Warranties, Non-Compete, Earn-Out: The Essential Clauses

Selling a business is much more than a simple transfer of ownership. The sale agreement, or SPA (Share Purchase Agreement), is the central document that structures the transaction and protects the parties. Yet, many Quebec business leaders neglect the importance of securing certain critical clauses, which can lead to litigation, financial losses, or considerable delays.

Mastering the essential clauses before signing is therefore indispensable to secure the transaction and protect your interests.

The SPA goes beyond a simple legal formality. It defines responsibilities and guarantees transaction security. A solid agreement protects:

• The business's value: avoid risks or uncertainties justifying a price reduction.
• Legal security: prevent post-sale litigation that can extend over years.
• Credibility with the buyer: a clear and complete SPA builds confidence and accelerates the transaction.

The agreement is therefore as much a protection tool as a lever to maximize price and facilitate the sale.

Typical Profiles

Profile 1: The confident entrepreneur "I've always been sure of my business's strength, nothing to worry about."

Common mistake: Underestimating legal obligations, warranties, and liability clauses.

Recommended strategy:

• Conduct a complete audit of contracts, debts, and tax obligations before the sale.
• Include precise warranty clauses on financial situation, assets, and legal compliance.
• Clearly define payment conditions, price adjustment mechanisms, and potential indemnities in case of liabilities discovered after the sale.
• Prepare an operational transition plan and designate responsible parties to secure the transfer.

Advantages:

• Secures the transaction and reduces litigation risks.
• Strengthens credibility with the buyer.
• Limits requests for holdbacks or additional guarantees.
• Accelerates the sales process.
• Protects the real value of the business.

Profile 2: The family business "We've always operated orally and in complete trust."

Common mistake: Absence of non-compete clauses, verbal agreements, or inadequate tax structuring.

Recommended strategy:

• Draft shareholder agreements and formalize voting rights, share transfers, and exit terms.
• Implement non-compete clauses and protect intellectual property (trademarks, patents).
• Structure tax benefits to benefit from capital gains exemption.
• Define a succession or transition plan for key family members involved.

Advantages:

• Avoids internal conflicts and secures transmission.
• Protects intangible and commercial assets.
• Maximizes tax reliefs.
• Increases confidence of external buyers.
• Facilitates post-sale integration.

Profile 3: The indispensable founder "The business depends on me, but I'm ready to sell."

Common mistake: Not delegating, not documenting processes, and remaining the only key person.

Recommended strategy:

• Establish an autonomous management team and document essential procedures.
• Define the founder's responsibilities and post-sale obligations in the SPA.
• Secure employment contracts and incentive schemes to retain key managers.
• Formalize communication and systems to demonstrate that the business can operate without the founder.

Advantages:

• Reduces risk perceived by the buyer.
• Ensures smooth and rapid transition.
• Preserves the business's value and reputation.
• Facilitates attraction of strategic or financial buyers.
• Limits post-sale operational disruptions.

Tax or legal levers used

1. Warranty clauses

• Definition: Seller's commitment regarding the financial, legal, and operational situation of the business.

• How it works in practice: Guarantee the accuracy of financial statements, absence of hidden debts, and legal compliance.

• Advantages: Protects the buyer and limits subsequent recourse.

• Example: Price adjustment if an undeclared liability is discovered after the sale.

2. Non-Compete Clauses

• Definition: Prohibition for the seller to compete with the business after the transaction.

• How it works in practice: Define the duration, territory, and prohibited activities.

• Advantages: Protects clientele and commercial value, reduces risk of post-sale revenue loss.

3. Price adjustment clauses (Earn-out)

• Definition: Price adjustment mechanism based on the business's future performance.

• How it works in practice: Determine financial or operational objectives to achieve to trigger additional payment.

• Advantages: Allows compromise between seller and buyer, secures real value and distributes risk.

Practical case 

A Quebec SME specializing in retail integrated detailed warranty clauses, non-compete provisions, and a price adjustment mechanism into its SPA. The founder agreed to stay two months to ensure transition, while financial adjustments were planned based on post-sale sales. Result: the transaction closed in less than six months, the final price was 15% above the initial valuation, and no post-sale litigation occurred.

What we often forget

• Vague or missing clauses: imprecise commitments open the door to litigation.
• Insufficient protection of intangible assets: patents, trademarks, trade secrets can be lost.
• Absence of transition plan: slows post-sale integration and can harm perceived value.

Essential questions to ask yourself

• Do my warranties cover all major risks?
• Have I secured intangible assets and intellectual property?
• Are the non-compete clauses appropriate and enforceable?
• Is the price adjustment properly framed?
• Have I planned a clear transition plan for the buyer?

Ignoring these clauses can lead to post-sale litigation, sometimes costly and lengthy, unexpected price adjustments or financial claims, potential loss of value and tarnished reputation, or delays in concluding the transaction as well as tensions between parties.

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The sale agreement is the heart of the transaction. Including solid warranty, non-compete, and price adjustment clauses protects your interests, secures the transaction, and maximizes your business's value. Meticulous preparation today guarantees a smooth and profitable sale tomorrow.