Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / How the M&A Rep Letters Trap Sellers After Close
Transcript
- Lucas: So you sign the purchase agreement. You hand over the company. The wire hits your account. You think it's over. But then, six months later, the buyer sends a letter claiming you misrepresented something in the interim period — and they want money back. Luna: That sounds like the representation letter trap. I've heard about this, but I think most founders don't realize how exposed they are until it's too late. Lucas: Exactly. And this is a really common post-close surprise in the middle market. Today we're going to walk through a specific case: a family-owned manufacturer in the Midwest — let's call them Omega Components — that sold for $60 million in 2024. The buyer came back demanding $4 million after close, citing a representation letter the seller signed at closing. Luna: Four million on a sixty-million-dollar deal. That's nearly 7 percent of the purchase price. What was the alleged misrepresentation? Lucas: The buyer claimed that Omega had failed to disclose a change in customer payment terms during the interim period — between signing and closing. The CEO had verbally extended net-60 terms to a long-standing customer to keep the relationship smooth. It was a standard goodwill gesture. But the rep letter at closing required the seller to certify that 'no material adverse change' had occurred. The buyer argued that the payment terms change was material. Luna: And this rep letter — it's separate from the reps in the purchase agreement itself, right? Lucas: Right. The purchase agreement has a whole set of representations and warranties about the business at signing. Those are typically baked into the deal and covered by indemnification. But the rep letter is a separate document, signed at closing, where the seller essentially re-reps that nothing has changed. It's a snapshot of the business right before the buyer wires the money. Luna: So it's like a fresh certification. And if anything changed — even something the seller thought was minor — they could be on the hook. Lucas: That's exactly it. In Omega's case, the buyer's argument was that the customer payment terms change was a material deviation from the ordinary course of business. The seller's position was that it was a routine accommodation. But the rep letter didn't have a 'materiality' qualifier — it used absolute language. And the buyer had a financial expert testify that the change effectively gave the customer a free loan, which shifted working capital dynamics. Luna: So the seller ended up settling? Lucas: They did. After months of legal fees and distraction, Omega agreed to pay $2.5 million to make the claim go away. The buyer had leverage because the rep letter was certified by the CEO personally — it wasn't just a corporate representation. The CEO had signed in his individual capacity. That's another trap: personal liability. Luna: Wait — the CEO signed personally? That's not standard, is it? Lucas: It's becoming more common in private equity-led deals. The buyer's counsel often insists that the CEO or the founder sign the rep letter individually, especially if the company is closely held. The rationale is that the CEO has direct knowledge of the business's day-to-day operations. But it means the buyer can go after personal assets, not just the escrow or the indemnity cap. Luna: That's terrifying. So what should a seller do to avoid this? Lucas: First, push to have the rep letter incorporate the same materiality qualifiers that are in the purchase agreement. If the SPA says 'no material adverse change,' the rep letter should say the same thing. Second, limit the scope of the reps to a specific list of items that the seller can actually verify — like financial statements, litigation, and material contracts. Don't sign a blanket certification. Luna: And the personal signature issue — can that be negotiated away? Lucas: Absolutely. Most experienced sellers insist that the rep letter be signed by the company, not by any individual. If the buyer pushes back, you can agree to have the CEO sign as an officer of the company, but with explicit language that no personal liability attaches. I've seen deals where the seller's counsel adds a sentence: 'This letter is executed by the undersigned solely in his or her capacity as an officer of the Seller, and not in an individual capacity.' Luna: That seems like a must-have. But even with corporate-only signing, the company itself could be on the hook for a big claim. So the real protection is in the indemnification terms. Lucas: That's right. The rep letter doesn't override the indemnification provisions in the SPA. But the buyer will argue that the rep letter creates a separate, independent obligation. You need explicit language in the SPA that any claim arising from the rep letter is subject to the same indemnity caps, baskets, and survival periods as other reps. Otherwise, the buyer might try to treat it as a standalone warranty with no limits. Luna: Right, because if the rep letter is a fresh representation at closing, the survival period might reset. So a rep that would have expired 12 months after signing could now be alive for 12 months after closing. Lucas: That's exactly the trap. In many SPAs, the survival period for general reps is 12 to 18 months from signing. But the rep letter is signed at closing, which could be