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.
When evaluating a target company for acquisition, the Buyer conducts a thorough check of financials, IP, tax obligations, contracts, customer lists, and other key aspects of the business.
That’s due diligence.
But to make an informed decision on whether or not to move forward and close the deal, there’s another aspect of diligence that I recommend…that some don’t seriously many do not consider – insurance diligence.
You get some insights on the mindset of management and the caliber of operations from the amount of insurance and the quality of that coverage they have in place.
Also, digging deeper, if they have had a lot of insurance claims, that could provide a red flag or at least insight on a problem area in either operations, management, or even both. Every insurance policy can deliver an up-to-date report on any claims that have been reported and the amounts that were paid. That’s called the loss run report, which is available for each respective policy.
Having that information in your back pocket can be helpful in deal-making when asking a target company about private litigation. They could dismiss a claim that was paid by their insurer and maintain the issue in question was not a big deal. They say they just gave it to the insurance company to take care of.
But when you are looking at the loss history and that the insurance paid a multi-million-dollar settlement …it shows you it actually was a pretty big deal. It provides unique insight into the management of the company and how they handle issues.
When first conducting insurance diligence, you’ll first discover how a target is insured and what specific policies are in place, whether it be Directors and Officers, IP Infringement Defense, General Liability, Product Liability, Property Insurance, Professional Liability, or some other type.
When looking at what coverage lines are in place, you also have to check to make sure the coverage is adequate or appropriate for the risk out there. For example, is it a $100M revenue company with a $500,000 limit policy? Not good.
You should also look for other potential gaps. You might be surprised that many technology companies do not carry Cyber Security & Privacy insurance. It’s counterintuitive, but it happens a lot. So don’t that for granted.
Likewise, many management teams do not carry D&O insurance because they are privately held and it’s not required. But even small companies should have D&O coverage in place as it is so important to protect the personal assets of the directors and officers (not to mention their spouses and estates) if they are personally sued for actual or alleged wrongful acts they’ve committed in managing the company.
Who Are They Insured With?
After examining the types of insurance and coverage levels the target company has, you should consider the quality of the insurance companies they are doing business with. They are not all created equal, by any means.
Are they financially solid, secure brand-name insurance companies with good reputations?
Or did the target try to go the cheap route and pick whatever company quoted them the lowest premiums?
It is very common that start-ups will get very small policies at the lowest cost possible in the beginning but then forget to scale up their protection as they grow over time. Also, insurance companies used by start-ups are entry-level carriers, which is why they are so cheap.
While appropriate at the start-up phase, these insurers aren’t equipped or qualified to handle larger policyholders.
Again, this is all too common. In their rush to grow, these start-up companies don’t make sure that insurance keeps up with where they are at the moment. Insurance needs can change quickly and can’t be left out.
Other Types of Insurance
The insurance in the target company you should be examining is not only that which covers the company and its management team, or the property and casualty coverage for the assets of the business.
If they have personnel, there is the health plan, benefit plan… any of those types of lines need to be considered, particularly when planning the transition. The last thing you want to do is cancel the employees’ health insurance.
Where to Go From Here
A huge benefit to this process, besides gaining insight into management and operations, is that the insurance diligence report can also provide advice on how to transition the target company’s insurance exposures into the Buyer’s existing program…or, if it makes sense, to create a new standalone program for the new company.
The bottom-line is in the overall world of due diligence don’t forget to do specific diligence on the potential acquisition’s insurance coverage.
This insurance diligence process does take time. But it’s well worth it.
A lot of attorneys look this information over. But you can fast-track the process if you work with a reputable commercial insurance broker who is familiar with all these lines of coverage, not just management liability and property casualty but also benefits plans.
Brokers provide this service on a fee-basis. But many brokers can waive the fee if they have an opportunity to either place coverage on a go-forward basis or participate in M&A transactional coverage.
My firm, Rubicon M&A Insurance Services, a member of the Liberty Company Insurance Brokers network of companies, can provide such services. Just get in touch with me, Patrick Stroth, for more details: pstroth@rubiconins.com.
Liberty Company Insurance Brokers is pleased to announce the acquisition of Rubicon M&A Insurance Services, LLC to its national network of specialty insurance brokerages. Rubicon is led by its founder Patrick Q. Stroth, ARM, a trusted authority in executive liability for over 30 years.
Given that there was unprecedented demand for M&A insurance in 2021, with all signs pointing to a continuation of this growth in 2022, this is a natural move that will allow Liberty direct access to this market.
Not only that, but this acquisition makes Liberty the only national broker network with a specific focus on micromarket M&A transactions, those that are sub $10M in transaction value. This is the fastest-growing segment of M&A.
