Indemnification in Private Company Business Sale: Risk Allocation Strategies for Selling Founders

When you sell your business, the purchase price is only part of the equation. What really matters is how much of that value you retain after the deal closes. And that often hinges on one word – Indemnification.

Often misunderstood or glossed over, indemnification provisions are one of the most consequential parts of any private company M&A transaction. They allocate post-closing risk, govern liability, and determine how claims are handled. For sellers, the wrong indemnification terms can quietly undermine the deal’s economics long after signing.

This page unpacks the core indemnification concepts and strategies that every seller should understand to protect their payout and mitigate lingering exposure after selling their business.

What Is Indemnification in M&A?

In private company M&A, indemnification provisions allocate the risk of certain post-closing losses between buyer and seller. These losses may arise from breaches of representations and warranties, violations of covenants, or liabilities that precede closing but materialize after the transaction.

From the buyer’s perspective, indemnification is the contractual mechanism to seek recovery. From the seller’s perspective, it’s a tool that defines and limits post-closing liability.

Well-structured indemnification provisions are essential to prevent ambiguity and disputes. For sellers, careful attention to indemnification terms is critical to ensuring that liability is appropriately scoped, limited in duration and amount, and not left to subjective or open-ended interpretation.

Core Components of Indemnification Provisions

1. Survival Periods

Indemnification obligations are not typically indefinite. The survival period determines how long after closing a party can bring a claim.

General representations and warranties typically survive for 12 to 18 months.
Fundamental representations (such as title to shares, corporate authority, capitalization, and taxes) often survive longer, or indefinitely.
Covenants typically survive for the duration of their stated terms or until they are fully performed.

Practical Tip: Buyers should ensure that the survival periods match the nature and scope of the underlying obligations. For example, a tax covenant or a non-compete should survive long enough to cover the applicable statute of limitations.

2. Covered Losses

Indemnification typically applies to losses arising from:

Breaches of representations and warranties
Breaches of covenants (pre- and post-closing)
Specific identified liabilities, such as pre-closing tax obligations, litigation, or environmental risks

Sellers should seek to narrowly define the scope of “losses” and ensure that the definition excludes speculative, indirect, or punitive damages unless expressly agreed.

SRS Acquiom’s 2025 Deal Terms Study notes that 97% of deals define losses to include actual damages, but only a minority cover consequential or special damages.

3. Indemnification Caps and Baskets

Indemnity limits protect sellers from unlimited liability and promote efficient claim resolution.

Cap: The maximum aggregate liability a seller may face, often equal to the escrow amount or a percentage of the purchase price (typically around 10%).
Basket: The minimum threshold of losses before a buyer can recover. There are two common types:
- Deductible basket: Buyer absorbs all losses up to the basket amount.
- Tipping basket (“first dollar”): Once the basket is exceeded, the buyer recovers all losses from the first dollar.

Mini-baskets may also apply to individual claims.

Certain categories of claims, especially those tied to fundamental representations, fraud, or post-closing covenants, are typically excluded from caps and baskets.

Sellers should work with counsel to implement custom indemnification provision drafting that balances market terms with the specific risks and dynamics of their transaction.

4. Fraud Carveouts

Buyers almost always negotiate a carveout for fraud, meaning claims based on fraud are not subject to caps, baskets, or survival limits.

Sellers should seek a narrow and precise definition of “fraud” in the agreement. The most seller-favorable definitions limit fraud to intentional misrepresentations made with actual knowledge and specific intent to deceive by a named individual.

Without clear fraud definitions, buyers may attempt to recharacterize ordinary indemnity claims as fraud, defeating the purpose of negotiated liability limits.

5. Materiality Scrapes

Materiality scrapes remove “material” qualifiers when determining whether a breach has occurred and calculating the amount of loss.

Double scrape: Removes materiality for both breach and damages.
Single scrape: Removes materiality only for determining breach.

Buyers prefer scrapes to avoid the burden of proving materiality. Sellers should resist scrapes or negotiate them carefully to prevent de minimis claims from exceeding baskets.

Escrows and Indemnity Funding

Even well-crafted indemnification rights are only as good as their enforceability. That’s where escrow arrangements come into play.

In seller-indemnified deals, a portion of the purchase price (typically 5–10%) is held in escrow for the survival period to cover potential claims. The release mechanics, scope of application, and procedures for releasing funds are typically set forth in a separate escrow agreement.

Escrows may be structured to:

Cover general indemnity obligations
Serve as a source of payment for purchase price adjustments (such as working capital adjustments)
Backstop specific indemnity obligations (e.g., tax or litigation escrows)

If a representation and warranty insurance policy (RWI) is used, the size and scope of escrows may be reduced or eliminated for certain risks.

Indemnification and Reps & Warranties

Indemnification exposure stems directly from breaches of representations and warranties. Understanding the relationship between these provisions is critical for sellers.

General reps cover business operations and are subject to typical caps and baskets.
Fundamental reps include organization, authority, capitalization, and taxes. These are often carved out from indemnification caps and baskets, and will survive longer than general reps.

