From the FDD report to the SPA: Earn-outs, reps & warranties and indemnities

From the FDD report to the SPA:

There is a moment in every company sale when the analytical work turns into legal obligations. The buyer has commissioned its financial due diligence (FDD), the report is on the table, and with it a normalised EBITDA, a list of tax and labour contingencies, a working capital figure that does not match the one reported, and three or four risks nobody saw coming. All that intelligence is worth precisely what the contract manages to capture. The FDD report protects no one on its own: what protects the buyer is the clause that grows out of it.

That translation —from the financial diagnosis to the wording of the Share Purchase Agreement (SPA)— is where value is genuinely won or lost, and where most post-closing litigation is incubated. This article walks through the three tools that channel the FDD findings: the earn-out (for uncertainty about the future), representations & warranties (for latent, unknown risk) and specific indemnities (for risk that is already known). The backbone is Spanish law; the contrasts with Anglo-Saxon practice appear where they illuminate a concrete decision.

A map before we start: Each finding, its instrument

Before getting into the detail, it helps to have the full map. A good advisory team does not cover every risk with the same tool: it assigns each type of finding to the contractual mechanism that neutralises it at the lowest legal cost. The logic is this:

The first two rows are resolved in the price —they are the value bridge that leads from Enterprise Value to the money the seller actually receives—, territory we develop in detail in Locked Box vs. Completion Accounts. Our focus here is the last three, the ones that genuinely allocate risk between the parties beyond the closing figure.

Beneath that table lies a conceptual distinction worth keeping in mind, because it determines the right tool and prevents the most common error —using the warranty as a catch-all for everything. Not every risk is of the same nature:

• Value risk: the asset is simply worth less than thought, even though no one has breached anything. If a third of the reported EBITDA is non-recurring, the problem is one of price, not warranty.
• Representation risk: the buyer needs the seller to contractually assume a state of affairs as true (that the accounts show a true and fair view, that there is no hidden litigation). This is the domain of representations & warranties.
• Known contingent risk: both parties know a potential event exists —an inspection, a lawsuit— but not its final cost. Here a specific indemnity is cleaner than a general warranty.
• Future-performance risk: no one can state today what the outcome will be. Turning it into a warranty is a misclassification; it calls for an earn-out or a milestone-linked condition.
• Post-closing conduct risk: arises when the buyer controls the variable that determines a contingent payment. It stops being a financial problem and becomes one of contractual governance.

The question that orders the whole exercise is not “what did we find?”, but a more precise one: for every euro of value the diligence has cast into doubt, who bears the risk if the assumption turns out to be false, under what trigger, for how long, and with what source of payment? That, in a sentence, is the transition from the report to the contract.

Earn-outs: pricing the disagreement about the future

The earn-out exists because buyer and seller rarely agree on what tomorrow is worth. The seller trusts their growth plan; the buyer prefers to pay for what has been proven. The earn-out bridges that gap: part of the price is paid at closing and part is made contingent on the business hitting certain milestones —typically over one to three years. In the Spanish market the variable tranche usually ranges between 10% and 30% of the price; exceeding 40% is unusual and signals strong uncertainty about the asset.

Deferred price or contingent price? The difference matters

It is important not to confuse the earn-out with a simple deferred payment. In a deferred price the amount is already fixed and only the payment is postponed; in an earn-out, the very existence of the payment and its amount depend on something happening.

Legally it is a determinable price, a figure Spanish law admits without difficulty. Article 1447 of the Civil Code allows the price to be set by reference to objective criteria or to be left “to the determination of a specified person”. The single —and emphatic— limit is set by article 1449 CC: the price may never be left to the discretion of one of the parties. An earn-out formula whose calculation depends entirely on the buyer’s discretion is a formula that risks nullity.

From that legal nature flows all the conflict potential of the earn-out: alongside the obligation to pay a price, the buyer effectively assumes an obligation to act —to run the business in such a way that the target remains achievable. And that is where interests collide.

The metric comes from the FDD, not from thin air

Choosing the metric is the first technical decision, and it is where the FDD report is irreplaceable. Each option transfers a different risk:

• Revenue (top line): the least manipulable and most transparent metric, but it leaves the buyer exposed to the seller chasing volume at the expense of margin —aggressive discounts just to cross the threshold.
• EBITDA (bottom line): aligns the payment with real profitability, but opens the door to endless disputes over the allocation of corporate overheads, depreciation and shared costs.
• Gross margin: often the point of equilibrium: it ensures the sales counted are profitable while excluding the structural costs the buyer could inflate to depress the figure.