Patrick, who written extensively on Transaction Liability and hosts the M&A Masters Podcast, brings his decades of experience and knowledge to lead Liberty’s new Transactional Liability practice.
“I consider M&A to be the most exciting event in business,” says Patrick, “One that has the ability to create life changing, even generational impacts for owners, founders, and their families. I’m thrilled to have the opportunity to move Rubicon’s M&A practice onto a national platform which can scale to meet the ever-increasing demand for owners, founders, and their investors to secure a ‘clean exit.’”
According to Liberty CEO, Jerry Pickett. “We recognized the emergence of Transaction Liability as an essential coverage need for any Commercial Insurance Broker. With the addition of Patrick and Rubicon M&A Insurance Services, LLC, Liberty Company Insurance Brokers immediately becomes a leading source of M&A insurance expertise and solutions.”
We’re well into the second half of 2021 now…and Representations and Warranty insurance is more popular than ever. Given the protection it provides both Buyers and Sellers in an M&A deal that should be a good thing.
However, that popularity, based on the trust both sides of the table have placed on this coverage, has also brought about an unintended consequence that has resulted in PE firms and Strategic Buyers scrambling to get their deals covered.
Here’s the deal: insurance companies are declining to cover otherwise great risks due to bandwidth. In other words, they don’t have the teams of Underwriters they need to research and understand the deals and then determine coverage and terms for all those parties wanting coverage.
As a result, if your deal is under $400M in transaction value (TV), you can’t go to one of the major nationwide insurance brokers. They’re just stretched thin and are concentrating on the deals that will bring in the most substantial fees. They’re no longer looking at $100M or even $200M deals.
So, at this point, if you come under that threshold and are interested in R&W insurance, you must find a boutique firm to secure your coverage.
Why is this happening… and why now?
There are a few factors:
More M&A activity = more demand for R&W insurance.
Who Is Behind This Trend?
M&A activity is at record levels right now, across the board. Driving demand are:
3 Steps to Take Now in Light of This Trend
Despite these trends, all hope is not lost to secure R&W coverage this year, even if you’re deal is under $400M in TV. But you do have act quickly and put in some extra effort to make an insured deal happen. (And you should still prepare yourself for waiting until 2022.)
Here’s what you should do now:
1. Line up all your diligence experts right now, e.g. lawyers and accountants.
R&W policies right now are being placed on $400M TV deals and up. If your deal is smaller than that, look for boutique broker. Go to solid, experienced regional boutique firms in law, accounting, and insurance to get response you need. If you need a Quality of Earnings report, the big 5 nationwide accounting firms won’t touch you at this point.
Contact these smaller firms and get on their calendar now.
2. Engage with an experienced, boutique regional R&W insurance broker now. The sooner you get your engagement lined up, the better, even if you are at the Letter of Intent stage.
In both cases you want to avoid the backlog at bigger, national/international players.
3. Expect and plan for increases in diligence costs, insurance costs, and R&W premiums. The sooner you act, the better as costs continue to rise. It’s simple supply and demand.
To give you an idea, the total cost for a $5M Limit R&W policy was under $200,000, now it’s running $225,000 to $240,000.
But also remember that the protection and peace of mind these policies offer is well worth even the increased costs… and all things considered this coverage is cheap.
As you can see, there is real urgency here.
If you’ve got a deal in the pipeline and are thinking of using R&W insurance to cover it, we should talk now so I can help guide you through the process.
You can contact me Patrick Stroth, at pstroth@rubiconins.com.
An innovative new product, very similar to Representations and Warranty (R&W) insurance, is available now and will provide coverage for small, or “micro,” M&A deals.
Transaction Liability Private Enterprise (TLPE) insurance is available for deals with a Transaction Value of $250,000 to $10M.
London-based insurer CFC Underwriting is the company behind this innovative new insurance product, and with 230,000 deals in that range of TV, they decided to go after this underserved market.
While similar to more traditional R&W insurance, TLPE coverage differs in key ways, and not just in that R&W is intended for much larger deals.
One of the most noteworthy differences is that TLPE policies are sell-side only, which means they are triggered only when the Buyer brings a claim against the Seller because of a loss caused by a breach of the Seller representations in the Purchase and Sale Agreement.
Also, deals can be insured for up to 100% of enterprise value.
This is a very new product. Not many people have heard of it. But it definitely reaches an underserved market, and many Buyers and Sellers involved in micro-deals will get a lot of value out of it.
(If you haven’t already, I’d recommend you read my first article on TLPE insurance to get more of the basics about this unique coverage.)
Why Is TLPE Insurance a Good Idea?
