M&A experts worldwide are using an insurance policy known as a Representation and Warranty (R&W) to transfer risk from the parties in a transaction to an insurance company. R&W policies are designed to, “step in the shoes” of a seller to pay indemnification claims made by the buyer for inaccuracies of the representations and warranties outlined in the purchase/sale agreement. Due to the low cost of R&W insurance, sellers are driving the demand for these policies rather than accept large, lengthy escrow or withhold terms. Buyers are discovering how R&W insurance can enhance their bid without having to raise their offer.
Limit Capacity – Up to $100M on a single policy. Excess capacity up to an additional $400M available as needed.
Retentions – commonly 1% to 3% of the purchase price. Reduces over time
Premium – 3% to 4.5% of the limits purchased (including taxes and fees). Minimum premium is $300,000
Underwriting Fee – From $25,000 to $35,000 in addition to the premium. Covers the cost of Insurer’s attorney’s fees and due diligence costs to review and manuscript a policy. Non-refundable.
Terms – designed to match the survival period. Post survival extensions available upon request.
I know of a company that was on the verge of being bought for $100M. Then COVID-19 came in, the deal fell through, and now the business, forced to go through bankruptcy, is selling its assets for $20M.
This will not be a unique case. In the coming weeks and months, expect a growing list of companies looking at bankruptcy as their way out due to the ongoing economic effects from the pandemic.
Unlike past downturn-related bankruptcy sales, there is a very valuable M&A tool that can be brought into the transaction that greatly benefits both Buyers and Sellers (also known in these cases as debtors):
Representations and Warranty insurance.
As Bryan O’Keefe, Gena Usenheimer, and James Sowka, partners at Seyfarth Shaw, put it in their recent article, “How An M&A Tool Can Benefit Bankruptcy Sales”:
“When properly utilized, reps and warranties insurance can increase the value of the distressed asset while simultaneously providing the asset purchaser with a backstop on the promises made in the purchase agreement.”
R&W coverage transfers the indemnity risk away from the Seller to a third party – the insurer. And the Buyer simply goes to the insurer with a claim for damages from any breaches post-closing. It’s a win-win for both sides of the transaction.
In bankruptcy deals covered by R&W insurance, the Seller’s company and/or its assets are more valuable, which gives them more cash to cover their debts. The simple reason why is that an asset backed up by an insurance company is more valuable to a Buyer than an asset that is bought as is. They can sell for more, simply put.
For Buyers, this coverage gives them protection and peace of mind that if something goes south and there are unknown breaches of the reps and warranties of the Purchase and Sale Agreement, they won’t have to go after the debtor (which doesn’t have funds to cover the damages because of their financial situation) for relief because the insurance company is ready to go.
This is vastly different than how business is usually done with these 363 sales. In the past, the mode was “as is, where is.”
It’s kind of the like buying a used car “as is”—it’s up to the purchaser to have a mechanic check out the vehicle to make sure it’s in good running order and there are no hidden issues. When a car warranty is added to the deal, not only does it cover repairs if something breaks down unexpectedly, but the owner can also actually increase the selling price.
With a 363 sale, the burden of conducting due diligence of the target asset is on the Buyer, and they often have a shortened timeline to conduct it. Things can be overlooked. R&W coverage acts like the car warranty.
As Bryan, James, and Gena say in their article:
“Most 363 sales are ‘as is, where is’ – a bankruptcy term of art meaning that the asset purchase agreement has no indemnities and the debtor is not standing behind the usually limited reps and warranties contained in the agreement.”
“While the bankruptcy court’s 363 sale order wipes out third-party claims against the assets, it does nothing for so-called ‘first party claims’ – that is, the reps and warranties made between the debtor and buyer around the overall state of the assets.”
R&W coverage is more affordable than ever. It causes no friction or change in dynamics in the deal; in fact, it makes negotiations smoother. And it’s now available for middle market companies. This has meant its widespread adoption in some M&A circles.
PE firms have been on board with R&W insurance for several years now. And SPACs are warming up to R&W as well. Now it’s time for bankruptcy sales to join in.
Why haven’t bankruptcy attorneys already been using this unique insurance product? They simply were not familiar with it.