Whichever is chosen, the normalised EBITDA produced by the FDD —cleansed of above-market owner salaries, related-party rents, non-recurring items and intra-group transactions— is the only defensible base. In Spanish SMEs the gap between reported and normalised EBITDA frequently runs between 15% and 30%, so defining the metric precisely is not a technicality: it is money. And it is not enough to write “adjusted EBITDA” in the contract. The formula must be ring-fenced:

Earn-out EBITDA = Reported EBITDA ± consistency adjustments (FDD) + structural costs imposed by the buyer − forced synergies ± related-party transactions at market value

Each term neutralises a specific avenue of manipulation: the corporate costs the parent pushes onto the subsidiary that did not exist before, the reallocation of customers to other group companies, or related-party transactions at non-market prices. The contract must also fix which accounting framework applies (Spanish GAAP / PGC), require consistency with historical criteria and govern the treatment of extraordinary items, a front where revenue recognition policies are the usual battleground.

Writing “1.5 times the adjusted EBITDA in excess of €3,500,000” settles nothing on its own: it merely shifts the fight to what “adjusted EBITDA” means. It is therefore worth setting an explicit calculation hierarchy in the contract, applied in cascade: (1) the definitions and adjustments agreed in the earn-out schedule; (2) a worked numerical example included in the contract itself; (3) the accounting policies of the reference accounts, applied consistently; and (4) Spanish GAAP only for whatever the first three steps do not cover. The purpose is to stop a legitimate change in the buyer group’s policies from retrospectively altering the variable on which the price was negotiated.

A worked example saves litigation. Suppose an earn-out equal to the lower of €1,500,000 and 1.5 × (adjusted EBITDA − €3,500,000), never below zero. If adjusted EBITDA is €4.2m, the excess over the threshold is €0.7m; multiplied by 1.5 that is €1.05m, below the cap, so €1.05m is paid. If EBITDA reaches €4.8m, the excess is €1.3m and 1.5 × 1.3 = €1.95m, so the cap bites and €1.5m is paid.

Putting this calculation in the contract forces the parties to discover before signing whether they read the formula the same way —which is exactly where future disputes hide. Where the KPI comes from data, it is also worth freezing the source of truth (which system, which extraction date) and preserving the records that allow the calculation to be reconstructed years later.

Protective covenants: good faith is not enough

Article 1258 CC requires contracts to be performed in good faith, and article 1119 CC —very useful here— deems a condition fulfilled where the obligor wilfully prevents its fulfilment. But relying on those principles alone is reckless: reaching them requires litigation.

A well-drafted earn-out builds in express management covenants during the accrual period: an obligation to operate in the ordinary course and consistently with the historical practices analysed in the FDD; maintenance of minimum levels of commercial investment and capex; a prohibition on charging unrelated corporate costs or diverting customers to affiliates; periodic information rights over management accounts; and an acceleration clause making 100% of the maximum payable if the buyer resells the company or removes the founder without cause.

Dispute resolution deserves a two-track design, because mixing the tracks becomes a source of disputes about the dispute itself. On one track, strictly accounting or calculation questions —whether €300,000 of a specific cost falls within the agreed definition— go to an independent accounting expert, who under Spanish law acts as an arbitrador (integrating the contract by fixing a figure, with a narrow scope for challenge), not as an arbitrator.

On the other track, legal questions —whether an integration breached a covenant, how the acceleration clause is interpreted, whether there was fraud— are reserved for the agreed arbitration or courts. Referring a contract-interpretation dispute to the “auditor” asks them to exceed their mandate, and that excess is itself grounds to set aside their decision.

The tax note not to overlook

For an individual seller, the earn-out is taxed as a capital gain in the savings base of personal income tax (IRPF), with the possible application of the instalment-sale rule; for a corporate seller, the article 21 participation exemption of the Corporate Income Tax Act may come into play. One risk deserves special attention: if the seller stays on as a manager and the payment is tied to their performance, the tax authority may reclassify part of the earn-out as employment income, taxed at far higher rates.

The remedy is to separate cleanly in the contract the price of the shares from any personal incentive to the management team —a point we develop in our note on taxation on business transfers in Spain. In any case, confirm the tax treatment with an adviser at the time of the deal; Maraz provides financial advice, not tax or legal advice.

Representations & warranties: why an alien regime was imported

Here lies the most interesting legal peculiarity of the whole transaction. When a company is bought by buying its shares, the legal object of the sale is the shares, but the economic object is the business. The Spanish Civil Code is designed for the sale of things, not businesses, and its safety net —the regime of hidden defects (saneamiento por vicios ocultos)— is wholly insufficient: article 1484 CC requires the defect to be serious, hidden and pre-existing; it grants a claim period of just six months (article 1490 CC); and it releases the seller if the buyer ought to have known of the problem through their own expertise. For a company sale, that is toy-grade protection.

