Imagine: you are about to get a promising investment. The “due diligence exercise” is successfully completed, papers are already on the founders’ table, and it seems like it is a done deal.

However, the best advice here would be: don’t jump to signing any papers. Take your time to carefully study all the documents. In particular, pay attention to the section “representations and warranties”, which is one more way to protect investors. Let’s find out what is the purpose of this section and if this is a must.

Legal definition  

Representations and warranties define founders’ statements about the facts related to the object of a deal (startup/product). Founders give representations about present and/or past facts related to a company/startup or product itself, and this process (such representations) predetermines the deal. In case the founder is not willing to answer for the reliability and accuracy of particular facts, the investor is more likely to turn down his funding offer.

In contrast to representations, warranties define founders’ guarantees that a particular circumstance related to the object of a deal took place in the past, is relevant in the present or will be relevant in the future. For example, founders could guarantee the investor that:

  • Startup’s software was developed without open licenses (past)  
  • Startup’s software is legally owned by the company (present)  
  • Startup’s software would not become an object of disputes (future)

In fact, over the past several years the distinctions between representations & warranties have become very subtle. They are often included in a single section “representations & warranties”.

Functions

Representations and warranties serve as informational and compensatory tools for an investor.

Informational function: founders give an investor trustworthy information that is used as a basis for making decisions and gives a bigger picture about the object of investment and future perspectives.

Compensatory function: in case a statement about any fact given by founders is violated, investors have rights for compensation for any losses resulting from this violation.   

Examples of most common Representations & Warranties in startup deals (that could be foreseen)

It’s hard to find any two deals that are identical. In the same way, it’s hardly possible to see identical Representations & Warranties. However, there are several most common basic blocks that investors include in the agreements. Such blocks define facts that (in case they are not valid) will cause troubles for investors.  

1. Properly established business  

Founders should guarantee that the company is registered and operates in accordance with home country regulations.  

2. Intellectual property rights and its transparency  

Crucial section for startup deals. Founders should confirm that the startup company is the sole owner of the IP, its IP is not the subject of any dispute and does not interfere with intellectual property rights of a third party as well as its IP does not include any unlawful content. 

3. Taxes  

Founders should guarantee that their company has always complied with the respective laws. In particular, facts that all the taxes have been properly filed and paid, and the company has no tax debts.  

4. Key employees  

Product quality and maintenance performance are inseparably connected with the development team. Here founders promise investors that particular employees will not leave the company during a certain period of time. This section also guarantees that key team members are employed in accordance with the respective laws (at least the company should have a signed employment contract).  

Representations & warranties: how do they look?  

Founders should provide representations & warranties in written form. They are often included in the transaction documents (in share subscription agreement, for example) either as an additional section or supplement. It is also possible to provide them in a separate document.  

To sum it up, Representations & Warranties serve as a mechanism for protecting investors’ rights. That’s why founders should be very careful and never promise anything they can’t deliver.  

Please always take a good look at the documents before the signing, and stay tuned!

This article was prepared by REVERA law group. Original text in Russian can be found here

ecosystem

investments

law

startups