You should know that insurance companies have departments that specialize in R&W coverage exclusively for 363 sales, which means not only are they experts in the field but also are coming in with aggressive pricing for the policy, which is a relief of companies in trouble, who face higher legal and other fees in general.
As bankruptcy attorneys realize these and all the other benefits of R&W coverage, watch for its use to increase as the coming wave of bankruptcies crests in the near future.
To find out how this specialized type of insurance can be a game-changer in your 363 sale or more straightforward deal, contact me, Patrick Stroth, at pstroth@rubiconins.com for all the details.
Representations and Warranty (R&W) insurance is a specialized coverage that transfers all the indemnity risk to a third-party – the insurer. If there are any breaches of reps and warranties post-closing, the Buyer simply files a claim and gets paid damages.
In many cases, it’s a much more affordable alternative to traditional indemnification – the holdback of funds in escrow to pay out any possible damages that come up from breaches. Because they take home more cash at closing, R&W insurance is especially appealing to Sellers.
Due to the protection it provides, R&W coverage is becoming an increasingly common feature of transactions in just about every industry. And because it’s now available for deal sizes under $20M, it’s been embraced by Buyers and Sellers of lower and middle market companies, including PE firms and strategics.
Despite its many advantages, R&W insurance went over like a lead balloon in Silicon Valley for many years.
Why? Early R&W policies would exclude intellectual property. It was considered uninsurable. And because IP is such a central part of deals with tech companies, what would the point be of seeking a policy that didn’t protect for breaches in that area?
These days, breaches of IP-related reps and warranties, in which the Seller states that there is no litigation or claims related to IP infringement, they are the sole and exclusive owner of the IP, and they have the right to transfer the IP, are insurable.
This doesn’t have ramifications just for mergers and acquisitions among Silicon Valley tech companies.
Today, every company is a technology company, not just those that have hardware and software as their central offering.
Consider McDonald’s. In 2019, the fast-food giant made three key acquisitions of innovative tech companies: Dynamic Yield, which offers personalization and logic technology, Apprente, known for its voice-based conversational technology, and Plexure, which creates mobile apps.
The goal was to incorporate tech from these companies to install more efficient and personalized ordering through mobile devices, self-order kiosks, and drive-thrus at McDonald’s locations.
When companies like McDonald’s make acquisitions, they want to ensure the IP they’re buying is free of encumbrances that could cost them months or even years down the line, such as code that comes from another source.
During my recent interview with veteran M&A lawyer Louis Lehot, formerly of DLA Piper and founder of his own boutique law firm, L2 Counsel, he highlighted three different ways a Buyer might get access to IP they need:
We don’t know if R&W insurance was used in these acquisitions by McDonald’s. However, in deals like this, where the technology and the intellectual property is so important, it’s a good idea for Buyers because of the many risks that might prevent it from fully making use of the IP it has acquired:
A nightmare scenario: A Buyer acquires a cutting-edge startup with the technology it needs to keep up with their competition. However, post-closing it is discovered – when a lawsuit comes their way – that a bit of critical code backing up this IP was actually from another company. The programmer was simply trying to take a shortcut, and nobody noticed.
Did each founder assign his or her IP to the company? “I’m always shocked to find the number of defective assignments of IP at formation,” says Louis. “And so that’s an easy fix, as long as the founder that contributed that IP is still around. But if you have a co-founder that was really key to the development of the IP, that formation has departed, and you have no leverage to get that person to sign in as assignment later on, that can be sticky.”
During the interview, Louis also explained that R&W insurance has revolutionized how deals are done in recent years. Not only does it provide protection but also helps create a less potentially contentious relationship between Buyers and Sellers down the road. As he put it:
“I think it’s in the interest of Buyers and Sellers to externalize the risk of breaches of reps and warranties with insurance. And it really takes the sting out of the friction of an ongoing relationship between a Buyer and the Buyer’s new employees, who are helping the Buyer monetize the IP.”
“Really, going back to those employees and dinging them for indemnification claims is really the last thing you want to be doing and the easiest way to disincentivize them and demotivate them from doing what they need to do.”