Hence Spanish practice has imported from the Anglo-Saxon tradition a complete contractual regime that lawfully replaces —under the freedom of contract in article 1255 CC— the default statutory regime. The seller states in writing the legal, financial, tax, labour and operational condition of the company, and undertakes to indemnify if those statements prove inaccurate as at the closing date. It moves from a defects regime to an objective regime of representations: it is enough to prove that what was stated did not match reality.

What the Spanish courts say (and what they do not)

The case law of the Supreme Court on this subject is, in all honesty, inconsistent, which reinforces the value of a well-drafted contract. In its judgment of 21 December 2009, faced with the purchase of a company that owned a hotel affected by aluminosis, the Court reasoned that the buyer “did not buy the hotel, but the company”, and sidestepped ruling on the breach of the warranties.

In that of 20 November 2008 it steered a balance-sheet warranty towards the hidden-defects regime. But in STS 187/2019 of 27 March, faced with sellers who had dressed up the accounts, it allowed the buyer’s damages claim under article 1101 CC and —decisively— confirmed that the indemnity is not capped by the price: a award well above what had been paid for the shares was upheld. The lesson for the reader is simple: precisely because the default law is uncertain, the only reliable protection is the agreed clause. This is the terrain of representations & warranties.

There is one more judgment, from December 2021, particularly useful for whoever drafts the contract, because the dispute arose from the interplay between different clauses and the financial information handed over. The Supreme Court interpreted the contract systematically and found it decisive that the disputed debt appeared in the balance sheet prepared for the deal: it did not treat it as a hidden debt the buyer could ignore by relying on another clause, nor did it infer a waiver of the claim without a sufficiently clear statement.

The takeaway is operational: the reference balance sheet, the definitions schedule, the disclosure letter and the debt schedule must be reconciled before signing. An inconsistency between schedules is not a drafting slip; it can shift millions of euros in the allocation of risk.

Categories, qualifiers and the disclosure letter

Warranties divide into fundamental (the seller’s capacity, title to and free disposal of the shares) and business warranties (annual accounts and true and fair view, tax, labour and social security, litigation, IP, real estate, environment, change-of-control contracts, compliance). The seller narrows their exposure through qualifiers: knowledge (“to the seller’s best knowledge”) and materiality (only what is relevant is warranted). And, above all, through the single most important document for their defence: the disclosure letter, which lists the exceptions to the warranties. What is disclosed ceases to be warranted.

A classic battle is fought here. The seller will try to have the whole data room deemed “disclosed” en bloc; the buyer must insist on the fair disclosure standard: only precise, intelligible information that allows a professional buyer to assess the risk exonerates the seller, not the indiscriminate dumping of documents. It is also the point where the FDD and the contract meet: every contingency detected in diligence must be channelled consciously —as an exception in the disclosure, as a price adjustment or, if serious, as a specific indemnity.

Specific indemnities: euro-for-euro protection for known risk

When the FDD surfaces a concrete, quantifiable risk —an open tax inspection, unrecorded overtime, an ongoing dispute with a supplier— subjecting it to the general warranty regime is a technical mistake. Because that risk is in the report and will be in the disclosure letter, the seller will have a perfect formal defence against any warranty-breach claim: “you already knew.” The only way to protect the buyer is the specific indemnity, a standalone obligation to hold the buyer harmless that operates outside the general limits.

The practical difference between the two instruments is considerable:

A prior rule, though: an indemnity is not used to correct a price error already known at signing. If the FDD detects €800,000 of financial debt that was not included in the value bridge and that item is debt-like, the correct move is to reduce the equity value by those €800,000 at closing. Having the buyer pay them and then reclaim them through an indemnity adds credit, procedural and evidential risk while creating no value. The indemnity is for the uncertain; the certain and quantified is deducted from the price. Confusing the two planes is one of the most expensive and frequent mistakes.

Quantification: caps, baskets, de minimis and survival periods

The liability regime is calibrated with four levers.

• The cap or maximum limit (in the Spanish market, business warranties usually sit in a 10%–30% band of the price without insurance; fundamental warranties reach 100%).
• The basket or aggregate threshold, which can be tipping —once the threshold is passed, everything is claimable from the first euro— or deductible —only the excess is claimable.
• The de minimis, a minimum amount per individual claim that filters out the trivial.
• And the survival periods, which must be aligned with limitation: 18–24 months for ordinary warranties, but up to the statutory period for tax (4 years) and social security (4-year limitation), bearing in mind that the labour and social security periods do not coincide.

