Insights

Two Ways TLPE Insurance Might Cover Your Next Deal
POSTED 11.2.22 M&A

Two Ways TLPE Insurance Might Cover Your Next Deal

When it comes to acquisitions by PE firms, having Representations and Warranty insurance to cover the deal has become almost S.O.P. – it’s that common.

But not every transaction qualifies, such as those under $30M in EV, or deals where the target’s financial records weren’t complete, and the Underwriters declined to cover the deal or at least included many exclusions.

There is an alternative to traditional R&W insurance. A specialized new product that can also act as a solid alternative to “tail” policies for Directors & Officers liability coverage, also known as “naked tail” policies.

First, here’s what to do if R&W coverage is not an option.

The Lowdown on TLPE

Transaction Liability Private Enterprise (TLPE) is a Sell-Side policy where the Seller, rather than the Buyer, is the policyholder. It was designed specifically for smaller deals, under $20M… $30M, where R&W is just not a fit.

There are plenty of other advantages. For example, retention is only .5%% of EV or $10,000, whichever is higher. The Underwriting is streamlined, and the processing time is quick. And often, these policies are much cheaper.

For Buyers there advantages too. Even though this is a Sell-Side policy they are protected from a breach of Seller’s reps. Plus, with a non-disclosure add-on to their policy, they are also covered in cases of Seller fraud. On top of all that – the Seller pays for the TLPE policy.

In short, TLPE adds a layer of security and assurance for the Buyers. TLPE policies are triggered when a Buyer claims damages from the Seller. As with Buy-side R&W, once Underwriters are notified of a breach, the immediately spring into action and commence their investigation and conversations for a prompt settlement.

This is especially handy when the target’s management team is coming on board after the acquisition. With those folks on the team, the Buyer simply does not want to have to go after folks for damages. They want a smooth transition and nurture strong relationships.

As a PE guy I know said to me: “Good management teams trump great business models in almost every case.”

It should be noted that even when the owner/founders are not remaining post closing, Buyers don’t want to resort to becoming a “collection agency” pursuing the Sellers, which makes TLPE even more beneficial.

TLPE Instead of a Naked Tail

Many founders of small- and medium-sized privately help companies don’t have D&O insurance. They simply don’t see the need for an operation of their size.

Trouble is when they go to sell the business, this lack of coverage becomes a problem. Most Buyers will then compel the Seller to secure a D&O tail policy to ensure that, if there are any wrongful acts against employees or fraud committed that come to light post-closing, they are held liable.

To give the Buyer peace of mind that claimants won’t come after them for things that happened before the sale, they usually require this naked tail coverage for up to six years post-closing.

This is even the case when the Buyers have taken out a R&W policy as insurers want to protect that policy from being pulled in to cover those claims.

In many cases, I’d recommend TLPE coverage as a viable alternative to these naked tail policies.

The reasons for that, and the big difference that D&O tail policies specifically exclude claims for breach of contract, while they are covered under TLPE insurance. That’s because naked tail policies are not intended to serve as a guarantor of contracts. If there is a breach of the purchase and sale agreement, claimants with D&O tail policies have a tough time finding relief because they have to deal with this universal D&O exclusions.

Conversely, TLPE insurance was made to address breaches of the purchase and sale contract. The coverage is much broader. Plus, while D&O tail policies only provide up to $1M or $2M in limits, a TLPE policy can go significantly higher, up to $20M depending on the size of the deal.

That’s why I tell Buyers to require a TLPE policy instead of a D&O tail if the target does not have regular D&O coverage in place. I’d say most Sellers welcome TLPE, even though they have to pay for it, because of the protection it provides them and the low cost and ease of securing coverage.

The minimum cost for R&W insurance for a $5M deal is around $225,000, depending on the carrier. That does NOT include the cost of underwriting or preparing diligence. There is also the cost of having lawyers, accountants, and other experts, paid hourly, to be on two-hour due diligence calls.

But with TLPE, a $5M policy will cost around $100,000… all in. Underwriting is minimal. The process is easy and fast.

As TLPE, which is a relatively new product, becomes more well-known I expect to see it widespread use thanks to all the benefits it provides Buyers and Sellers.

If you’d like to discuss TLPE coverage in the context of naked tails or as an alternative to traditional R&W coverage for deals under $30M EV, I’d welcome filling you on the benefits of this unique new insurance product. Please contact me, Patrick Stroth, at pstroth@rubiconins.com.