The addition of IP protection to Representations and Warranty insurance, as well as its recent price drop and availability for deals involving lower and middle market companies, has made it a game-changer in the M&A world. As a broker, I’ve been fortunate to have had years of hands-on experience with R&W coverage. I’m ready to discuss how it might benefit your next deal. You can contact me, Patrick Stroth, at pstroth@rubiconins.com.
Artificial intelligence and machine learning have radically changed the way business is done in countless industries. And the M&A world is no different.
This cutting-edge technology has the potential to cut the average time to get an M&A deal done by 66% – if not more – within the next five years.
It’s the biggest advancement going on right now in M&A, with the greatest impact felt in the due diligence process, which will be cut from three months to one month or less when AI and machine learning are used to review and analyze the data in virtual data rooms.
In this report from Datasite (formerly Merrill Corp.), The New State of M&A 2020 – 2025, M&A practitioners from around the globe were surveyed on this issue.
48% felt that due diligence could be enhanced by technology the most; so there is clear demand for its implementation.
35% said that combining that technology with virtual data rooms would help accelerate due diligence the most.
30% believed that AI and machine learning will have the most transformational impact on M&A in the next five years.
Faster due diligence means more deals getting done because this element is the most important success factor in M&A and also the most time consuming – the Datasite report notes that 66% of those surveyed felt due diligence was the most time-intensive part of an M&A deal.
AI and machine learning will make due diligence more secure, more complete, faster, and more cost-effective.
And contrary to popular belief, technology will enhance the process, not replace the people.
Software can’t replace deal-makers or those guiding investment and acquisition strategy. We will always need people to negotiate prices and terms, and we will always rely on experience and expertise. And, not even due diligence can be automated completely.
During the typical due diligence process, there are hundreds and thousands of pages of disclosures, financial statements, contracts, and other data about the target company. It’s all electronic these days, placed in various “folders.”
It’s organized. But trying to locate a specific piece of information among all those documents is very difficult and time consuming, requiring Buyers to read through pages and pages to get the data they need. Hence the usual delays to the process.
When you upload the documents to a virtual data room and have AI and machine learning software scan all of them, you now have a very effective search tool to help you pinpoint, accurately and quickly, the specific document you need to get the answers you’re looking for.
Importantly, machine learning and AI can also search documents, identifying important sections and highlighting potential risks based on parameters set by the person conducting the diligence, helping them better assess the opportunity.
It’s an appealing picture. And it must be why 65% of those surveyed by Datasite said that “new technologies should enable greater analytical capability in the due diligence process.”
As with any change in the way things are done, you might expect some resistance to the widespread adoption of using AI and machine learning to essentially create a searchable virtual data room. In fact, only 26% of M&A practitioners surveyed for the Datasite report believe this technology will help accelerate due diligence.
Some of their concerns? The financial constraints and data security and privacy issues.
But, I think that the benefits sell themselves, and more people will come around as the technology progresses and costs come down. Savvy Buyers and Sellers know that the quicker the due diligence process is over… the quicker the deal gets done.
According to the Datasite report, 56% of those in M&A believe due diligence time will be cut to a month or less in five years’ time – so there is clearly confidence this technology will progress to where it needs to be for widespread adoption by then.
And besides, with the pandemic, everybody has become more comfortable with technology like Zoom… and that will translate to being more open to tech like AI and machine learning.
It’s like when years ago, the idea of the paperless office started floating around. It was slow going at first. But once there were effective digital scanning and storage solutions, like cloud storage, and the costs came down, the paperless office became a reality.
Or, think about virtual data rooms themselves. Twenty years ago they didn’t exist. Today, you can’t do a deal without one.
Another example: Representations and Warranty (R&W) insurance.
For years, many felt it was only for big deals or too cost prohibitive. But as more insurers have started offering this product and more Buyers and Sellers are insisting on this coverage, the price has come down. Plus, deal sizes of under $20 million are now routinely accepted.
Implementing AI and machine learning into the due diligence process for your next deal may not be feasible yet. But you can still enjoy the protection of R&W insurance coverage.
As a broker with years of hands-on experience with this unique product, I’m standing by to answer your questions. You can contact me, Patrick Stroth, at pstroth@rubiconins.com.