The limit no clause can cross. Here is the point most often overlooked and worth internalising: the entire scaffolding of limits collapses in the face of fraud. Article 1102 CC provides that liability arising from fraud (dolo) is enforceable in every obligation and that any waiver of the action to enforce it is void.

Translated: if the seller fraudulently concealed a liability, neither the cap, nor the basket, nor the de minimis, nor the agreed periods, nor an anti-sandbagging clause protects them; moreover, under article 1107 CC they will answer for all losses, not only the foreseeable ones. For the same reason, fraud is never insurable under a W&I policy. No contractual architecture, however sophisticated, shields the seller who deceives.

Managing the inherited dispute (conduct of claims)

Where the indemnity covers an ongoing lawsuit or inspection, one clause generates real friction: who runs the proceedings. The seller demands control of the defence because it is their money that will pay any adverse outcome. The buyer resists, because poor handling can damage relationships with key customers or entrench a tax position that is harmful for future years. The usual balance: the buyer keeps formal control of the defence at the seller’s cost, with the seller’s right to be informed and consulted, and an express prohibition on settling or admitting liability without their written consent. This, incidentally, is the natural terrain of economic-financial expert reports, both to quantify the contingency and to sustain it in any arbitration.

A clause is worthless if the seller cannot pay

A warranty or an indemnity is worth only as much as the solvency of whoever stands behind it. If the seller is an individual who distributes the price, or a fund that pays out to its investors and winds down (the clean exit), the clause can become a dead letter. Hence the payment security mechanisms: the escrow account (a typical retention of 5%–15% of the price for 12–36 months, held by a notary or bank), the price retention with a right of set-off against deferred consideration, and the first-demand bank guarantee, whose maximum amount can decrease as the contingencies lapse.

And an indispensable closing rule: no double recovery. A single finding can touch several mechanisms at once —cutting the price, adjusting the earn-out and triggering an indemnity— and the contract must expressly stop the buyer from being paid twice for the same loss. If a contingency already reduced the price or was already netted off in the earn-out calculation, it cannot also be claimed in full through the indemnity. A well-drafted no double recovery clause is what prevents the buyer’s legitimate protection from turning, unintentionally, into unjust enrichment that the seller will successfully resist.

Warranty & Indemnity (W&I) insurance

The instrument that has most transformed the Spanish mid-market in recent years is Warranty & Indemnity (W&I) insurance, which has moved from a niche product to something close to standard on deals of a certain size. Its appeal is twofold: it allows the seller a clean exit —collecting 100% at closing, with no retentions— and gives the buyer a solvent counterparty (the insurer) to pursue any claim against. For private equity funds it is almost mandatory, because it maximises IRR by freeing up cash immediately.

The connection with the FDD is total, and explains why the quality of diligence matters so much: the insurer’s underwriting rests on the financial and legal reports. And there is a limitation worth understanding well, because it defines the product’s boundary:

W&I cover = SPA representations − Risks identified in the FDD

The insurer expressly excludes anything already identified in due diligence (the known matters exclusion). In other words: W&I transfers the unknown, latent risk; the known risk surfaced by the FDD falls outside the policy and must be covered another way —price adjustment, specific indemnity or escrow. The two layers are complementary, not substitutes. And a caveat consistent with the above: seller fraud is never insurable (an insurance contract requires uncertainty), which ties back once more to the mandatory nature of article 1102 CC.

Four differences from Anglo-Saxon practice worth knowing

A reader negotiating with an international fund or an Anglo-Saxon strategic buyer will encounter contractual reflexes different from ours. They are worth placing side by side:

The underlying difference is cultural and legal at once: the Anglo-Saxon contract aspires to self-sufficiency —defining every term and closing every list, trusting no default law to fill the gaps— whereas the Spanish contract historically leaned on the Civil Code for whatever was not agreed. The Iberian mid-market is trending towards that exhaustiveness, precisely because —as the Supreme Court’s contradictory case law shows— entrusting protection to the default law is entrusting it to an uncertain outcome.

