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.
Representations and Warranty insurance transfers all the risk in an M&A deal, including the indemnity obligation, to a third party – that’s the insurer.
It’s hard to argue against a major benefit like that. Plus, R&W coverage makes negotiations smoother and faster (and cheaper when it comes to less attorney fees) because all the nitty-gritty of a deal doesn’t have to be picked over. If there’s a breach, a claim is filed, and the insurance company pays.
Easy. It’s no wonder it is more widely available and widely used than ever before.
The perception may be that R&W coverage has gone from an obscure insurance product to something that is ubiquitous in the M&A process. And if you’re Private Equity that may be the case. PE firms are the most common repeat buyers. They’ve embraced this coverage in a big way – so much, in fact, that demand has grown exponentially.
But not everybody is totally convinced of the value of this coverage.
In the case of one Strategic Buyer I interviewed recently, while he didn’t object to R&W insurance being part of the deal, there was definite reluctance on his part. Simply because it was the first time he had used it on a deal.
This reluctance to take on R&W insurance – or at least their lack of exposure to it – on the part of Strategic Buyers is no surprise. In the past, they never really needed it. Until a few years ago, it was more of a Buyer’s market… the Buyer had more leverage, especially a Strategic Acquirer like a massive corporation buying a smaller company.
So, the Buyer didn’t have to accommodate the Seller with R&W coverage. They could impose escrow requirements and essentially be unopposed. The Seller had no recourse. In many cases, Strategics have been convinced by their attorneys that there is nothing more secure than having cold hard cash sitting in an escrow account.
Also a factor: Because Strategic Acquirers have not used this insurance before, there is a fear that it would slow the deal down or alter the process in a way that would cause a delay. They didn’t want to add this new, “foreign” element they weren’t familiar with to get in the way of what had been their smooth, well-oiled machine.
Then, things changed…
Why Strategic Buyers Are Changing Their Mind on Rep and Warranty Insurance
Strategic Buyers seemingly had plenty of reason to push R&W insurance to the side. But they can’t ignore it any longer.
It’s a Seller’s market out there right now. And Sellers, even smaller companies being acquired by vastly larger companies, now have leverage. And they’re using that power to make R&W coverage standard in M&A deals.
So Strategics have been forced to make this accommodation in increasing numbers to make quality deals to buy solid companies they want.
The good news is, the process to secure this specialized coverage, even if you’re totally new to it, is straightforward. Here are some things to keep in mind:
1. A professional Strategic Buyer, when making such a big investment as acquiring a company, is going to be doing thorough and appropriate due diligence. That’s a given.
Well, that means they’ve probably done enough due diligence to qualify for R&W insurance. You simply send the diligence over to the Underwriters. It’ll probably have to be rearranged or organized in a different way, but the diligence is there.
2. Underwriters are ready to work with Strategic Buyers, so it never hurts to look at R&W coverage to see what the options are. Underwriters will provide applicants with a quote that outlines the major policy terms before committing funds for underwriting fees. Within those indications, the Underwriters will comment on what they’re concerned about with the deal, what they call “heightened areas of risk.”
They’ll put in their quote that they’ll be looking closely at Topic A, Topic B, Topic C, etc. So, if a Strategic can respond to these topics and show their diligence in these specific areas, Underwriters will be satisfied.
This eliminates a concern had by many Strategic Buyers: that they’ll pay an underwriting fee to get R&W insurance and then there will be a lot of exclusions on the policy. But it’s not true. You can go in with eyes wide open and get all the details before you spend a dollar.
3. Working with an experienced broker who knows M&A and Rep and Warranty coverage is key. A broker can convey information back and forth between the Buyer and the Underwriter. A broker knows what information is needed. They can manage expectations, provide reasonable timelines, be diligent in following up to make sure the proper due diligence and documentation – in the proper format – is flowing to the Underwriters.
Not just any broker will do. Some less experienced brokers have a tendency to be reluctant to ask a client for more documentation when requested by the Underwriter. They don’t want to be a bother or have the client ask why they didn’t request the document at the beginning of the process.
