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:
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.