How To: M&A Deal Baskets and Reps & Warranties Insurance

In this article, we will:

• Examine how different kinds of baskets work in M&A agreements
• Discuss how deal parties should think about baskets in the context of RWI policy self-insured retentions (SIRs)
• Look at recent market trends around baskets and SIRs

What Is an M&A Basket?

When entering into an M&A agreement, a buyer will typically expect the seller to give a certain set of representations and warranties. To ensure being compensated for losses relating to breaches of those reps & warranties, the buyer will also typically ask the seller to indemnify the buyer for a negotiated set of losses. This promise to indemnify is, in essence, the seller’s promise to financially back its claims that all the assets it is selling to the buyer are in as tip-top shape as the parties discussed when they embarked on the deal.

To eliminate the hassle of having to deal with minor losses, the seller may negotiate a basket mechanism into the purchase agreement. This mechanism will require the buyer to absorb a certain, specified amount of losses before the seller is required to step in and indemnify. Three different types of baskets are used in purchase agreements:

1. Deductible Basket

This one resembles your typical house or car insurance deductible. It usually says that the seller will not be required to indemnify the buyer for any losses until the aggregate amount of all such losses reaches a negotiated deductible amount (e.g., $100,000). At that point, the seller will be responsible for covering the losses above the $100,000 deductible.

2. First Dollar or Tipping Basket

This one is similar to the deductible basket, but the parties negotiate a threshold amount (e.g., $500,000). When the aggregate losses reach that threshold, the seller will be responsible for covering all losses starting at $0 (or first dollar). So in this scenario, the seller will need to step in and cover not only the losses that exceeded the $500,000 threshold, but also all losses leading up to $500,000.

To visualize this, think of a basket that keeps filling up with small losses. Once it is full, it tips over, spilling all of those losses to the ground. At this point, the seller will need to step in, pick up all the spilled losses, and pay them, and any additional losses above the $500,000, to the buyer.

3. Combination Basket

The combination basket is a variant of the tipping basket with the introduction of a lower amount as the deductible. Continuing with our example, in this scenario, when the aggregate losses reach the $500,000 threshold and the basket tips over, the seller will also need to step in and pick up the spilled losses but only pay those losses that exceed the negotiated deductible (e.g., $100,000).

To prevent costs from spiraling out of control, some sellers negotiate caps on the losses that they would be required to cover in the above scenarios. These caps essentially set maximum limits on the seller’s indemnifiable liabilities. Having a cap allows both parties to understand the extent of the seller’s indemnification obligations and to have an alternative plan for meeting losses that exceed that cap. One way of doing so is through purchasing and correctly structuring a reps & warranties insurance policy for the transaction.

Interestingly, the latest American Bar Association (ABA) purchase agreement studies seem to indicate that indemnity caps in deals with RWI were lower than those in deals without RWI.

How Does Retention Work in an RWI Policy?

A typical reps & warranties insurance policy will specify a certain amount, calculated as a percentage of the purchase price or transaction value (e.g., 1%), to serve as self-insured retention. In simplest terms, the RWI policy will not pay any claims until the aggregated losses associated with breaches of reps and warranties in the purchase agreement reach the SIR amount. Once that amount is reached, the policy will step in and pay any valid claims above the SIR, up to the limit of the policy.

Most RWI policies will have two SIRs: an initial SIR and a dropdown SIR. The dropdown SIR is simply a lower amount (e.g., 50% of the original SIR) that typically takes effect after the policy has been in place for 12 months. For more details on how RWI retention dropdowns work and why they are important to understand, read our blog post about retention dropdowns..

Putting Baskets and SIRs Together

So how should parties whose deal structure involves both a basket and an RWI policy think about: 1) the best way to handle the risk and 2) the most reasonable amount to choose for their basket? They can start with understanding what SIR their policy will contain.

If they reach out to their RWI broker early enough in purchase agreement negotiations, their broker can secure several RWI quotes, which will specify what SIR the carriers would be willing to offer for their deal. They can then use those SIR numbers as the starting point in their basket negotiations.

For example, if the deal purchase price is $100 million and the initial SIR being quoted is $1 million, the parties will know that one or both of them will be responsible for covering losses up to that $1 million before the RWI policy steps in. If, for example, each agrees to cover $500,000 of the SIR, they could use that $500,000 as their threshold amount for the basket.

Ultimately, the basket amount and structure, as well as which party will be responsible for the SIR and in which sequence and proportion, are completely up to the parties as they negotiate the terms of the deal. However, having an understanding of the SIR amount and how it will function as part of the reps & warranties insurance policy will go a long way toward laying the most reasonable framework for the basket.

“What’s Market” in Baskets?

The American Bar Association’s M&A Committee has been conducting deal point studies and analyzing M&A deal trends over the last few years. The Committee has noted a few interesting takeaways, relating to baskets specifically, in its latest study release.

• Over the period covered by the 10 studies (2005–2023), the level of indemnity baskets as a percentage of transaction value has remained fairly consistent, with most sitting in the 0.5% or Less category. Basket amounts tend to be lower when RWI is present in a transaction.

• Deductible baskets have become increasingly common and have now appeared in two-thirds to three-fourths of transactions reviewed in the past few studies.

SRS Acquiom also notes in its 2024 Deal Terms Study that when the deal includes buy-side RWI, sellers’ indemnification obligations are more likely to be structured as deductible baskets than as first-dollar or tipping baskets. 

“What’s Market” in RWI SIRs?

Because of the continued competition in the reps & warranties insurance market, over the last year, carriers have been willing to settle for lower SIR amounts as a percentage of the purchase price or enterprise value of the deal. Whereas 1% used to be market standard in previous years, the market shifted to 0.75% in 2023 and held to that SIR through mid-2024. Over the last few months, however, we have seen a further reduction in SIRs to between 0.50% and 0.60%, with the dropdown SIR percentage going even lower for some deals.

What’s Ahead?

With current market volatility, modest deal volume, and continued fierce carrier competition, we are not anticipating any short-term changes to current market SIR levels. Most carriers are choosing to inch up premium pricing before increasing SIR percentage requirements for their deals. This trend will likely continue for the rest of 2025. If you are negotiating a basket for your deal, take these numbers into account as you decide on the structure, thresholds, and deductible amounts for your basket.