Recourse & Rights After the Deal Closes

Recourse and Rights After the Deal Closes

When you’re looking at an SMB transaction, a lot of focus is on getting the LOI done, reaching an agreement with the seller, and getting the deal closed. That usually means working through financial due diligence, legal due diligence, and getting bank financing approved.

But often we don’t think about what happens after the deal closes.

That includes how you’re going to run the business, and also what happens if something goes awry. What are your remedies in the transaction? This is about looking forward at worst-case scenarios and being prepared, even while hoping those scenarios never happen.

Why Post-Closing Recourse Matters

There are things you can do leading up to signing and closing to make sure you’re in the best position possible. A useful way to think about this is a basic hierarchy of deal protections.

There’s an age-old premise in M&A: buy a good business at a fair price from a good person. This principle is especially important in the SMB and lower middle market space.

You’re not just doing a deal with the seller. You’re likely going to need them to support the transition of the business. Doing diligence, hiring experienced advisors, and negotiating strong agreements all play a role.

Watch the Full Webinar

If you like this content, I’m hosting another webinar later in August where we’ll be talking about deal structuring and financing.

If you’re a searcher under LOI or actively searching and thinking about asset versus stock sales, financing options, earnouts, and structure, you can scan the QR code or find it on my LinkedIn page.

A free recording will be sent.

Hierarchy of Deal Protections

The hierarchy starts with buying a good business at a fair price and not overpaying. Next is working with good sellers and negotiating strong representations, warranties, and covenants in the purchase agreement.

Representations and warranties are promises the seller makes about the business, including assets, customers, suppliers, and authority to do the transaction. They act as the backstop of what you’re buying.

Finally, there needs to be some form of security or pool of money to go after in the event there’s an issue after closing.

In small businesses, liquidity is often a challenge. If you close a deal with 100% cash paid upfront and no holdback or seller note, your only remedy may be a direct lawsuit. Other mechanisms like seller notes and holdbacks provide leverage and practical recourse.

Seller Notes, Holdbacks, and Escrows

A seller note allows payments to be offset in the event of a claim. A holdback is where the buyer retains part of the purchase price for a period of time. An escrow introduces a third-party agent to hold funds.

Each tool has tradeoffs. Seller notes do not provide immediate liquidity. Holdbacks and escrows can provide access to cash if there is a valid claim.

Lenders, especially in SBA deals, may require escrow proceeds to be applied toward loan paydown. These details matter when structuring the deal.

Real HVAC Case Study: Truck Failure After Closing

A real example involved an HVAC business with a $2 to $3 million purchase price. The agreement included representations that the trucks and equipment were in good operating condition and suitable for ordinary business use.

The trucks were itemized in the purchase price allocation, with notable value attributed to them.

After closing, the buyer discovered two trucks were unsafe and unusable. They had to be scrapped and replaced, creating immediate expenses and capital outlays.

The buyer submitted a claim based on the representations. Damages were approximately $20,000 to $30,000. Rather than going to court, the parties agreed to offset the damages against the seller note.

Because the seller note had a standby period, no payments had yet been made. The buyer was able to defer payments and effectively recover the damages.

What Could Have Been Done Differently

In asset-heavy businesses, inspections can be performed pre-closing. Mechanics and equipment specialists can help validate asset condition and value.

In this case, good protections were already in place, which allowed the buyer to resolve the issue without litigation.

Liquidity and Working Capital Planning

Seller notes help with recourse but do not provide immediate cash. Holdbacks and escrows can address liquidity needs.

Another important planning tool is securing a line of credit before closing. It is harder to obtain after the deal closes. Lines of credit help manage working capital and unexpected post-closing issues.

Understanding working capital needs, collectability of accounts receivable, and cash flow timing is critical to sustaining operations.

Delaware Case Study: $3.2 Million Judgment

In a Delaware case, a buyer acquired a medical equipment company. The seller represented that material customer contracts were valid and not subject to termination.

After closing, internal emails revealed that major customers had already given notice they were ending the relationship. These customers represented significant earnings.

The court awarded damages equal to the multiple paid on the lost earnings, resulting in a $3.2 million judgment. Knowledge of the issue did not preclude the buyer’s claim.

This case illustrates how representations about customers can directly impact valuation and post-closing recovery.

Survival Periods and Claim Timing

General business representations typically survive one to two years. Fundamental representations, such as ownership and authority, often survive much longer.

Buyers usually discover issues relatively quickly once they own the business. Understanding survival periods is critical, as claims must be made before they expire.

Purchase agreements define procedures, notice requirements, and indemnification processes. Documentation and timely action are essential.

What to Do If You Have a Claim

The first step is to analyze the agreement and facts. Determine whether there is a representation, warranty, or covenant breach.

Claims must be made following the procedures in the agreement. Written notice is required. Sellers often respond, and many disputes are resolved without litigation.

Litigation involves cost, time, and distraction from running the business. Buyers must weigh the impact and severity of the issue.

Buy-Side Takeaways

For buyers, post-closing recourse is often overlooked. Strong diligence, updated financials, customer walkthroughs, and real-time data matter.

Do not rely on stale information. Small businesses are volatile, and performance can change quickly.

Structuring recourse, liquidity, and protections before closing is far easier than fixing problems afterward.

Key Takeaways

• A lot of focus is on getting the LOI done and getting the deal closed, but it’s important to think about what happens after the deal closes.

• Buy a good business at a fair price from a good person, and do your diligence with experienced advisors before signing.

• Negotiate strong representations, warranties, and covenants, because they define your rights and remedies after closing.

• Liquidity matters, and tools like seller notes, holdbacks, and escrows provide practical recourse if issues arise.

• Survival periods and timing matter, so understanding your agreement and acting quickly is critical.