six months later. So the buyer effectively gets an extra six months to bring a claim. A good seller's lawyer will tie the rep letter survival period to the same clock that starts at signing. Luna: So the lesson is: treat the rep letter as a serious negotiating point, not a procedural formality. Lucas: Exactly. And there's one more layer. If you have reps and warranties insurance, the policy typically covers breaches of the reps in the SPA — but it may exclude breaches of the rep letter. So the seller could be self-insured for that risk. That's another thing to check before you sign. Luna: Yeah, that's a huge hidden cost. I've heard of cases where the buyer's RWI policy specifically carves out 'bring-down conditions' from coverage. Lucas: And that brings us to something we don't talk about enough on this show. A lot of this nuance comes from the fact that we're able to spend real time on these deep dives. And that's only possible because a small group of listeners supports the show directly. If these conversations have helped you think more clearly about a deal or strengthened your negotiating position, consider chipping in at buy me a coffee dot com slash fexingo. It keeps this podcast ad-free and lets us keep covering the traps that lawyers don't always warn you about. Luna: Yeah, it's a pretty straightforward way to keep the show going. And we genuinely read every message that comes through. Lucas: Alright — back to the rep letter. Another practical tip: sellers should negotiate a 'bring-down' that only covers a subset of reps — typically the fundamental reps like organization, authority, capitalization, and maybe financial statements. Not the operational reps about customers, suppliers, or compliance. Those are harder to certify on the fly. Luna: That makes sense. The operational stuff can change day to day. A customer could delay a payment, a supplier could raise prices — those aren't necessarily material, but they could be argued as a change. Lucas: Right. And the buyer's counsel will want the broadest possible rep letter to create leverage after close. I've seen rep letters that are 15 pages long, essentially re-stating every rep in the SPA. That's a trap. The seller should push for a short-form letter — one or two pages — covering only the essentials. Luna: And what about the 'no litigation' rep? That's a common one. If a lawsuit is filed between signing and closing, the seller has to disclose it. But what if the seller doesn't know about it yet? Lucas: That's a great point. The rep letter usually requires the seller to disclose any litigation filed or threatened. But if a lawsuit is served on the Friday afternoon before a Monday closing, the seller might not have actual knowledge. Some rep letters include a 'knowledge qualifier' — the rep is only made 'to the seller's knowledge after reasonable inquiry.' That's a critical protection. Luna: So the knowledge qualifier should be in the rep letter, not just in the SPA. Lucas: Exactly. And the seller should define what 'knowledge' means — usually the CEO, CFO, and maybe the general counsel. Not every employee. And 'reasonable inquiry' should be specified: a phone call to the legal department, a review of the docket, that kind of thing. Luna: I'm thinking about the Omega case again. If the CEO had a knowledge qualifier, could he have avoided liability for the payment terms change? Lucas: Possibly. The argument would be that he didn't know extending net-60 terms was a material change — it was routine in his industry. But the buyer's expert might still argue that a reasonable CEO should have known. The qualifier helps, but it's not a silver bullet. The best protection is to limit the scope of reps in the letter. Luna: So what's the ideal rep letter look like for a seller? Lucas: Short, with a clear list of reps that are already covered by the SPA, subject to the same materiality standards, with a knowledge qualifier, and with a survival period that runs from signing, not closing. And the seller should have the right to update the letter up to the moment of closing — so if something changes, they can disclose it and still close. That's called a 'bring-down' with a disclosure schedule update. Luna: And if the seller discloses a change, the buyer has to decide whether to waive it or walk. That puts the power back in the seller's hands to some extent. Lucas: Exactly. The buyer can't later claim they were misled if the seller disclosed it in an updated schedule. But the buyer's counsel will push back on that — they'll want the rep letter to be 'clean' with no updates. That's a negotiation. In a competitive process, sellers have more leverage to get these terms. Luna: So the takeaway is: the rep letter is not a formality. It's a potential landmine. Founders should involve their counsel early and push back on aggressive language. Lucas: Absolutely. And if you're listening and you're preparing for a sale, ask your lawyer to walk you through the rep letter specifically. Don't assume it's just a repeat of the SPA. We've seen too many sellers sign it without reading, thinking the hard work is done. It's not done until the wire clears — and even then, the rep letter can come back to haunt you. Luna: So next time you're in a deal room, make sure that final piece of paper gets the same scrutiny as the term sheet. Lucas: That's the takeaway. Thanks for listening, and we'll see you next time with another trap to avoid.