Before signing the SPA: seven control questions

Translating the FDD well into the contract comes down, in practice, to answering seven questions honestly:

• Does the earn-out metric come from the FDD’s normalised EBITDA, with the accounting framework and consistency defined, and with management covenants and information rights that prevent it being manipulated?
• Does every identified contingency have an explicit destination? Price adjustment, exception in the disclosure or specific indemnity: none should be left in no-man’s-land.
• Do the warranties distinguish fundamental from business ones, with reasonable qualifiers and a disclosure subject to the fair-disclosure standard, not the data-room dump?
• Are the cap, basket, de minimis and periods aligned with tax and labour limitation, and is it understood that none of them protects against fraud (art. 1102 CC)?
• Is there real payment security? Escrow, retention with set-off, guarantee or W&I, sized to the risk and to the seller’s solvency.
• Is the tax treatment coordinated? Instalment sales, the article 21 participation exemption and the risk of the earn-out being reclassified as employment income.
• Does the contract prevent double recovery? No loss already deducted from the price or the earn-out should be claimable again through the indemnity.

Conclusion  - From the FDD report to the SPA

The financial due diligence report is neither a compliance document nor an expert opinion to be filed away: it is the operating matrix that decides which risks are deducted from the price immediately, which are deferred and made contingent on future cash, and which are ring-fenced with indemnities impervious to the ordinary limits. The earn-out, the representations & warranties and the specific indemnities are the three pipes through which that intelligence reaches the contract. Well connected, they capture the value detected in diligence and avoid litigation; poorly connected, they leave on the table exactly what cost so much to uncover.

At Maraz Corporate Finance we support mid-market entrepreneurs across the whole process, from the preliminary analysis to the negotiation of the SPA’s economic clauses. If you are weighing a purchase or a sale, explore our M&A advisory service or our financial due diligence service.

Javier de Rojas Roca de Togores

Partner - Maraz Corporate Finance

Faqs - From the FDD report to the SPA

What is the difference between a representation & warranty and a specific indemnity?

A representation & warranty covers unknown risk: the seller states that a set of facts is true and answers if it proves inaccurate, but subject to limits (cap, basket, de minimis, periods) and neutralised by whatever is disclosed in the disclosure letter. A specific indemnity covers known risk: a contingency already identified in due diligence that is ring-fenced as a standalone obligation to hold the buyer harmless, euro for euro, outside the general limits and without prior disclosure defeating it. In a sentence: the warranty is for what is not known; the indemnity, for what is.

Is an earn-out valid under Spanish law?

Yes. The earn-out rests on the determinable price concept that the Civil Code admits: article 1447 allows the price to be set by reference to objective criteria or left to a third party. The only relevant limit is article 1449 CC —the price may never be left to the discretion of one of the parties— so a formula whose calculation depends entirely on the buyer’s discretion risks nullity. That is why a well-drafted earn-out minimises that discretion with a precise formula, closed definitions, agreed accounting policies and an independent expert to resolve calculation disputes.

Can the seller limit their liability if they concealed a problem?

No. This is the mandatory ceiling of the whole system. Article 1102 CC provides that liability for fraud (dolo) is enforceable in every obligation and that any waiver of the action to enforce it is void. If the seller fraudulently concealed a liability, neither the cap, nor the basket, nor the de minimis, nor the agreed periods, nor an anti-sandbagging clause protects them; moreover, under article 1107 CC they answer for all losses, not only the foreseeable ones. For the same reason, seller fraud is never insurable under a W&I policy.

How long should the seller’s liability for the warranties last?

It depends on the category. Ordinary business warranties usually survive 18 to 24 months (one or two audit cycles). Fundamental warranties —title to the shares, capacity— run to the statutory period. And tax and social security matters must align with their limitation periods (4 years for tax; 4 years for social security), bearing in mind that the labour period and the social security period do not coincide. The survival of each warranty or indemnity should track the real life of the risk it covers, not a uniform “four years from closing” rule.

What is Warranty & Indemnity (W&I) insurance and what does it not cover?

It is a policy that transfers to an insurer the risk that the seller’s warranties prove inaccurate, letting the seller achieve a clean exit —collecting 100% at closing with no retentions— and giving the buyer a solvent counterparty. Its key boundary is the known matters exclusion: the insurer excludes anything already identified in due diligence. W&I covers the unknown, latent risk; the known risk surfaced by the FDD falls outside and must be covered by price adjustment, specific indemnity or escrow. The two layers are complementary, and the quality of the diligence directly conditions the scope of the policy.

How does the contract stop the buyer being paid twice for the same problem?

Through a no double recovery clause. A single finding can cut the price, adjust the earn-out and trigger an indemnity all at once, and the contract must stop the buyer recovering twice. If a contingency was already deducted from the price or the earn-out calculation, it cannot also be claimed in full through the indemnity, thereby avoiding unjust enrichment that the seller would successfully resist before the courts.