But the truth is, and an experienced broker knows this, that sometimes, in the course of the underwriting process, there are questions that come up that must be satisfied. An experienced broker can head that off somewhat because they’ll have identified those areas of heightened areas of concern and addressed those with the Buyer upfront.
Where to Go From Here
With the right help, the process to underwrite a R&W policy have this coverage in place in an M&A deal is actually quite easy. That’s even for a Strategic Buyer that has never used this insurance before.
If you’re engaged with accounting firms and law firms experienced in this area, along with an experienced broker who can work with Buyer and Underwriters alike to shepherd the policy from application to closing day, it can be a frictionless process.
And having that coverage means that between Buyer and Seller all the most sensitive issues of a deal – indemnity, escrow, etc. – are now non-issues.
Soon enough, I expect more Strategic Buyers to happily embrace R&W coverage and become converts. All it takes is facing the unknown and going through the process once.
My firm has extensive experience in Representations and Warranty insurance. If you’re looking at this coverage for the first time, or are already an enthusiastic user, you can contact me, Patrick Stroth to chat about your next deal. You can reach me at pstroth@rubiconins.com.
If you thought M&A activity would slow in 2022 after the record year in 2021…think again.
Market watchers see current levels continuing through at least the first half of next year. As you know, an increase in M&A activity equals more demand for R&W insurance.
And that means you should expect to see many of the same trends driving the use of Representations & Warranty (R&W) and other M&A-related coverage continue as well—if not become even more widespread.
Here’s a breakdown of what you should be looking out for in the coming year:
1. The “extra” frees being charged on smaller deals are creeping into all
For a while now, many insurance brokers have been quietly adding fees onto what are considered small deals (under $50M TV). They typically add fees when they don’t charge commission. Now they are trying to do so on all the deals they cover.
Premium ranges that used to be standard at 2.5% to 3% of the amount of the policy, so $250,000 to $300,000 for a $10M policy, are now at or above 5%.
There could be some pushback on this from policyholders as premiums go up. However, many brokers will still be able to “sneak in” fees like this because the overall cost of an M&A transaction is expensive and those fees can get lost in the shuffle, so to speak.
This is fair warning to keep an eye out.
2. Increased scarcity for a home for sub-$50M TV deals.
As I wrote in my article, “Limited Bandwidth for R&W Insurance in 2021”, there are fewer and fewer Underwriters who want to work on deals under $50M in Transaction Value. Simply because there are so many deals above $500M+ out there. With limited time and resources, insurers, of course, will focus on those deals generating higher revenues..
As Woodruff Sawyer put it in their Private Equity and M&A Looking Ahead to 2022 report:
“We expect RWI options for deals less than $50 million in enterprise value to be scarce leading into the end of the year. As bandwidth reaches capacity, underwriters will pick and choose only deals they deem highly profitable to pursue. We believe there will be limited to no capacity for small deals or deals with financial issues or a lack of underwriting.”
But if you don’t hit that desirable threshold, all hope is not lost.
What you need is a clean deal and solid due diligence. With a simple package like this that Underwriters could process quickly, there could be a receptive audience. You should also find a smaller, boutique firm that specializes in smaller deals and will give you their full attention.
With an approach like this coverage is scarce but not impossible.
Why would Underwriters turn away business from smaller deals?
If the due diligence is lacking, that leads to unanswered questions. As a result, Underwriters have to put exclusions in the policy or limit the coverage. And they don’t like to do that because it makes them look like the “bad guys”—they get the blame when policyholders get upset.
This type of situation often happens because the insurance broker did not adequately manage expectations.
Sometimes, Underwriters just need clarification in these types of cases where they might otherwise decline to cover a deal.
For example, in the case of one company that was buying a film and TV library. The Buyer had not done extensive diligence on who owned all that content, which made the Underwriters very nervous. They were expecting thorough legal diligence on the intellectual property.
