The good, the bad and the ugly: being honest about issues when selling a business

Disclosure is an important part of selling a business. If you’re selling a business, the buyer will give you a shopping list of statements about the business that they will ask you to agree to and underwrite. The legal jargon for these statements is warranties. Warranties can ask you to confirm a variety of things from confirming that no one is suing you to where you store your data.

So what happens if you are asked to give a warranty, but you know it isn’t true? In short, you need to tell the buyer. But you have to do so formally, in a letter that is handed over with the purchase agreement. This is what we mean by disclosure – this is a “disclosure letter”.

If you say explain how a warranty is untrue in a disclosure letter then the seller can avoid liability. If you don’t tell the buyer, and the buyer suffers a loss as a result, then the seller will be liable to pay compensation.

Like children, no business is perfect. Even the best run businesses have the odd page of a contract missing or an out of date policy or procedure. My job is to make sure that these hiccups don’t come back to haunt the seller of a business later on. I do this by not keeping these problems quiet. My job during disclosure is to tell the buyer all about them. I tell them all about your business: the good, the bad and the ugly. I’ll even show them the evidence.

This is counter-intuitive for sellers. Will you get the best price for your company, will you lose the deal, if a problem is laid bare? It’s normal to try and present the best, shiniest version of your business with all skeletons firmly locked about in closets. So why do clients have to be frank during disclosure?

Keep in mind that this is part of the sale process. The buyer’s lawyer will expect disclosures. And, like buying a house, if the basics are sound then a buyer will just want to know what problems they need to resolve but won’t walk away if there is dry rot (or an employee claim).

Most business purchase contracts will say that if the seller doesn’t tell the buyer about a breach of warranty in the disclosure letter, it doesn’t count. This can lead to frustration if a seller has been honest with the buyer from the outset of negotiations. It feels like I’m covering old ground and focusing on the negative.  I’m not. I’m protecting my client.

The other problem with disclosure is that you need to provide detail. Not only do you air your dirty linen, you have to explain where the stains came from. The law says that to be protected from a warranty claim, a seller should provide enough detail to allow the buyer to make a reasonable evaluation of the issue and the potential implications. That means supporting documents to explain the problem – the buyer should know as much as the seller.

All that said, how and when you tell a buyer of a problem needs carefully managed. Fixing a problem, then explaining what has happened, is always better than presenting an ongoing issue with no solution! (‘fessing to issues once there’s a signed confidentiality agreement helps, too).

If you’re selling your business, the more detail you share with your lawyer and put in the disclosure letter the better protected you will be. So, honesty really is the best policy.

If you would like further information on the topic discussed in this blog, please contact Derek Hamill by email: dhamill@gilsongray.co.uk or by phone: 0141 530 2022 / 07973 924 333. You can also view Derek’s profile by clicking here.

The information and opinions contained in this blog are for information only. They are not intended to constitute advice and should not be relied upon or considered as a replacement for advice. Before acting on any of the information contained in this blog, please seek specific advice from Gilson Gray.