Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The Most Dangerous M&A Clause Nobody Reads
Transcript
- Lucas: So there's this clause buried in nearly every acquisition agreement — usually around page 35 or 40 — that most sellers skim over because it looks like standard boilerplate. Luna: I think I know which one you're talking about. The indemnification survival period? Lucas: Exactly. It determines how long the buyer can come back after closing and claim the seller breached a representation or warranty. And the default language in most first drafts is something like '18 months for general reps, six years for fundamental reps and tax.' Sounds fair, right? Luna: But the trap is in how those periods are actually applied during a claim. Lucas: Right. I sat in on a post mortem last month for a $50 million software acquisition that closed in 2023. The seller — a founder who'd built the company over 15 years — had a standard 18-month survival period for general reps. But the buyer discovered a revenue recognition issue 14 months after close. They filed a claim under the survival window. Luna: And they won? Lucas: They won $12 million in indemnification. The founder had to cut a check back to the buyer because his payout was structured partly as a note and earnout. The survival period gave the buyer a huge window to find problems. Luna: But wasn't there a due diligence period where the buyer could have found that issue? Lucas: You'd think so. But here's the nuance: the survival period doesn't just give time to discover known issues — it incentivizes the buyer to defer deep diligence. Why spend money verifying every contract before closing if you can wait 18 months to comb through it and then claw back money? Luna: So the longer the survival period, the more leverage the buyer has to reduce the effective purchase price post close. Lucas: Exactly. And sellers often don't realize that the survival period clock starts at closing, not at signing. So if there's a long gap between signing and closing — say six months for regulatory approvals — the buyer already has a head start on their 18-month window. Luna: I've heard some sellers try to negotiate a cap on indemnification, like 10 or 15 percent of the purchase price, to limit their exposure. Lucas: That helps, but it's not enough if the survival period is too long. In that software deal, the cap was 20 percent — $10 million — but the actual payout was $12 million because the earnout was structured as additional purchase price, not subject to the same cap. Clever lawyering on the buyer's side. Luna: What about the basket? I've seen deals where the buyer can only make claims once total losses exceed a certain threshold. Lucas: Right — a deductible or a basket. In that deal, the basket was $500,000, which is tiny for a $50 million transaction. So almost any claim would exceed it. The seller's attorney should have pushed for a larger basket tied to a percentage of the purchase price, like one percent, or $5 million. Luna: But isn't the basket usually a compromise? I've heard buyers argue that without a low basket, they can't pursue legitimate small claims. Lucas: They can still pursue claims above the basket. The trick is to set the basket at a level that discourages nuisance claims but allows for serious ones. One percent of purchase price is standard in institutional deals. Founders selling their first business often get rolled with a much lower threshold. Luna: So what's the ideal survival period for a seller? Lucas: For general reps and warranties, I'd push for 12 months, max 18. For fundamental reps — like capitalization, authority, tax — you might have to live with longer, but you can carve out an exception: no claims under fundamental reps unless the buyer can prove they discovered the breach within the survival period and notified you promptly. Luna: That 'promptly' part is often ambiguous. Lucas: Very. So you specify a concrete number: 'within 30 days of discovery.' And you tie it to the escrow release. Most deals have an escrow holdback of 5 to 10 percent of the purchase price, released in stages. If you align the survival period with the escrow release schedule, you're not leaving money on the table for years. Luna: I've also seen sellers negotiate a 'sunset' on representation survival — like all reps expire at the end of the survival period, even if notice was given before that date. That way the buyer can't file a claim after the period ends using a notice they sent on day 18. Lucas: That's a great point. It's called a 'cut-off' or 'sunset' provision. Without it, a buyer could send a vague notice on the last day of survival, then spend months building a case. The seller is left in limbo. Luna: Are there any industries where longer survival periods are standard? Lucas: Healthcare and life sciences, for sure. Regulatory reps often survive for three to five years because the FDA can come knocking years later. Also, if the seller is providing a representation about the accuracy of financial statements, buyers will push for a survival tied to the statute of limitations for fraud. Luna: Which can be four to six years in some states. Lucas: Right. So you need to negotiate that the survival period for financial statement reps is capped at, say, 24 months unless the buyer can prove intentional misrepresentation. That's a compromise that gives the buyer protection against fraud without leaving the seller exposed indefinitely. Luna: Let's talk about the one that really trips up founders: the 'sandbagging' clause. I know you covered anti-sandbagging in an earlier episode, but it ties directly into survival. Lucas: It does. If the deal has a 'pro-sandbagging' clause — meaning the buyer can make a claim even if they knew about the breach before closing — then the survival period becomes even more dangerous. The buyer could have known about a problem, closed anyway, and then file a claim during the survival period. That's exactly what happened in the software deal I mentioned. Luna: The buyer knew about the revenue recognition issue during diligence? Lucas: There were red flags in the financial footnotes. The buyer's CFO flagged them, but the deal team decided to close anyway and pursue a post-close claim. The survival period gave them the time to build the case. The seller's attorney hadn't negotiated an anti-sandbagging clause, so the buyer was within their rights. Luna: That's brutal. So what's the single most important thing a seller can do to protect themselves? Lucas: Hire an M&A attorney who specializes in sell-side representation, not a general corporate lawyer. Then negotiate three things: a survival period capped at 12 months for general reps, a basket of at least 1 percent of the purchase price, and an anti-sandbagging clause that prevents the buyer from claiming a known breach. Luna: And don't sign the first draft of the indemnification section without reading every word. Lucas: Exactly. The survival period is the lever buyers use to turn a deal into a litigation. If you control the timeline, you control the outcome. Lucas: You know, every time I talk about these traps, I think about how much time and money goes into learning them the hard way. Luna: Yeah, and we try to short-circuit that learning curve here. If today's episode saved you even a fraction of the headache that founder went through, that's the goal. Lucas: And if it was worth a coffee to you, there's a link — buy me a coffee dot com slash fexingo. Keeps this thing ad-free and independent. Luna: We don't do sponsors, so listener support is what keeps the lights on here. Lucas: Alright. Back to the nitty gritty. One more tactic I want to mention: some sellers are now using 'representation and warranty insurance' to cap their exposure. The insurer takes on the risk of breaches, usually up to the policy limit, and the survival period for insured reps can be negotiated separately. Luna: But that insurance isn't cheap — typically 3 to 5 percent of the policy limit. Lucas: Right. For a $50 million deal, a $10 million policy could cost $300,000 to $500,000. But if it means the buyer agrees to a 12-month survival period and drops the escrow requirement, it can be worth it. Especially for a founder who wants a clean exit. Luna: So the survival period is really a negotiation lever that affects the entire indemnification structure. Lucas: Exactly. It's not just a timeline. It dictates how much risk the seller carries, how long they carry it, and how much post-close legal exposure they face. Founders who treat it as boilerplate end up with a ticking time bomb. Luna: And with M&A activity picking up this year — we're seeing more deals in tech and healthcare — this clause is going to trip up a lot of first time sellers. Lucas: Particularly in this rate environment, where buyers are more cautious and looking for ways to protect downside. The survival period is their favorite tool. So if you're selling, treat it as a key term, not a footnote. Luna: And that's the takeaway for today: don't sign the indemnification section without understanding how long your reps will live. Lucas: Exactly. Next time, we'll look at how buyers use the survival period to launch post-close audits — and how sellers can push back. Luna: Looking forward to it.