IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities. Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Eric Freilich of the BMS Group (https://www.bmsgroup.com/solutions/insurance/private-equity-m-a-and-tax):
Unlocking Value in M&A Transactions: The Benefits of Representations & Warranties Insurance for Sellers
In the dynamic world of mergers and acquisitions (“M&A”), efficient and effective deal facilitation tools can make the difference between a smooth and commercial transaction and a busted deal. A solution that can facilitate improved negotiations by offloading certain aspects of deal risk is Representations and Warranties Insurance (“RWI”). As the RWI landscape has grown more competitive, new products have emerged to fill market needs. Sell-side RWI policies are now available for transactions in the $500k–$20 million range, easing certain aspects of negotiations and ensuring that sellers are protected post-closing against potential claims arising from breaches of representations and warranties made in the acquisition agreement.
In acquisition agreements, sellers provide buyers with certain indemnities against breaches of representations and warranties, often secured (at least partially) by an escrow or holdback. This helps provide certainty for a buyer that they will be able to recover damages suffered for a loss due to a breach. However, this structure exposes sellers to unexpected liabilities after a deal closes, and many sellers view escrowed or held-back proceeds as uncertain. Sell-side RWI policies allow sellers to walk away from transactions knowing they have a safety net to protect those proceeds, as well as protection against any other indemnity claim a buyer might make due to an inadvertent breach of representations and warranties.
This certainty for sellers offers two advantages: (1) they can better plan for the use of the sale proceeds (whether for retirement or reinvestment in a new venture), knowing they will be made whole by insurance if a claim arises; and (2) they can often reduce the escrow or holdback (as discussed below), enabling them to receive more proceeds at closing. In many cases, the return on these additional proceeds can often cover the premium associated with the RWI policy.
Escrow Reduction and Other Transaction Terms
An escrow provides buyers with a safety net, ensuring that funds are available in case they need to make a claim under a seller’s indemnity. A buyer can be named as a loss payee under an RWI policy (meaning that paid-out proceeds flow directly to the buyer, bypassing the seller). If the buyer is satisfied with the RWI policy’s coverage, they often agree to reduce the escrow amount significantly. The insurance proceeds are readily available to the buyer if there is a valid claim, and there is no credit risk, as the payor is a reputable insurance company with deep pockets and a history of RWI settlement payouts.
Buyers can also benefit from the presence of an RWI policy. First, it provides a larger pool of money to satisfy indemnity claims with certainty (market escrows are generally smaller than indemnity caps, but insurance limits typically match the cap). Second, it allows for more buyer-friendly terms, such as higher indemnity caps or longer coverage periods (insurance is usually incrementally cheaper for additional coverage and is available for 3 years for operational representations and 6 years for fundamental and tax representations). Third, it generally reduces the need for extensive negotiation of representations and warranties and indemnities because, so long as both parties are confident in the coverage provided by the policy, wordsmithing is of limited value to the seller (but can be quite valuable to the buyer if they do need to make a claim post-closing). Because of these benefits, transactions with RWI often feature more buyer-friendly terms compared to those without, with the tradeoff being a reduced or eliminated escrow.
Post-closing dynamics are also significantly smoother with RWI in place. In cases where the seller retains a role in the company or continues to manage the business, a buyer’s ability to make claims against a third-party insurer rather than their new business partner can be the difference between pursuing a claim and letting it go.
Pricing and Process
Sell-side RWI policies are priced at 0.6%–1.75% of the coverage limit sought and require a one-time premium payment. Given the mutual benefits of the product, the cost can be flexibly allocated between the parties. Depending on when and how it is introduced into the transaction process, a sell-side RWI policy can be bound in as little as 2-3 days.
Summary
RWI offers mutual benefits to parties involved in M&A transactions, and new sell-side policies designed specifically for lower mid-market transactions have been introduced. RWI can simplify negotiations, reduce transaction risk for both parties, and ensure that sellers exit their business smoothly, with greater certainty of proceeds. As the market continues to evolve and awareness of these products grows, business brokers can play a crucial role in guiding sellers through the benefits of RWI, ultimately helping them achieve their goals with greater confidence.
If you have questions related to the content of this article Eric Freilich, Director and Legal Counsel, Private Equity and M&A for the BMS Group, would welcome the opportunity to answer them. Mr. Freilich can be reached at (647) 533-9699 or eric.freilich@bmsgroup.com.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses. IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.