The nature of risk in M&A deals has changed, and it’s made specialized insurance coverage more important than ever.
Data security is now, more than ever, one of the biggest concerns for those involved in M&A. And for good reason. It’s creating more risk in deals, especially those involving tech companies.
These days, businesses need to be aware of how the businesses they acquire collect data, secure data, and use data. There are several factors at play here.
Increased data privacy regulations in the European Union, known as GDPR, as well as the California Privacy Act (with similar policies sure to be put in place in other jurisdictions across the country), can put Buyers at severe risk, particularly when they acquire companies with less than effective data security.
And Buyers are taking notice.
In fact, according to Deloitte’s annual The State of the Deal: M&A Trends 2020, 70% of respondents (from Strategic Buyers and PE firms) stated that protection of data in a company they were acquiring was more of a concern than it was a year ago.
Andy Wilson, a partner in the M&A Services division of Deloitte & Touche, put it nicely:
“Data privacy can be a diligence issue. A target company may bring a cybersecurity weakness into the organization, or a transaction that involves layoffs or other workforce changes may create data security risks.
At the same time, data protection and management can be an integration issue, with a newly combined organization perhaps reaching into new geographies where regulations differ for the handling of data.”
GDPR (General Data Protection Regulation) was instituted in 2018 in the European Union and outlines strict guidelines for the collection, organization, storage, use, and destruction of personal data. Fines for violations, based on annual revenue, can run into the millions. For example, Marriott International in the U.K. was fined £99 million in July 2019 for a data breach of 339 million guest records.
Investigators believe the incident goes back to 2016, when Marriott acquired Starwood hotels group. The group had its systems compromised in 2014, but it was only discovered in 2018. Regulators faulted Marriott for not conducting proper due diligence prior to the acquisition or doing enough to secure its systems.
Elizabeth Denham, with the Information Commissioner’s Office, which administers these regulations, said this about the case:
“The GDPR makes it clear that organizations must be accountable for the personal data they hold. This can include carrying out proper due diligence when making a corporate acquisition and putting in place proper accountability measures to assess not only what personal data has been acquired, but also how it is protected.
Personal data has a real value so organizations have a legal duty to ensure its security, just like they would do with any other asset. If that doesn’t happen, we will not hesitate to take strong action when necessary to protect the rights of the public.”
As you can see, they’re taking it seriously, targeting businesses of every size in every industry. These days, every company has sensitive customer data. It’s not just tech or financial industries like banks or credit card companies that have to worry. Any business that touches the internet is vulnerable.
Plus, not only can you run afoul of regulators due to a privacy breach or data leak, but you can also introduce vulnerabilities to your own secure system by blending it with the newly acquired company’s system.
Purchase the right Cyber insurance.
Cyber Liability coverage is a must-have for virtually every M&A deal in today’s climate, due not only to regulatory penalties but also the financial damages from a data security breach. There are measures to take to protect data, of course, on the tech systems side. But hackers are ever more sophisticated and can get around even the most sophisticated protections.
The need for Cyber Liability coverage may sound obvious, but be aware that not all Cyber policies are alike. Avoid the cheaper versions that only cover data breaches. The top policies now offer coverage for malware attacks (which happen 5x more often than loss of data), electronic theft and ransomware attacks – all of which can seriously damage a company’s value if left unprotected. The difference in cost for a more comprehensive Cyber policy is negligible.
Due to the heightened exposures businesses face from cyber-related losses, most R&W policies will require a Cyber Liability policy be in place for the target company, and will impose exclusions for Cyber-related losses if no such coverage is in place.
In the case of both Cyber Liability and R&W coverage being in place, here’s how it works:
In the event of a breach, the insurance companies will let the Cyber Liability claim be paid first and then the R&W policy will cover any damages not covered. Keep in mind, the deductible on a Cyber policy is a fraction of a R&W policy retention, so Cyber provides a cost-effective first line of defense.
It’s comprehensive protection that’s very necessary today.
As a broker with extensive experience with both Cyber Liability and R&W insurance, I’d be happy to discuss coverage for your next M&A deal.
Please contact me, Patrick Stroth, at pstroth@rubiconins.com.
