What Does Representation Mean?
A representation is a specific statement about the state of affairs of a company to be sold. This statement is made by the parties in an agreement. A representation may be made only for material matters or out of knowledge. It may include positive statements, such as details about the management team in place, or negative phrases, such as "there is no pending litigation." The representation provides the premise upon which parties rely to close a deal.
Divestopedia Explains Representation
A wide variety of statements are made in purchase and sale agreements, along with a schedule in which exceptions to the representations are listed. A buyer expects certain aspects of a firm to be in order. If this is not the case, the buyer expects to pay less to acquire the company. This is why a representation, or a statement of facts about the past, the present or the future, is made for the transaction.
For example, if the document were to state that "the use of intellectual property in a firm does not infringe upon the rights of any third party," then this statement needs to be a true fact. If it is false, the buyer is entitled to a remedy. A buyer tries to elicit full disclosure from the seller. Due diligence analyzes the representations also. If the sale is on an "as is, where is" basis, then the buyer is forced to bear the full risk. Inaccuracies in a representation made by the seller can sometimes result in costly liabilities.
Overall, representations serve the following purposes:
Informational: A representation, along with due diligence, enables the buyer to know more about the firm before a definitive acquisition agreement is made;
Protective: If the facts are contrary to a representation, a buyer can renegotiate the terms before closing; and
Supportive: A representation gives the framework for a seller’s obligations to the buyer. The buyer requires extensive representations regarding corporate organization and capitalization, assets and liabilities, employment matters, product liabilities, compliance with laws, financial statements and taxes, contracts, leases, and other commitments.
If the purchase price is paid in cash, the seller also requires a representation from the buyer to assess its financial status.