Insights

Rep & Warranty — Who Pays for it?
POSTED 6.5.17 M&A

Over the last 3 years, Representation & Warranty Insurance (R&W) has been gaining interest throughout the M&A Sector. R&W is an insurance contract designed to protect buyers and sellers from financial loss that result from a breach of the seller’s representations.

I’ve spoken to numerous law firms, M&A consulting groups, CPA’s and had the privilege to serve on a dozen conference panels during this time. It never fails that I get the same 3 questions. I’ve written about the 2 most common questions previously.

The 3rd question: Who Pays for it?

My response: “It depends.”

The actual cost of an R&W policy is based largely on the amount of Policy Limits needed. The formula is a simple percentage 3% to 4% of the Policy amount.

Let’s say a Seller is considering a $100M transaction, and the Buyer wants a $20M indemnity cap.

The Seller can transfer ALL the indemnity risk to an insurer by securing a $20M Limit R&W policy (matching the indemnity cap) at a cost of 3% to 4% of that $20M Limit, or $600K to $800K.

When you consider how R&W can remove tens of millions of indemnity obligation away from the Seller, the cost is arguably negligible.

Prior to 2013, the same $20M R&W policy would cost around $2,000,000, which explains one reason R&W is becoming more popular — the cost is much lower than it was just a few years ago.

There are three scenarios I’ve seen when it comes to paying for R&W:

  1. The Buyer pays the premium because, in 90% of the cases, they are the sole beneficiary of the R&W policy.
  2. Sellers, insisting on the removal of the indemnity obligation have offered to pay the premium on behalf of the Buyer.
  3. The two parties share the cost as both are benefiting from R&W: Buyer getting certainty of collection in the event of a breach / Seller getting a clean exit.

As with every negotiation, whoever has the most leverage controls the payment terms. R&W is flexible either way and is designed to make M&A deals “get done.”

If you have a deal and wondered whether or not R&W would be a fit, let me know and I’ll make a quick, no obligation review and give you some initial terms to share with your client so you can both make an informed decision.