When founders dive into term sheets, they often focus on valuation, board rights, and liquidation preferences. However, the representations, warranties, and indemnities (RWI) clauses form a critical foundation of trust between investors and founders. Let's decode these essential yet often overlooked provisions.

What are Representations and Warranties?

Representations and warranties are statements of fact and promises about your company's condition. Think of representations as snapshots of your company's current state, while warranties are promises about its past and future conditions.

Understanding Representations?

For founders navigating term sheets, understanding representations is crucial - these are essentially your formal statements about your company's current state and historical facts. Think of them as your official "report card" to investors. Let's dive deep into what these representations typically cover.

Key Representations Usually Include:

Corporate Structure and Authority

Valid company incorporation
Proper authorization to enter into agreements
Clear ownership structure and cap table

Financial Accuracy

Truthfulness of financial statements
Disclosure of all liabilities
Accuracy of projections shared during diligence

Business Operations

Ownership of intellectual property
Validity of material contracts
Compliance with applicable laws
Status of employee agreements

Disclosure

Completeness of information shared
Absence of material misrepresentations
Full disclosure of pending litigation

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Understanding Warranties: Your Promise to Investors

Unlike representations which are statements of current or historical fact, warranties are ongoing promises about your company's condition and operations. Think of warranties as your company's ongoing commitments to investors. Let's break down these crucial promises.

Types of Warranties in Term Sheets

Fundamental Warranties

Title and Authority

Clean title to shares being issued
Authority to execute agreements
No conflicting obligations
Valid and binding commitments

Corporate Structure

Maintenance of good standing
Continued compliance with incorporation documents
Proper maintenance of corporate records
Validity of share capital

Business Warranties

Financial Warranties

Accuracy of financial projections
Maintenance of proper accounting records
Disclosure of material changes
Management of working capital
Proper tax compliance

Operational Warranties

Continuation of business as presented
Maintenance of key contracts
Protection of material assets
Preservation of customer relationships
Compliance with business plans

Asset-Related Warranties

Proper maintenance of assets
Valid title to properties
Protection of intellectual property
Maintenance of insurance
Preservation of business value

Scope and Duration

Time Limits

Fundamental warranties: Often survive longer (3-7 years)
Business warranties: Typically shorter (12-24 months)
Tax warranties: Usually extend to statutory limitation period

Why Do Warranties Matter?

Warranties serve as your guarantee that these statements will remain true for a specified period. They're particularly important because:

They force comprehensive disclosure during due diligence
They provide a basis for post-investment dispute resolution
They help allocate risk between founders and investors
They protect investors from undisclosed issues

Understanding Indemnities

Indemnities are the teeth behind representations and warranties. They specify what happens if any representation or warranty proves false. Think of indemnities as the financial consequences of breaching your promises.

Common Indemnification Structures:

Scope of Protection

Direct losses from breaches
Third-party claims
Specific identified risks

Financial Limits

Caps on liability (often tied to investment amount)
Baskets (minimum threshold before claims)
Time limits for claims

Process Requirements

Notice provisions
Defense and settlement rights
Cooperation obligations

Practical Tips for Founders

1. Due Diligence is Your Friend

Conduct thorough internal due diligence before making representations
Document everything meticulously
Address potential issues proactively

2. Negotiate Reasonable Limitations

Push for knowledge qualifiers ("to the best of knowledge")
Set appropriate monetary thresholds
Define clear time limits for claims

3. Watch Out for Red Flags

Unlimited personal liability
Absence of materiality thresholds
Indefinite survival periods
Broad indemnification obligations

4. Seek Balance

Standard market practice usually includes reasonable limitations
Focus on material issues rather than minor details
Consider separate treatment for fundamental warranties

The Founder's Perspective

While Reps, Warranties and Indemnity clauses might seem investor-friendly, they serve an important purpose in creating transparency and trust. As a founder, you should:

Be truthful and thorough in your disclosures
Understand exactly what you're promising
Maintain good record-keeping practices
Consider insurance options for larger transactions

As your company grows, these provisions become increasingly important. Future funding rounds and eventual exits will require similar or more detailed provisions. Building good practices early helps create a strong foundation for future transactions.

Key Takeaways

Reps, Warranties and Indemnity (RWI) clauses are fundamental to establishing trust between founders and investors
Clear understanding and documentation are crucial for compliance
Reasonable limitations and qualifications are market standard
Professional legal advice is essential for navigating these provisions

Remember, while these provisions might seem daunting, they're designed to protect both parties and create a foundation for a successful partnership. The key is finding the right balance between investor protection and founder flexibility while maintaining transparency throughout the process.

Need professional guidance on your term sheet's RWI provisions? Our experts at VentureLex can help you navigate these crucial clauses with confidence.

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