Representations (or reps) and warranties can cover a broad range of topics in a financing transaction and they typically get more thorough as the amount of money gets bigger. In general terms, a representation is an assertion that the information in question is true at the time of the financing, and the warranty is the promise of indemnity if the representation turns out to be false. For example, a company might rep that they have no unpaid salaries, or that they are not currently being sued. We address two more specific reps below.
If you want to get a taste of probably the most typical sort of representations and warranties companies give in private financings, you can review the representations and warranties in the Series Seed documents.
A capitalization rep or cap rep is a representation and warranty in a securities purchase agreement in which the company makes assurances to you about its ownership and capital structure. For example, the company may represent and warrant that it has authorized 10M shares of common stock and that it only has 2M shares outstanding. If they are wrong, the investor can sue for damages and remedies.
The cap rep is critical in a fixed-price financing. If the company does not give you a cap rep, how do you know much of the company you will own? This is true even in a convertible debt financing, although a cap rep is less common in those documents because the amount of the company you will own as a result of those transactions will be governed by a valuation to be determined later, or a valuation cap set forth in the convertible note.
Financial Statements Rep
Whenever you make an investment, you would prefer the company make a representation and warranty about the company’s financial statements. As an aside, you should take a look at those statements to see how much cash is left in the bank and what if any outstanding debts exist.