Reps and warranties insurance (R&W insurance) provides parties in an M&A transaction with a risk mitigation solution for uncertainties that traditionally would be addressed by an indemnification from the seller. While available to either buyer or seller, R&W insurance policies are most commonly purchased by the buyer as a first-party insurance solution to either replace or supplement indemnification provided by the seller for breaches of representations in a purchase agreement. A few specifics on what R&W insurance provides include:
- Financial coverage to the insured in the event of a breach of a representation or warranty by the counter party in an underlying purchase agreement
- Reduces the sellers indemnification cap and survival periods, but still affords appropriate levels of protection to the buyer
- Can help facilitate deals by transferring risk to an insurance carrier that would otherwise be allocated between the parties
- May be used by sellers, private equity firms, and corporate buyers
R&W insurance provides private equity firms, strategic and corporate buyers, risk managers, and other stakeholders with a risk mitigation solution for uncertainties in a merger or acquisition. The policy is available to either the buyer or seller and provides protection against financial loss, including defense costs for certain unintentional or unknown seller breaches. A few key advantages of having R&W insurance are:
- Provides a secure and clean exit for both parties
- Reduces the sellers indemnification obligation to the buyer
- Minimizes post-closing liabilities
- Allows for greater flexibility in negotiating deal terms
- Assists in the auction process
- Mitigates post-close solvency concerns
According to Daniel Posnick, Transactional Liability Leader at IMA Financial Group, “R&W insurance policies allow for sellers to have a clean break after a transaction closes and buyers to have more indemnity.”
The cost of R&W insurance has decreased in recent years and is covered by the buyer approximately 60% of the time. In the remaining 40% of transactions, buyers and sellers typically split the cost of the policy. Many buyers will address R&W insurance requirements in the LOI and include the amount required to be paid by the seller, however this can be negotiated by an experienced sell-side advisor. The cost of a policy is normally based on a percentage of the enterprise value of a deal, including the premium and underwriting fees. A typical policy provides for three years of general coverage and six years of fundamental and tax coverage.
The most common breaches of a Purchase Agreement post-closing, items that can be addressed and covered by an R&W insurance policy, include:
- Financial statements
- Compliance with laws and regulations
- Taxes
- Material contracts with suppliers and customers
While there are several options for R&W insurance, certain factors such as price, coverage, industry focus, and carrier reputation can impact the decision-making process. Working with an experienced broker-dealer can help buyers and sellers as they analyze the best policies and coverage available to them. If you have questions about R&W insurance or would like to discuss further, please contact us at ib@crewe.com.
