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 firstname.lastname@example.org.