Insights

How R&W Insurance Has Changed the M&A Landscape Part 1 
POSTED 2.4.20 M&A

Representations and Warranty (R&W) insurance is not just here to stay, but growing – not to mention changing the way deals are structured.

More than a dozen insurance companies now offer this specialized product that transfers the indemnity risk away from the deal parties over to a third party – the insurer. And while only the big deals were eligible before, Underwriters will now take on deal sizes as low as $15M, which opens up a new world for Buyers and Sellers in those mid- to small-market companies. Plus, policies are cheaper than ever before.

Strategic buyers, VCs, and PE funds are all talking R&W coverage. Sellers are insisting on it because it reduces their escrow obligations and indemnity risk, and Buyers find having this insurance in place makes it easy to move forward.

All Signs Point to More R&W in Deals

This widespread adoption of R&W insurance has had a tremendous influence in the M&A world, not just smoothing out negotiations and getting deals done faster but also altering very specific and often contentious deal terms when it comes to the Purchase and Sale Agreement.

All this provides a critical mass that will bring R&W insurance to the forefront, with wider awareness and adoption in the coming year almost a given, even as it changes deeply ingrained accepted practices.

First, a little context and background.

You know there is a sea change going on when even the most resistant “old guard” companies change the way they do business.

For years, SRS Acquiom was the go-to provider in M&A deals for holding escrows and other financial guarantees. It’s no wonder that for a long time they actively discouraged Buyers and Sellers from using R&W insurance. They maintained that having cash in escrow was safe and more advantageous than spending money on insurance.

But they weren’t able to hold back the R&W tide, and now they’ve set up a brokerage within the company to sell… R&W coverage. So, they’re finally catching on. It’s a can’t beat ‘em, so let’s join ‘em type of thing.

The major change resulting from the wider spread introduction of R&W insurance is how it’s disrupted the balance of “power” in the M&A world.

The Buyer Power Ratio

SRS Acquiom has a metric – the Buyer Power Ratio (BPR) – that they use to gauge the negotiating strength of Buyer and Seller. It’s a simple calculation: Buyer Market Cap / Target Purchase Price = Buyer Power Ratio. For example, if a Buyer’s Market Cap is 25 times the value of the target company, then the Buyer would have a BPR of 25. The higher the BPR, the greater the leverage for the Buyer in terms of size.

Basically, the larger the Buyer is compared to the Seller, the more power and leverage they have to get favorable deal terms. For example, companies such as Apple, being a thousand times larger than any potential acquisition target (thus a BRP in excess of 1,000), will always have the complete upper hand. In deals where Buyer and Seller are similarly sized… the less leverage and the more negotiation will take place.

R&W insurance has introduced a wrinkle here. When the Buyer Power Ratio is low, Buyers are now increasingly using R&W as a way to make themselves more attractive to Sellers while decreasing their risk.

For example, it’s harder for the Buyer to exercise their walk rights once the Letter of Intent is signed and the target company is off the market. At this point, the two sides are joined at the hip.

If the Buyer tries to walk away, the target feels like they’re damaged goods and will have a hard time attracting another potential acquirer. If the Buyer wants to abandon the deal at this stage, they face a severe financial penalty. It’s like canceling a wedding at the last minute and not getting your deposit from the caterer or hotel ballroom back.

However, this puts Buyers in a tough spot if they spot something during due diligence in the run up to closing the deal. They want to walk away but is the issue worth the penalty? That’s where R&W insurance comes in.

The Buyer can shift this risk to the insurer. By hedging the risk, they can feel comfortable moving forward with the deal.

Overall, the mindset of Buyer and Seller going into deals when they have an R&W policy in place is:

What steps can we take to shift risk to the insurance company? And, how can we make sure the insurance company will accept risk?

Now, we see two parties angling to have terms that they consider a risk to be covered by insurance.

In part 2 of this article, we’ll drill down into some of the specific deal terms that are changing with the introduction of R&W insurance and how it will impact a M&A deal going forward, including elements like the double materiality scrape, non-reliance clauses, and more.

For now, if you have any questions about Representations and Warranty insurance and how it could change the dynamics of your next M&A deal – whether Buyer or Seller – you can contact me, Patrick Stroth at pstroth@rubiconins.com or (415) 806-2356.