Up until very recently, rep and warranty insurance, which offers many advantages to buyers and sellers during mergers and acquisitions, has been available primarily with deals worth $50 million or more.
But good news for those involved in smaller deals.
Now, more and more insurance companies – both established brands and ambitious newcomers to the industry – are offering a suite of rep and warranty insurance products to cover deals as low as $30 million… even $20 million.
Insurance companies have had much success operating at the higher-level transactions, and that’s attracted new carriers to jump on the bandwagon.
Three years ago, there were only five companies offering rep and warranty coverage. At the time of this writing, the number stands at 22.
With insurance premium pricing and normal escrow requirements, it’s unlikely that coverage will be offered in the future for deals smaller than $20 million.
But still, this change in the industry opens up the protection of this type of coverage to much smaller businesses. What the industry calls the lower and middle market.
Why the change?
With the rise in popularity of this insurance, and the ability to write much smaller policies, a new market has risen to meet demand. This type of insurance was created in 1999 and has steadily grown since.
The number of policies written around the world jumped 240% from 2001 to 2015, with 40% of the policies in North America.
Rep and warranty coverage gives both parties involved in the sale of a business many benefits. It is designed to protect the parties in an M&A transaction from financial loss resulting from a breach of the Sellers’ representations and warranties outlined in the purchase and sale agreement.
It reduces the buyer’s risk, allows the seller to leave much less in escrow (they get to keep 6% to 9% more of the purchase price at closing) and avoid paying indemnification claims after the deal closes (unless there is a clear case of fraud) – the insurance company pays.
Essentially it transfers the Sellers’ indemnity obligation to a third party – the insurer. Buyers like it because they have certainty of recovery in the event of a breach. Sellers LOVE it because it gives them a clean exit from their deal.
As a result, this smooths out the negotiation process and brings the deal to closing much sooner and with less hassle. In fact, deals with rep and warranty coverage in place are EIGHT times more likely to successfully close.
Rep and warranty coverage is affordable, with premiums running from 2% to 4% of the limit of liability, with an absolute minimum of $150,000.
For a $10 million policy, that would be between $200,000 and $400,000. And it’s easy to obtain – once you’ve contacted an insurance company, the policy can typically be back from underwriters in less than two weeks.
If you’re set to buy or sell a business, you’d be well served in using rep and warranty insurance to cover the deal.
As with any “bubble,” you have to be cautious with the insurance company you work with when seeking out rep and warranty coverage for your business acquisition. These new companies are attracted by the chance to get in on this lucrative market.
But some could be inexperienced. Others try to make a splash when they first enter the market and offer very low rates and then don’t have enough revenue to pay claims that come up later. As a result, they have to shut down after 18 months.
If a company has to write 50 policies to pay one claim – that’s not good.
So, if you’re looking for rep and warranty coverage for a deal of any size, it pays to proceed with caution.
But never fear. There are plenty of reputable companies new to this market offering coverage for deals as low as $20 million, among them start-ups, as well as new divisions of established brands.
Based on my experience as a broker, I’ve personally identified insurance companies of all sizes who offer quality – and safe – coverage.
When you work with companies like AIG, Concord Specialty, and The Hartford to get your rep and warranty coverage, there are clear advantages.
New companies aren’t automatically a risky proposition.
Many are very nimble and able to offer better service – and terms – than the larger companies.
Smaller operations are often much more in tune with smaller business acquisitions and better than some bigger brands that can’t accommodate small deals.
They want to be where the bigger brands are not and aren’t a big monolithic entity – they offer more personalized service.
So how do these upstart smaller companies, without the deep pockets of a big-time player like Hartford, Zurich, or AIG, make it work?
Many partner with Lloyd’s of London or other larger insurers, which puts up the money, so to speak, and offers the financial security. And they draw from the experience of their bigger rivals by recruiting the rising stars and in some cases, entire underwriting teams from those very established players.
The new company is granted the ability to do the underwriting, negotiate terms, and oversee the actual implementation of the policy – the “binding” of insurance capacity.
It basically combines the best of both worlds – you get the service and attention of a smaller company with the backing of a major insurance carrier.
With the availability of rep and warranty insurance for deals starting at $20 million, more buyers and sellers than ever can take advantage of its protections that come with transferring risk to an insurer.
It’s low-cost, makes negotiations much easier and faster, and makes it more likely that an M&A deal will go through.
If you’re selling your business or looking at buying one – and the deal meets that $20 million threshold – you should take a very close look at getting a rep and warranty policy.