ICYMI: Using Reps and Warranty Insurance to Close the Deal

In case you missed our Exit Planning Institute Chapter meeting this month we’re dropping this recap below.  Great meeting with a ton of valuable content for both those in the “deal world” as well as those considering acquiring / divesting. 

This month we focused on reps & warranties insurance (also referred to as “transactional risk insurance”) and what role it plays in M&A deals. The goal for this meeting was to ensure that our attendees left feeling as though they could speak knowledgeably about the product by answering these three questions:

  1. What is it reps and warranty insurance?
  2. How can I evaluate whether it makes sense for a particular client or a transaction?
  3. How does it work?

What is reps and warranty insurance?

To answer the first question, we addressed exactly what transactional risk insurance is and why you should never leave it as an afterthought while deep into a transaction. To give you a simple definition:

“Created to facilitate M&A transactions by addressing indemnification issues that arise during the negotiation of the transaction or during due diligence that may prevent the deal from signing.”

R&W insurance is fundamentally a risk transfer mechanism designed to move risk away from the parties and to an insurance company.  Of course insurance companies are risk averse by nature, heightening the need for thorough due diligence and ensure that your transaction goes as smooth as possible. This can be a challenge however, as sellers and buyers typically face competing goals: speed to closing vs. surety on diligence items. Knowing how reps & warranties will work for both sides of the transaction arms you with the knowledge to be able to evaluate if they’re needed in your given situation (whether it be for a client or a transaction).

When is it appropriate?

In order to be able to evaluate accurately, there are a number of benefits to both the buyer and the seller when it comes to reps & warranties insurance that you must consider as well. To name a few:

For the seller:

  • Limits the exposure for unknown risks that would otherwise trigger indemnity obligation (for breach of reps)
  • Predictability for sellers as to how much money they’ll walk away within a sale
  • Quicker and less expensive negotiation of deal terms

For the buyer:

  • Competitive advantage for the buyer
  • Leads to a speedier transaction
  • Leads to a less costly transaction

Deal size is also a consideration.  Most deals employing R&W insurance are in the $50M + range, with Marsh indicating their median deal size to be approximately $80M last year.  That said, deal sizes (and pricing) are coming down as the product gains further adoption.

Ok, so how does it work?

But how does it really work? Typically, transactional risk insurance is used in order to protect two specific types of risk that could potentially arise from a transaction:

  • Unknown and unforeseen loss (i.e. reps & warranties insurance: buy side-policy & sell-side policy)
  • Identified and known risk (i.e. identified tax issues, other contingent risks, successor liability)

This is why understanding the big picture of RWI is so important. Being able to diligently prepare the client or the transaction for the known and unknown risks will allow you to ensure that there won’t be any issues that can arise that could potentially keep a deal from going forward. You want to make sure that your transaction is being covered for any financial losses resulting from breaches of reps & warranties that could possibly be made by the buyer or the seller in the purchase agreement.

If you want to dig in deeper, feel free to download the Transactional Risk Insurance Slide Deck.

Join Us Next Time!

If you’re in the know (and hopefully you are) we hold our EPI Chapter events every month in the DC region where we talk all things exit planning, valuation and M&A. If you haven’t yet attended one of our events or are just interested in more information regarding them, make sure to visit our event site.