Insights

The Biggest Impact of TLPE Insurance
POSTED 5.19.22 M&A

The Biggest Impact of TLPE Insurance
Transactions—the major decisions in the life of a business—impact both Sellers and Buyers.

In a standard transaction, a Buyer will request that money from the purchase price be held in escrow. While I’ll admit there is a strong argument justifying these requests, there are viable alternatives.

Why do Buyers Want Holdbacks?
Often, there’s not enough data available for both parties to reach an adequate level of certainty when it comes to risk, so Buyers use escrows/holdbacks as a hedge. This way, the Buyer can immediately respond to a breach, if one occurs, and they’re holding some cash from the sale.

The amount held back is usually 10% of the purchase price. This may be reasonable to the Buyer, but it can be quite significant for Sellers of small companies looking for an exit.

Recently, Representations & Warranty insurance has emerged as the most significant risk transfer solution. With this coverage, if there is a breach of the Seller reps, the Buyer can recover any losses without going after the Seller. The Buyer simply makes a claim with the insurer.

R&W coverage is easy to purchase, claims are paid, and it works. Thus, it has become increasingly popular in the M&A world.

The Wrinkle in R&W Insurance
There is a wrinkle, however, because R&W isn’t readily available for sub- $20M EV deals.

But there is a solution:

Transaction Liability Private Enterprise Insurance (TLPE).
Unlike traditional R&W insurance, TLPE is a sell-side policy where the Seller, rather than the Buyer, is the policyholder. The policy is designed trigger when the Buyer makes a claim against the Seller. Instead of going after the Seller directly, the Buyer simply collects from the insurer. Easy.

Think of TLPE as a simplified version of R&W coverage that can be placed in days rather than weeks at a fraction of the cost.

Sellers benefit from this insurance as well, and we’ve seen the results first-hand. The lesson we’re learning after 10 months of small business placements is that TLPE is effectively reducing escrow levels from 10% to 1% of the purchase price. (TLPE is only 1% of EV or $10,000 whichever is higher.)

Some examples from recent deals include:

  • $1.4M apparel wholesaler had their escrow fall from $140,000 to $14,000.
  • $6M consumer product manufacturer had his escrow fall from $600,000 to $60,000.
  • $11M SaaS company’s escrow fell from $1.1M to $110,000.

I regularly hear from M&A professionals who say that R&W coverage, including TLPE policies, removes a significant amount of stress from the process.

One big reason may be that Sellers are closing with significantly more money in their pockets at no cost to the Buyer. That’s a nice goodwill gesture, to be sure.

If you’re looking to reduce risk when you sell for less than $20M EV and increase your closing payment, TLPE is the best way forward.

Please contact Patrick Stroth, for more information at pstroth@rubiconins.com.