Securing TLPE coverage is a no-brainer if you’re involved in a deal under $10M. TLPE insurance is new, it’s just launched. It’s meeting a big need out there.
And while this may be controversial… I’d say it’s as good as R&W coverage, if not better in some cases.
It’s better for Sellers, that’s for sure. Here’s why:
1, Availability
In professional sports, the greatest “ability” is “availability”. You may be the best athlete, but if you don’t show up on game day, your talents are useless to your team.
By the same token, R&W insurance is an invaluable tool. But it’s simply not available at any cost to the lower middle market transactions.
2. The Cost
The cost of a sell-side TLPE policy is less than a similar sized R&W policy, by as much as one-third. There are several reasons for this.
3. No Underwriting Fee
In addition to lower premiums, there is no underwriting fee for TLPE. These policies are underwritten by the Seller completing an application (just like any other insurance policy). Underwriters then use that application as a basis for evaluating risk. This method reduces the overall cost for the program by $35,000 to $50,000 per deal.
4. The Deductible Is Less
To further reduce costs, the retention, or deductible, for TLPE policies is significantly less than a traditional R&W policy. TLPE will feature deductibles as low as $10,000, all the way up to $100,000 for a $10M limit – that’s 1%. Compare that to R&W with a minimum retention of $250,000 to $300,000.
5. Lower Escrows and More Cash at Closing
The lower deductible enables Sellers to negotiate lower escrows, or withholds, with Buyers. This further increases the amount of cash Sellers get at closing.
6. Sellers Are Not Beholden to Buyers
With TLPE insurance, Sellers are not forced to ask permission of Buyers for protection from breaches of Reps and Warranties. In a traditional R&W policy, no matter how much the Seller wants it or thinks they need it for peace of mind, if the Buyer doesn’t agree to include coverage in the deal, it doesn’t happen.
The alternative in the past was a traditional sell-side R&W policy. However, the Underwriters on sell-side policies in these cases would not be able to rely on an application as they do with TLPE.
In fact, they would conduct even more stringent due diligence. This costs more and can even limit coverage because Underwriters are not equipped to underwrite R&W on that side. (In buy-side policies, they rely on the Buyer’s diligence.)
Sellers don’t need the Buyer’s input at all for underwriting a TLPE policy as everything hinges on the Seller’s input, not the Buyer’s. Seller’s seeking peace of mind can acquire it entirely independent of an uncooperative buyer.
7. The Short Timeframe
The underwriting time in TLPE is in most cases a matter of days, definitely less than a week. Compare this to the minimum timetable for traditional R&W insurance underwriting of two to three weeks from beginning to end.
8. Peace of Mind
The Seller has control of policy placement and coverage terms, which means they feel better knowing that whatever proceeds they’re supposed to get from the transaction… they are going to keep.
9. Legal Defense Costs Covered
A sell-side TLPE policy provides legal defense to help the Seller against Buyer claims. The lawyer for the policyholder (Seller), who will protect them and try to negotiate a lower settlement, is at the cost of the insurer, not the Seller. It’s built into the policy.
With traditional R&W insurance, even if there is a claim brought by the Buyer, the Seller would have to engage an attorney to respond to make sure they aren’t taken advantage of. In fact, the Seller usually isn’t involved – the Buyer is taking action against the insurer to get their claim paid.
But if the Seller has a $1M to $3M escrow they still need their own attorney for that piece of it.
Where to Go Next
If you have an upcoming deal under $10M, it’s clear that if you’re the Seller, TLPE is a must-have.
If R&W is Wall Street, then TLPE is Main Street. Insurers in this space want to insure mom & pop retail stores, franchise restaurants, small tech companies, or maybe a small manufacturer.
The cost is super low thanks to the three ways TLPE saves you money (lower deductible, no underwriting fee, more cash at closing), the process is quick and easy, and this new type of insurance offers a lot of protection to make sure you take home the proceeds you deserve from your sale.
All this being said, there is a key similarity between TLPE and R&W coverage:
The claims paying ability is no different between the two. You can count on great claims services with TLPE, just as you’ve heard about R&W.
I’m happy to speak with you about both TLPE and R&W insurance, whichever is most appropriate for your deal. It is important to work with a broker experienced in TLPE insurance when trying to secure this coverage as there are key conditions and limitations.
And one last thing about TLPE:
10. TLPE Policies Can Be Placed Post-Closing
This means if you did not get protection for a previous deal, and it is in that $250,000 to $10M range, it can actually be revisited if you’re interested.
To get more details on how TLPE might fit your specific deal, be sure to contact me, Patrick Stroth, at pstroth@rubiconins.com.
