Introduction
Exits are decisive moments in the life cycle of every start-up. For founders, they are the culmination of years of risk-taking and tireless efforts. For investors, especially family offices that have supported a company over several rounds, they offer the opportunity to realize profits.
But exits also bring with them increased legal complexity. Even experienced investors can underestimate the pitfalls that arise when negotiating liability, transaction security or purchase price mechanisms. Mistakes in these areas not only affect the sale proceeds, but can also expose the seller to unexpected risks long after closing.
This article provides a structured overview of the most important legal issues that family offices should consider when exiting start-ups in Germany and beyond.
I. Liability: the obvious risk
One of the trickiest aspects of any exit negotiation concerns the extent of seller liability. Sale and purchase agreements (SPA) usually contain extensive representations and warranties designed to bridge the information gap between buyer and seller. They fulfill an important function, but they also open the door to liability that can extend far beyond the transaction.
The following points deserve particular attention:
1. Content of the warranty catalog
In practice, the content of the sellers‘ warranty promises is typically the subject of intensive negotiations. A well-advised or experienced investor knows that forward-looking guarantees (e.g. the company will achieve its forecast or all of the company's claims will be fulfilled) are unusual. Sellers should also limit themselves to assurances of facts. For example, measures to safeguard business secrets can be described in a guarantee or the content of insurance contracts can be guaranteed. Whether the security measures are appropriate or insurance cover exists to an extent that is customary for the industry, on the other hand, is an assessment that is the responsibility of the buyer and should not be the subject of a guarantee. Finally, a seller should not provide warranties for circumstances over which it has no control. A seller should not guarantee whether a customer intends to reduce business with the company due to a lack of control. On the other hand, a guarantee that the seller has no knowledge that a customer intends to reduce the business or (even better) that no customer has informed the company of this, at least in text form, might be presentable.
2. Limitation of guarantee liability
Probably the most effective starting point for limiting liability is the attempt not to assume any guarantees vis-à-vis the buyer. In practice, it is not uncommon to encounter business angels and other financial investors who claim that they cannot assume any guarantees for the target's operating business because they have no knowledge of the details of the operating business. In this respect, the founders must assume 100 % of the guarantees. Even if this approach is not convincing on closer inspection, as the buyer usually wants to secure its purchase price calculation with the guarantee catalog, investors are successful with their approach in individual cases and can avoid the assumption of guarantees.
If the parties agree (as usual) that all sellers should assume the guarantees, investors should work towards ensuring that the buyer insures the guarantee catalog through a W&I insurance policy, which means that the sellers are only liable for a symbolic amount of EUR 1.00 for unknown risks.
If this is also not desired in a specific case, it is important to limit the sellers‘ liability for unknown operational risks, ideally to 10-20 % of the purchase price actually received by the respective seller.
From an investor's point of view, it is equally important not to agree on joint and several liability, but on partial liability in proportion to the shares sold or the purchase price received.
3. Avoiding liability for deliberate misrepresentation
If, in the first step, investors have succeeded in negotiating a reasonable warranty catalog and limiting liability to a reasonable portion of the purchase price, possibly even limiting it to almost zero in conjunction with a W&I insurance policy, the second step is to ensure that the agreed limitation of liability also holds in the event of a dispute. This is because it is not uncommon for the buyer to make a claim against the seller for deliberate misrepresentation, particularly in the case of damage that exceeds the liability limit or occurs after the limitation period has expired. If the buyer succeeds in proving this, the limitation of liability does not apply and the limitation period does not begin with the closing oft he transaction, but with the buyer's knowledge of the breach of warranty.
In order to avoid such intentional liability, the sale and purchase agreement should contain a clause that clarifies the factual basis on which the seller provides the guarantees or which sources of information they have used. In the absence of such a clause, a buyer could claim that he relied on the fact that the sellers had comprehensively checked the facts and legal issues contained in the warranties and that a failure to carry out such a comprehensive check constitutes a statement into the blue (Angaben ins Blaue hinein).
Furthermore, it is important that the intent of one seller is not imputed to another seller. In this context, it is also advisable that investors are not represented by other investors or founders when the purchase agreement is notarized, as this could result in an imputation of knowledge.
