World Class Mergers & Acquisitions  |  For Companies $5 Million to $250 Million in Revenue

Representation & Warranty Insurance for Sub-$20 million Deals

Approximately ten years ago the mechanics of M&A changed forever.  What I’m speaking of is the advent of Reps & Warranty Insurance (RWI). This metamorphosis continues today as RWI is now readily available, and more importantly, affordable, for M&A transactions under $20 million in enterprise value.

The history of RWI dates back to the turn of the century when the concept was first introduced, but it was overly clunky, very expensive, and rarely, if ever used. In the early teens, it was re-engineered and re-introduced – and this time it took. Over the subsequent ten years, RWI became ubiquitous in M&A transactions anywhere from $20-$30 million purchase price up to several billion+ as the benefits for both sides continually outweighed the premium costs.

The recent game changer is those same RWI benefits are now available at a cost that make economic sense for transactions between $250,000 – $20,000,000 via a relatively new, sell-side RWI solution.

Instead of having to spend a minimum of between $200,00-$300,00 for traditional RWI, it can now be obtained for approximately less than $10,000 per million dollars of coverage through this new, sell-side solution. The higher the limit chosen, the lower the cost per million of limit becomes.

What this means is owners of companies who sell for under $20 million purchase price, can now also benefit from RWI. The primary benefit is the reduction or elimination of the escrow and indemnity, so they can walk away from the closing table with 100% of their sale proceeds, and the peace of mind to know that should the buyer claim a breach of a rep post-close, they have insurance to protect their sale proceeds. In addition, having a RWI policy in place provides the buyer greater comfort with the deal itself, and can increase close percentages.

Cost indications can be obtained within 24 hours with only the target industry and the estimated purchase price needed.  There are no cost commitments to obtain indications.

  Quick Overview

  • Intended for deals between $250,000 – $20 million purchase price
  • Benefits to the seller included a reduced or eliminated escrow/indemnity, and peace of mind their sale proceeds are protected for 6 years post close
  • The primary benefit to the buyer is it provides greater comfort with the deal itself knowing there is a legitimate recourse for 6 years post close.
  • Another benefit for both parties is that it smooths out the negotiations over the reps & warranties in the agreement knowing the deal is insured
  • Seller is the Named Insured (see comments below)
  • Coverage is very inexpensive relative to traditional RWI
  • Costs are approximately $10K per $1M in limit, which varies depending on limit chosen
  • $0 deductible for claim payments, $20K deductible for defense costs only
  • Buyer can be added to the policy as a Loss Payee, which adds even more comfort
  • Often paired with a buyer-side sister policy that only covers Seller Fraud
  • Several hundred policies have been bound since product launch
  • An application, deal docs, and VDR index are only items required for underwriting, no buyer diligence required
  • No underwriting call required
  • Policy limits up to 100% of deal size are available (and quite common)
  • Coverage for defense costs and duty to defend are standard
  • A 6-year policy coverage period is automatic for both general and fundamental reps, vs. 3-years for general reps under standard RWI
  • Paper is Lloyd’s (led by Travelers), all A rated
  • The policy language is generally non-negotiable, subject to a specific request or two
  • Indication / underwriting process:
    • Only a website and expected EV are needed for indication
    • If indication is attractive, underwriting consists of a completed application, a few emailed questions, and receipt of the deal docs and VDR index
    • The process typically takes about a week, but will follow deal timing
    • It’s possible to bind coverage within a few hours if needed

Sell-Side Policy vs. Buy-Side Policy

 It’s important to note this is sell-side policy only. The policy backstops the seller indemnity, vs. replacing the indemnity as is the case on a more traditional buy-side policy. However, it essentially works like a buy-side policy as it provides the same/similar benefits as traditional RWI does to both parties and is therefore often used to reduce the seller indemnity/escrow. The policy is triggered when the seller makes a claim in response to the buyer making a claim on the indemnity for a breached rep.

Having the target as the Named Insured instead of the buyer also creates new efficiencies in the underwriting process. Instead of requiring a host of 3rd party diligence reports, a 2-hour underwriting call, and incurring a $35K – $40K underwriting fee, the only underwriting required on the sell side product is an application, an index of the data room, and a $500 policy fee.

 Market Opportunity

The potential ramifications of this development are huge. The annual M&A market value for just the deals that are under $10 million is estimated at $6 -8 billion, and this market is almost completely untapped from an RWI standpoint.

Awareness has now grown to the point that from here forward, penetration of RWI into the lower market is expected to grow exponentially year over year. Therefore, M&A advisors who serve this end of the market would be wise to further educate themselves and their clients on how to use RWI to their benefit.

This development was originally initiated by insurers and brokers who have a bent toward innovation, and saw an opportunity to unlock a new market. CFC, is the insurance carrier to credit for this innovation. CFC is an A rated London-based insurer, who completely dominates not only this new RWI market, but also has provided value-add innovation across the spectrum of M&A Insurance. Other CFC innovation includes RWI for Real Estate, and RWI-Portfolio which is designed to streamline RWI for Buy & Build models, among other market leading innovation.

In Summary

RWI for the lower market is here to stay, and we’re only in the first inning of the expected growth. Innovation and technology have combined to fill a previous unmet need in the ever-dynamic M&A marketplace, and business owners looking to exit are the ultimate beneficiary.

To learn more contact Tray Traynor, partner and M&A Insurance practice leader for Sterling Seacrest Pritchard, ttraynor@sspins.com, 404-949-1072.

 

If you know of a business owner who’s thinking of selling or buying a business and who might benefit from a complimentary, confidential, consultation with us, have them contact me directly at: mertel@transworldma.com, or one of the other managing directors at Transworld M&A Advisors.

 

Mike Ertel, CBI, M&AMI, CM&AA
Managing Director
Transworld M&A Advisors
813.299.7862 Direct

©2024 J. Michael Ertel PA