged reputation.

Bottom line: Whether it’s an asset or stock deal, if the business offers warranties, you must address who’s responsible for them.

What Sellers Are Thinking

Sellers rarely see this issue the same way buyers do. Two common objections:

1. They worry your customer service post-closing will drive up warranty claims.
2. They fear “open-ended” liabilities post-sale. Their goal? A clean break.

Structuring Warranty Obligations

Here’s how to handle warranty obligations effectively:

1. Identify warranties: Are they manufacturer-only, parts and labor, or something else? What are the dollar/time limits?
2. Define responsibilities: Typically, you’ll handle claims as the new owner, but this can vary if the seller remains involved.
3. Clarify payment obligations: Who pays for what?
4. Set limits: Cap liabilities to avoid open-ended exposure. This applies to both you and the seller.
5. Establish payment terms: Deadlines and mechanisms matter.

Address Warranties Early

Don’t wait until your lawyer drafts the purchase agreement to address warranties. That can spook sellers.

Instead, reference warranties in the LOI. A simple sentence—“Warranty obligations will be allocated between buyer and seller on terms to be negotiated”—is enough to set expectations.

Sample Warranty Terms

Here are two structures I’ve seen work well:

1. For hands-off sellers:
   • Buyer processes claims and does the work.
   • First $X annual aggregate cost is split.
   • Costs above the limit are 100% seller’s responsibility.
   • Warranty obligations expire 2 years after closing.
2. For sellers staying involved:
   • Buyer notifies seller of claims; claims are processed jointly.
   • Buyer fulfills the work.
   • First $Y annual aggregate cost is 100% seller’s responsibility.
   • Costs above the limit are split.
   • Warranty obligations expire 2 years after closing.

These aren’t the only options, but they’re fair, easy to understand, and often effective.

More Warranty Tips

1. Don’t just ask about warranties—review what customers receive in writing.
2. Respect the seller’s perspective. This is a sensitive topic.
3. Estimate how much work is subject to warranties based on length and terms.
4. Include a rep and warranty clause confirming the terms provided.
5. Ensure warranty obligations are carved out of indemnity caps and baskets to avoid getting stuck with limits on this liability.

Addressing warranties early and strategically ensures you get the value you expect, avoid hidden liabilities, and close your deal.

What’s your approach to handling warranties?

Until next time, happy deal hunting!

Eric

M&A Lawyer, Publisher, Freedom Through Acquisition Newsletter

PS, I'm working on putting together some exciting new products and resources for you this year. Can you help me by answering a quick question in this poll about your biggest challenges?

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