Representation and Warranties insurance is a complex solution for a complex situation. There is nothing standard about the sale or merger of a company and so very little is standard about the insurance that supports it.
Reps and warranties insurance is essentially breach of contract cover designed to enhance or replace the indemnification given by the seller to the buyer. In short, once the ink has dried on the merger or acquisition deal, this covers some of the unforeseen costs caused by any breaches of the seller’s representations, whether it’s issues with their customer contracts, employment agreements, or the super secret recipe of their product.
There has been a large uptick in the amount of strategic buyers that use this product. In most instances, the General Counsel or the Risk Manager is often tasked with gaining an understanding of R & W Insurance and then explaining it in easy-to-understand terms to the rest of the team. At Woodruff Sawyer, we’ve developed the primer below for our clients to use when trying to explain this product internally as simply as possible.
Not wishing to sound boastful, but the reviews from our clients have included phrases like “brilliant,” “saved me a ton of time,” “just what I needed,” and “you’re the wind beneath my wings.” (Ok, that last one is a lie.)
Anyway, in the interest of being helpful, please see the aforementioned primer below.
Reps and Warranties Primer
So what do you really need to know about Reps & Warranties to be able to inform your colleagues?
- Whilst either buyer or seller can be the insured, 90% of the policies placed are buy-side, protecting the buyer from any breaches of the seller’s representations. Why?
- Buy-side has additional fraud coverage which sell-side cannot provide
- The insured buyer can pick a limit and time period beyond what the seller is willing to give
- With this coverage, the buyer can avoid suing their newly acquired management team should any breaches or misrepresentations come up; they can go directly to the carrier instead
- Buy-side allows the buyer to offer lower escrows or more competitive terms in an auction.
- When drawing up Reps & Warranties Insurance, underwriters assess the risk on the following criteria:
- The nature of the seller’s representations and warranties, such as…
- The nature of the SPA terms and conditions such as multiples and consequential damage language, single of full materiality scrapes, sandbagging language,
- The quality of the due diligence. Underwriters wish to provide coverage for the truly unknown so they are looking to “diligence the diligence.”
- The coverage is designed to cover all warranties. But certain exclusions are standard:
- Forward-looking warranties (for example, sales projections, etc)
- Purchase price adjustments
- The availability or usability of Net Operating Losses or R&D tax credits
- Certain areas that are difficult to get cover for, like FCPA, Union activity, underfunding of pensions, wage and hour, etc.
- It’s a two-part process:
- Initial Non-Binding Indication
- This occurs one week from receiving the target financials, draft SPA, and any IM that has been prepared by the seller
- Costs nothing
- $30k up front “diligence fee”
- Requires access to the data room, third-party diligence reports, and the buying team for conference call
- Takes 1 week but is dependent on the timing of the deal process.
- Pricing: Two Alternatives
- Retention – this is expressed as a percentage of overall transaction size. The minimum is 1% of the transaction, meaning a $100m transaction has a minimum $1m retention. This can be in the form of a seller’s escrow, the buyer’s deductible, or a combination of the two.
- Premium – this is expressed as a percentage of the limit of coverage bought and is not related to transaction size. Currently, premiums are running 2.5-3.5% of the limit bought. For example, a $10m limit would mean a $250-$350k one-time payment for a six-year policy. It is worth noting that currently minimum premiums are running around $150-$200k, so we generally don’t recommend this product if the insured is seeking less than $5m of coverage.
I’d love to hear if you found this summary useful or if you feel there are ways we can improve it. This is a fast-growing market with a wide variety of knowledge levels. No matter your experience or your familiarity, Woodruff Sawyer is committed to helping everyone understand complex coverages as simply as possible.