Then the Buyer made several good points. Since they were simply distributors, they were not subject to intellectual property infringement laws —those who produced and planned the use of the content would be on the hook. And not only were they not exposed in that way, but all their contracts had indemnification language, so they were further insulated from IP complaints. On top of that, they had insurance to respond to IP related issues.
That was shared with the Underwriters and the rest of the underwriting process went smoothly, was completed ahead of schedule and with no limitation on IP.
It’s the perfect illustration of how packaging makes all the difference.
3. Rates will continue to be high well into Q1 2022…and beyond
Premium rates went up from 2020 to 2021…and I see them continuing to rise into 2022, at least into the first half of the year. Demand for R&W insurance is just too high to compel a decrease. And, as I said at the beginning M&A activity is on a tear and will continue.
4. Watch out for the impact of the shake-up at R&W insurers.
R&W insurance companies have an Underwriter problem. First, new insurers are entering this lucrative market and poaching whole teams of Underwriters from established carriers. This interruption in talent and staff could slow down processing.
Also, in some cases one of the larger national brokers is losing experienced brokers, and executives in the wake of a failed merger which would have made them redundant. They’ve seen the writing on the wall and decided to leave and start their own firms, including some Underwriters who want to get in on the brokerage side.
They have the contacts. They have repeat clients they can bring over. It’s the perfect opportunity.
5. Expect increased scrutiny from Underwriters with regard to insurance that the target is carrying and cybersecurity.
R&W insurers and Underwriters are looking to pull other policies in to recover losses to be paid in the event of a breach. The thinking being those losses are actually insured by a company’s traditional commercial insurance policies.
There is also a focus on cybersecurity. Underwriters want to see that companies have adequate IT and cybersecurity measure in place to protect data.
As Woodruff Sawyer puts it on their report: “If a deal team does not perform diligence in these key areas, they should expect additional questions and/or exclusionary language related to things like Management Liability, Cyber Liability, and Professional/E&O Liability.”
6. Claims are steady.
More R&W insurance claims are being paid these days. But it stands to reason as more claims are being reported…because there are more policies out there. No big concern here. “Roughly 20% of policies result in claims, and about 25% of submitted claims result in a limit loss,” as they mention in the Woodruff Sawyer report, and that is a similar rate to 2020.
The rate of claims being paid has not changed.
7. Expect more deals with no indemnity.
There is an interesting phenomenon that has been occurring.
The accepted wisdom in M&A Insurance circles for a long time was that R&W policies with no Seller indemnity would be more risky and have more claims. As a result, Underwriters used to favor deals where the Seller indemnity clause was present, and deductible was shared by the parties. They wanted to see both sides have “skin in the game.”
However, in practice this has not been the case. There is no discernible difference between the two types of deals. So, expect to see more deals be covered with no indemnity needed.
Here’s how it used to be:
In the Purchase and Sale Agreement there would be an indemnification clause that the Seller must pay the Buyer’s loss if there was a breach. If there was a R&W policy in place, the policy stepped into the Seller’s shoes to take care of that and pay the loss. Although the Seller would still be on the hook for at least a share of the deductible.
Today, however, now Sellers want no indemnity and negotiate that the reps and warranties do not survive past closing. They want to sell “as is” – kind of like a used car. To be clear, in these types of “as is/non-indemnity agreement”, the Seller is liable to the Buyer for nothing…ever…nothing is held back. However, the risk is hedged for the Buyer because they have R&W insurance in place.
8. Concern about COVID is waning.
As the pandemic winds down, insurers are less concerned about pandemic-related claims. Although they will continue to ask about COVID in their diligence process.
9. Prices for targets are not going down.
From attendees of a recent McGuire Woods Independent Sponsor Conference, the word is that prices for targets are not going down any time soon—despite any pandemic effects. Many vulnerable companies pulled themselves off the market. And they are strengthening. The multiples and competition for these targets is going up, not down. So, if you’re waiting for a dip in evaluations…it’s not happening.
It’s clear that it’s going to be an interesting year in 2022. And I’m happy to help with your M&A insurance needs.
You can contact me Patrick Stroth, at pstroth@rubiconins.com.
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.”
