Interesting piece. As one who most often sits on the Seller’s side of the table, I thought I’d add to the Seller’s counsel argument. If a Buyer proposed uncapped indemnification obligations or even a cap that was 4x what is considered reasonable in lower middle market deals, I would object, but not only for the reasons you suggest in your summary. I would counsel my client that the Buyer is either attempting to shift nearly all of the risk of its diligence back onto Seller, or they’re sandbagging (and you would have struck the anti-sandbagging position after our first turn). Either way, it raises questions about the Buyer and undermines trust right out of the gate.
Take your car analogy. If I’m selling my car and I allowed the Buyer to take it to her mechanic, and the mechanic looks at it and says it is in the condition I represented it to be, should I still be on the hook for a condition that is discovered after I sold it, even if I wasn’t aware of and Buyer’s mechanic didn’t even pick it up? (Obviously this analogy has some limitations, but hopefully you see my point).
Consider how this works in earnouts, which are part of many lower-middle-market deals. Seller has a substantial portion of the purchase price tied to Buyer’s ability to run the business profitably post-closing. But Buyers resist restrictions that would require them to continue to run the business as it is currently conducted, or even agree that if they deviate from past operational practice they won’t hold it against the Seller for purposes of the earnout. So by taking a “no cap” position on indemnification liability, and simultaneously taking a “no responsibility” position on preserving the earnout potential, it undermines trust right out of the gate.
I understand your point as Buyer’s counsel - the Seller should stand behind all of their reps and warranties unconditionally, and if anyone should bear the risk it should be the Seller. But if this is a relationship where the Seller isn’t just walking away - either because they’re staying involved in the business, have an earnout, or rolling equity - I think taking such an aggressive position on the indemnity cap sends the wrong message.
Interesting piece. As one who most often sits on the Seller’s side of the table, I thought I’d add to the Seller’s counsel argument. If a Buyer proposed uncapped indemnification obligations or even a cap that was 4x what is considered reasonable in lower middle market deals, I would object, but not only for the reasons you suggest in your summary. I would counsel my client that the Buyer is either attempting to shift nearly all of the risk of its diligence back onto Seller, or they’re sandbagging (and you would have struck the anti-sandbagging position after our first turn). Either way, it raises questions about the Buyer and undermines trust right out of the gate.
Take your car analogy. If I’m selling my car and I allowed the Buyer to take it to her mechanic, and the mechanic looks at it and says it is in the condition I represented it to be, should I still be on the hook for a condition that is discovered after I sold it, even if I wasn’t aware of and Buyer’s mechanic didn’t even pick it up? (Obviously this analogy has some limitations, but hopefully you see my point).
Consider how this works in earnouts, which are part of many lower-middle-market deals. Seller has a substantial portion of the purchase price tied to Buyer’s ability to run the business profitably post-closing. But Buyers resist restrictions that would require them to continue to run the business as it is currently conducted, or even agree that if they deviate from past operational practice they won’t hold it against the Seller for purposes of the earnout. So by taking a “no cap” position on indemnification liability, and simultaneously taking a “no responsibility” position on preserving the earnout potential, it undermines trust right out of the gate.
I understand your point as Buyer’s counsel - the Seller should stand behind all of their reps and warranties unconditionally, and if anyone should bear the risk it should be the Seller. But if this is a relationship where the Seller isn’t just walking away - either because they’re staying involved in the business, have an earnout, or rolling equity - I think taking such an aggressive position on the indemnity cap sends the wrong message.
Thanks again for posting this!