Insights

How Private Equity Firms “Stack the Deck” in Their Favor in Every Deal, and How You Can Do the Same When You Sell
POSTED 5.11.17 Insurance, M&A

The Seller’s Nightmare is Real

Time is a cruel and silent thief, with its hand deep in your pocket. The longer the process drags on, the lower the price will go (or the smaller the check will be at closing). All BAD NEWS for you.

The only way to stop the bleeding is to agree to accept more risk in indemnification agreements than you’d like to or swallow large escrows or withholds – delayed money is money you may never see. Sellers, like you, often find themselves forced against their will, to choose between delays on collecting a big chunk of their money at closing, or accepting a lot more personal risk than they should, post-deal.

Clean Exits are Good Exits

What you should be looking for is a quick, profitable, and clean exit from the transaction; where the deal is closed quickly, with the confidence that you not only get more cash at closing, but you can keep it all without worry of a claw-back.

The Clock and the Vault

Time kills deals. The longer the due diligence process or negotiations over the reps and warranties takes, the less money a seller collects. Sellers either have to make significant compromises in terms of less cash or more indemnity risk, or face their deal falling through and having to go back on the market. This will have a devastating effect on a company’s value, not to mention the wear and tear on the seller and his/her team. One of the “laws of nature” in the M&A world that you will learn when selling your company is this… The first offer you get from the buyer is the best offer you’re going to get…

The Solution that Puts More Money in Your Pocket and Dramatically Lowers Your

Post-Deal Risk

There is good news for you…fixing these problems is easy. In fact, it’s the secret behind how other private equity firms extract maximum value and absolve themselves of post-deal risk when they exit a company. Shouldn’t you take a page from their playbook?

The answer is a simple insurance policy called a Rep & Warranty (R&W) policy.

Here’s how it works:

Insurance underwriters review the reps and warranties outlined in a Purchase Agreement, along with the Buyer’s due diligence. If they determine the reps are acceptable and the due diligence has been properly conducted, underwriters will, for a fee, offer to take all ,or a portion, of the indemnification responsibility for the life of the agreement. In the event the buyer suffers a financial loss resulting from a breach of the reps and warranties, they collect directly from the Insurance Company. The Seller and his/her money are entirely unencumbered post-deal.

The 13 Most Important Facts About R&W Policies

  1. R&W policies transfer the indemnity obligation outlined in a purchase/sale agreement from the Seller to an insurance company. In the event of a breach of the reps or warranties, the insurance company, NOT the Seller, pays the Buyer’s loss. The Buyer has certainty of collection and the Seller gets the clean exit and keeps their money.
  2. Cost of R&W policies are determined by the amount of insurance needed, NOT the size of the transaction.
  3. Payment of R&W premium can be split between the parties – it doesn’t have to fall entirely on one side or the other.
  4. Buyers welcome (or are at least open to) R&W because they have certainty of collection.
  5. The underwriting process will NOT slow the deal.
  6. Very little paperwork is necessary to secure reliable pricing indications.
  7. The insurance company’s goal is to cover ALL reps – so the entire deal is covered.
  8. Unlike any other insurance policy, the Insurer is virtually at the table with the parties while

the policy is being written. Underwriters view all the reps and warranties being negotiated, overseeing all the due diligence performed, so they can’t deny any coverage was breached because they were “in the room” when the deal was done and the policy terms were written.

  1. Policyholders have tremendous leverage because insurers will NOT hesitate to pay claims, otherwise they risk losing their entire market by appearing reluctant to pay on these R&W policies.
  2. Insurers will NOT pursue the Seller following payment of a claim. They pay the Buyer and move on. Pursuing the Seller defeats the entire purpose of the policy. Who wants to trade

being held liable to a Buyer, for being liable to an insurance company?

  1. PE firms use R&W to expedite their portfolio spin-offs and accelerate distribution of proceeds

to investors years ahead of other non-insured deals.

  1. R&W is not intended to by-pass due diligence. Insurers expect the parties to behave as if

there is no insurance in place.

  1. Insurers have paid tens of millions of dollars in R&W claims demonstrating time and time

again that a promise made is a promise kept.

Bridging the Gap between Close and Collapse

“I’ve seen the classic scenario where R&W has made the difference between success and failure…”

A telecommunications company targeted a software company for its application capabilities. The target company provided clean, well-organized documentation, and produced a list of “Buyer-friendly” reps and warranties. The Buyer’s due diligence process went smoothly, so there were no issues until the subject of the indemnity cap came up. The Buyer had an absolute minimum indemnity cap of 30% of the transaction value, a level to which the Seller adamantly objected. Despite the fact everything else in the deal was clean, it was in danger of falling apart due to the gap between the parties.

At the last minute, an R&W policy was brought into the deal. In less than two weeks, a policy was proposed to the Buyer with coverage that matched their required indemnity limit, without forcing the Seller to take on any additional risk. The two sides split the premium cost, and the deal moved swiftly to a successful close.

Is R&W Right for You? Here’s How to Find Out for Sure

How will you know whether or not R&W is a fit for your deal? There are strict eligibility requirements for these policies, which, in the hands of an experienced professional, can be navigated efficiently, but shouldn’t wait until the last second to see if you qualify.

Here’s how to know if it’s for you… If you want to extract maximum cash from your

business, without having it tied up in escrow or having to begrudgingly say “Yes” to high indemnity obligations, that frankly, keep you awake at night… never giving you a clean exit…then, an R&W policy might be for you.

If that’s YOU, here’s what to do next: Book a Cash Maximization and Risk Elimination Strategy Session right now, to determine, if your deal fits.