The Buyer purchased a company called SNEAKY for a purchase price equal to five times EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). The Buyer then discovered that SNEAKY’s EBITDA had been overstated by $1 million. Buyer wants to recover the damage — $5 million – an amount equal to the product of the EBITDA overstatement ($1 million) times 5, which was used to value the deal. Can he recover?
The answer is recovery is unlikely, although the Buyer’s expectation seems reasonable and the calculation seems sensible. This is because most Purchase Agreements have provisions to exclude damages for “diminution in value.” Thus the Buyer may be deprived of any effective remedy for breach of the most important representation in the whole deal – the accuracy of the financial statements.
The Purchase Agreements will have other provisions which will greatly affect Buyer’s remedies, such as disclaimers, etc. These provisions normally are buried deep in the fine print of the Purchase Agreement. Therefore a careful review of the entire document, preferably by an experienced M&A attorney, is critical to avoid pitfalls.
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