4. Exclusion of further claims (ring fencing)
After the sellers and the buyer have agreed on a balanced liability regime in the sense of a guarantee catalog together with legal consequences, possibly supplemented by specific indemnifications for known risks, the sellers must be protected against the balanced negotiation result being undermined by legal and quasi-contractual liability facts. This is usually achieved by a clause that waives all further liability (such as duties of disclosure or statutory warranty provisions) and the buyer alternatively waives any claims. Such an agreement is also subject to the reservation of mandatory intentional liability.
In short, the allocation of liability in exits is not a standard practice. The aim of investors should be to ensure a clean exit without residual risks undermining the success of the investment.
II. Transaction security: avoiding deal drift
Another key concern for sellers is transaction certainty, i.e. the certainty that a sale and purchase agreement will not only be concluded but also completed. There are several problems here that regularly lead to friction losses:
1. Material Adverse Change (MAC) clause
In particular, international buyers or buyers using external financing usually demand the inclusion of a MAC clause in the purchase agreement, which allows them not to complete the transaction if the target company or its financial situation deteriorates significantly between the conclusion of the agreement and its completion.
In the national context, sellers regularly succeed in resisting this request. If this is not successful, it is important to clearly define the scope of application of a MAC clause and, in particular, the exceptions (politics, terror, etc.).
2. Closing conditions
Even beyond the discussion about the necessity or justification of a MAC clause, sellers will attach importance to ensuring that the sale and purchase agreement contains as few closing conditions as possible, in particular no conditions whose occurrence the sellers cannot control. If the buyer insists on requiring declarations from third parties as a condition precedent (waiver of termination rights due to a change of control), sellers should provide these declarations before the contract is concluded in order to avoid becoming dependent on third parties. It is also important to stipulate in the sale and purchase agreement what the legal consequences are if such declarations are not provided.
3. Escrows and holdbacks
In order to ensure the enforceability of guarantees or indemnities, buyers often insist on so-called escrows or holdbacks, i.e. part of the purchase price is not paid to the sellers, but is paid into an account held by a trustee (escrow) or retained (holdback). Although these requests may be justified from the buyer's point of view (also to avoid joint and several liability of the sellers), the scope, duration and release conditions should be carefully negotiated and agreed. Escrows/holdbacks should not become de facto purchase price reductions.
As a rule, transaction security is an important legal aspect for sellers when drafting the purchase agreement. Transactions that fail late in the process regularly reduce the value of the target company.
III. Purchase price structures: Beyond the headline valuation
Perhaps the most visible, but also most misunderstood area of exit negotiations is the purchase price mechanism.
1. Locked box vs. Closing Accounts
In Germany, sellers and buyers predominantly agree on a so-called "locked box" mechanism - (i) in which the purchase price, in particular the equity bridge, is calculated on the basis of an effective date in the past and (ii) which generally prohibits asset outflows to the sellers (leakage) between the effective date and closing to protect the buyer. In contrast, "closing accounts" are preferred in the international context, where the purchase price is finally determined on the basis of closing date financial statements.
If a seller wishes to have certainty with regard to the purchase price, he should choose the "locked box" mechanism and reflect the cash-flow generated between the effective date and closing by way of interest. This is because the agreement of closing accounts makes the purchase price dependent on a closing date in the future (closing) and the consideration of any items that may be subject to dispute (e.g. provisions).
2. Earn-outs
Earn-outs are another frequently occurring feature in the sale of start-ups, especially when valuation expectations differ. They allow sellers to secure profits when milestones are reached, while protecting buyers from the risk of overpaying.
But earn-outs are also fertile ground for disputes. Key safeguards include:
- The earn-out payment should be contingent on metrics that are less prone to dispute (revenue is better than normalized EBITDA);
- Earn-out protection: Potential measures by the buyer that could negatively influence the key figure should be eliminated when calculating the key figure. This is not necessarily about protecting the seller from abuse, but rather about recognizing and eliminating potential conflicts.
Well-designed earn-outs can bridge valuation gaps and facilitate transactions. Poorly designed earn-outs often end up in arbitration.
IV. Conclusion: Exits require both a strategy and details
For family offices, start-up exits are not only liquidity events but also reputational milestones. They signal to the ecosystem how supportive and professional an investor has been. However, the legal pitfalls regarding purchase price, transaction security and liability are very real.
It is therefore important to approach the exit with strategic foresight and attention to detail. By recognizing these challenges early on, family offices can secure clean exits that protect returns and preserve the relationships that form the foundation for future transactions.
And as always, no two exits are the same. Tailored advice based on practical experience remains the surest way to manage complexity.
