The typical M&A deal can be a long, drawn-out process – and painful, too. Negotiations on the Purchase and Sale Agreement can stretch out for months – or longer – as lawyers haggle over terms and contract language. And Sellers are often dismayed by how much money is held in escrow at closing to cover indemnity.
There’s a way to make those problems go away: Representations and Warranty (R&W) insurance. This specialized type of insurance transfers risk in case of breach of the Seller’s reps to a third party – an insurance company. That means less money in escrow (which makes Sellers and their investors happy) and a quick remedy if a problem pops up post-closing because the Buyer simply files a claim with the insurance company. No legal action is needed.
The use of R&W insurance has risen in recent years, with a 240% jump in policies written from 2001 to 2015.
But even though it’s been around for years, many in the M&A world aren’t familiar with R&W, have some serious misconceptions about it, or haven’t kept up with the latest developments that make it more affordable and accessible to more deal sizes and types than ever before.
So, let’s clear the air.
In most cases, especially in Silicon Valley, M&A transactions can benefit from R&W insurance in several ways. One of the big benefits (shared with me by a San Francisco based investment bank): with this coverage in place, a deal is EIGHT times more likely to successfully close.
R&W insurance has never been more affordable. There are a few elements at play here:
Premiums are currently running 2.5% to 3.5% of the Policy Limit (i.e. a $10M Limit policy will run between $250K and $350K). As recently as 2011, the rate was 10% of Limit. So as you can see the price of R&W coverage has dropped significantly.
The minimum premium for R&W is $250K, so if you need R&W, a $10M Limit policy is about as low as you can go.
I’m often asked about smaller policies. The fact is that you can get a $5M Limit R&W, but it will simply cost the same as a $10M policy due to the minimum premium threshold.
It’s essential to note when discussing cost, to be sure and add in the Underwriting fee ($25K – $50K depending on the complexity of the deal).
The policy taxes (3% to 7% of the premium) which are determined by the Buyer’s state of domicile.
It’s worth mentioning that when R&W coverage is in place, deals are smoother and faster, with less negotiation needed between the Buyer’s and Seller’s legal team. A good rule of thumb is you can save 10% on attorney’s fees.
Securing an R&W policy is hassle-free and quick as long as you have your ducks in a row. As with any insurance, Underwriters don’t want to take on unnecessary risk.
Provided there is a draft Purchase and Sale Agreement (PSA) and audited or reviewed financials for them to review, Underwriters can issue a non-binding indication in a day or two.
If the client wants to move forward, following payment of the Underwriting fee, it routinely takes about two weeks to review and complete a formal R&W policy placement.
It’s important to understand this is not an adversarial process; it’s more a collaboration. And the quicker a policyholder provides documentation or clarifies any details requested by the Underwriters, the quicker the policy is written.
The underwriting process is well-defined and runs smoothly as long as the Underwriters have the data and documents they need.
1. Underwriters review the draft PSA, financials and CIM (if available) and provide a non-binding indication within 48-72 hours.
2. Following payment of an underwriting fee, Underwriters will access the data room and also reach out to the Buyer’s deal team.
3. A conference call is scheduled with the Buyer’s deal team within a week of commencement of the Underwriting process. Insurers will generally provide a list of questions that will be asked. Generally, they’ll want to speak with the CEO and CFO, as well as the CIO or CTO – if the company has those positions.
4. Formal proposal for R&W coverage is issued within two or three days of the conference call. If there are any outstanding supporting documents needed, those are listed as conditions of the policy taking effect.
5. R&W policy is ready for issuance upon signing/closing.
It’s essential that at every point in this process, the policyholder is responsive to any requests from the Underwriters in order to not cause any delays.
We’ve seen the Seller pay the costs. We’ve seen Buyers cover the costs. As with many business deals, who covers the costs depends on which party has the most leverage in the deal. But, most often the costs are split evenly between the two.
In many cases, Sellers are happy to pay for a Buyer Side policy because much less of their money is held in escrow and their liability is reduced.
It wasn’t too long ago that only deals valued at $100M to $1.5B were considered eligible for R&W insurance. But that benchmark has dropped steadily in recent years.
In general, today we see transaction thresholds falling within a $40M – $800M range as the best “fit” for R&W policies.
While there are Underwriters willing to insure deals with a $25M transaction value, our rule of thumb is that R&W insurance makes sense where deals carry a $10M or greater indemnity cap.
There’s really no cost benefit in purchasing anything smaller than a $10M limit R&W policy as it would be subject to the $250K minimum premium.
R&W is completely different from commercial insurance, so this is not the scenario where a company reaches out to their business insurance representative.
M&A parties and their advisers should seek insurance brokers that not only specialize in R&W but have done so for an extended period to have developed the relationships necessary with multiple R&W Underwriters. The significance of the transaction to be insured should not be left to a “beginner.”
The most experienced R&W brokers come from national firms such as Marsh & McLennan and Aon. But it’s often not the best choice to go with the biggest companies.
They have resources and experience to handle $1B+ deals. Anything less is simply not a priority for the national firms. Your policy could be subject to delays.
So, deals less than $1B are best handled by regional boutique firms such as Rubicon M&A Insurance Services in Silicon Valley. Boutique firms provide all the expertise of the national firms while delivering unmatched response and execution for the sub-$1B transactions.
R&W is unlike any other insurance product, covering a very specific set of exposures (Seller Reps and Warranties outlined in the Purchase and Sale Agreement), all of which have been subject to diligence.
Given this scenario, there are very few claims that end up triggering the R&W policy, making R&W wildly profitable for insurers. This is actually a benefit to policyholders.
The worst thing for insurers would be the perception that R&W insurers are reluctant to pay losses. Therefore, they bend over backward to make sure that policyholders’ claims are immediately handled and paid. Nowhere else do policyholders hold such leverage over insurers than with R&W.
The earlier the issue of R&W is addressed, the easier it is to incorporate it into a deal. And the sooner it can help smooth negotiations and get you to closing that much faster.
Ideally, R&W should be discussed at the Letter of Intent stage. Preliminary coverage terms can be prepared at no cost at this stage. And, if R&W isn’t a fit, it can be removed without interrupting the process, so there’s really nothing to lose.
It’s clear that R&W insurance offers many advantages to both Buyers and Sellers in M&A. Costs are minimal. And the process is painless to secure a policy. To explore to see if Representations and Warranty insurance is right for your upcoming deal – and to get answers to your specific and detailed questions, contact me, Patrick Stroth of Rubicon Insurance Services. We’re located in the heart of Silicon Valley. You can reach me here: firstname.lastname@example.org or (650) 931-2321.