The seller’s exposure will largely turn on:

The quality and accuracy of reps
Whether reps are qualified by knowledge or materiality
Whether scrapes are applied
Whether the buyer relied on disclosed exceptions (via the disclosure schedules)

Fundamentally, sellers should push for accurate, narrow, and appropriately qualified reps, supported by comprehensive disclosure schedules.

General vs. Fundamental Representations and Warranties

Understanding the distinction between general and fundamental representations is critical for structuring indemnification liability in a private company M&A transaction.

General Representations and Warranties

General reps cover the operating aspects of the business and are typically based on the seller’s knowledge and due diligence. These might include, but are not limited to:

Financial statements
Compliance with laws
Contracts
Employees and benefits
Environmental matters
Intellectual property

Indemnification for general reps is almost always subject to:

Time limitations (usually 12–18 months)
Caps (commonly 10% of the purchase price)
Baskets (thresholds before recovery begins)

These reps are where most claims occur, but also where the bulk of the seller’s protections reside.

Fundamental Representations and Warranties

Fundamental reps, on the other hand, go to the heart of the transaction. They are core assertions about the seller’s authority to do the deal and the target’s legal existence and ownership.

Typical fundamental reps include:

Title to shares
Due authorization and enforceability
Capitalization
Taxes
Brokers and finders

Indemnity for fundamental reps is usually:

Not subject to standard caps (and often uncapped)
Not subject to baskets
Subject to longer or unlimited survival periods

For example, a breach in capitalization could result in a post-closing ownership dispute—something buyers expect to be covered long after closing and without limitation.

Sellers should understand that the carveouts for fundamental reps are not mere formalities. These provisions often carry the most significant long-tail liability, and warrant close negotiation over both scope and wording.

Covenants and Indemnification

Indemnification applies not only to breaches of reps but also to breaches of covenants. However, covenants behave differently:

They may relate to pre-closing conduct (e.g., operation in the ordinary course) or post-closing obligations (e.g., non-compete, confidentiality, transition services).
Covenants often are not subject to caps or baskets, especially if post-closing.
Survival is tied to their duration, not the standard survival period.

Sellers should ensure:

Pre-closing covenants do not survive closing unless necessary
Post-closing covenants are clear in scope, duration, and limits

RWI and Indemnification Interaction

Representation and warranty insurance (RWI) has reshaped how indemnity is allocated.

Key characteristics:

The insurer, not the seller, bears the risk of covered breaches
The seller often has no indemnity obligations for general reps
Buyers typically retain recourse only for fundamental reps, fraud, and covenants

However:

RWI policies often exclude specific known risks
Claims under RWI must be timely, well-documented, and subject to policy exclusions and retention thresholds

Sellers using RWI should ensure the acquisition agreement is tailored to match the policy structure and coordinate closely with RWI counsel during negotiation.

Dispute Resolution Mechanics

Disputes over indemnity claims are common. Clear processes reduce the risk of escalation.

Key mechanics to define:

Time limits for bringing claims
Claim notice procedures
Process for resolving third-party claims (“defense and control” rights)
Escrow release mechanics and holdback triggers
Governing law and venue

Many agreements include a stepped dispute resolution process: negotiation, followed by mediation or arbitration, and only then litigation. Sellers should ensure they have the right to participate in or control certain third-party claims, particularly where their reputation or business interests are at stake.

Buy-Side vs. Sell-Side Strategy

Indemnification is inherently adversarial. The buyer wants broad recovery; the seller wants narrow, time-limited exposure.

Buy-side objectives typically include:

Extended survival periods
Broad definition of losses
Low baskets, high caps (or uncapped)
No materiality qualifiers (scrapes)
Indemnity for known and unknown risks

Sell-side objectives typically include:

Shorter survival periods
Caps equal to escrow (or less)
Tipping baskets or deductibles with carveouts
Knowledge qualifiers and materiality thresholds
Exclusions for speculative, punitive, or consequential damages

Indemnification is a risk-allocation game. Well-advised sellers focus on aligning liability with their knowledge and control of the business.

Our Indemnification Advisory Services

Linden Law Partners regularly advises sell-side clients on structuring and negotiating indemnification terms to protect post-closing value.

Our services include:

Indemnification Risk Assessment
Drafting Indemnity Clauses in M&A Agreements
Reps and Warranties Review & Advisory
Indemnity Claim Management
Escrow Structuring & Administration
Indemnity Cap and Basket Structuring
Survival Period Structuring & Legal Strategy
Dispute Resolution for Indemnity Claims

Indemnity Due Diligence Services
Post-Closing Indemnity Monitoring
Representation & Warranty Insurance Consulting
Materiality Scrape Clause Evaluation
Buy-Side/Sell-Side Indemnification Strategy Consulting
Custom Indemnification Provision Drafting
Fraud Exception Advisory Services

Conclusion: The Hidden Battle Over Deal Value

Every deal has a headline price. But it’s the indemnification structure that decides what you actually keep.

Buyers will naturally seek expansive indemnity protections to hedge their risk. Sellers must be equally proactive in negotiating terms that are commercially reasonable, market-aligned, and tightly defined.

Ultimately, sellers who understand the strategic and legal dynamics of indemnification—and negotiate accordingly—can walk away from a deal with their upside intact and their downside mitigated.

We’re here to assist you during every stage of the business lifecycle – from business formation through exit.