Looking for Reps & Warranties Insurance for the small business market?
Until recently, Reps & Warranty Insurance was only deployed in large corporate and upper-middle market deals where the premiums are significant, and underwriting fees are high. The lower middle market and small business deal-making market was out of luck finding protection for risks that arise in M&A transactions.
In this video, we describe Reps & Warranty (also known as R&W) insurance in general terms and look at a new product focused on deals in the $30 million Enterprise Value and under market. This is an excellent too for sellers to hedge their indemnification risks and to eliminate collateral escrow holdbacks commonly deployed in this segment of the market.
For buyers, there are also significant benefits to deploying R&W Insurance to reduce friction and facilitate closing deals.
What is Reps & Warranties Insurance?
Reps & Warranties Insurance, often called R&W Insurance for short, is a type of policy used in M&A transactions to provide protection against financial loss arising from unintentional and unknown breaches of the selling firm’s representations and warranties made within the purchase and sale agreement of a deal. The policy also includes coverage for the defense costs associated with litigation that may arise.
In the small business market (under $30 million of enterprise value), this policy is purchased by the seller, but specific endorsements can be arranged to protect buyers as well.
Since M&A insurance is unavailable in lower middle market deal-making, escrow holdbacks are typically used to help collateralize this obligation. The buyer holds 10 to 20 percent of the deal proceeds for a set number of years to protect them against future losses that may arise due to a breach of the representations by the seller.
This puts the seller in a precarious position. It ties up valuable capital they may want to invest into their next business and leaves them vulnerable to unknown risks post-close.
In this video, we discuss the basics of R&W Insurance and its use
What types of businesses are eligible for this form of R&W Insurance?
The small business R&W insurance we’re focusing on here is targeted to small and even “micro” deals where the enterprise value is between $250,000 to $25 million, with particular attention on:
- Real Estate
- Professional Service Firms
Industries typically not eligible: Regulated Industries, Healthcare, Financial Services, Energy, and Pharma.
Why Do Small Business Sellers Need This Reps & Warranties Insurance?
There are two reasons why R&W Insurance may make sense for a small business transaction:
- Litigation Risk
Let’s look at collateral first. Without R&W insurance, a buyer is usually going to require a collateral holdback to tap into should a representation made in the deal document prove to be inaccurate or untrue. Usually, buyers hold back 10 to 20 percent of deal proceeds to give them a security position for one to three years.
This, of course, will give the seller an uneasy feeling. A chunk of their capital is left on the closing table in the hands of a third party, not earning interest and not available to invest in the seller’s next venture or retirement.
R&W insurance can step in to eliminate the need for collateral. Buyers now have insurance instead of cash should there be a breach of a representation or warranty.
Second, when selling your firm, there’s the added risk of litigation should the buyer feel they have been duped or become dissatisfied with a deal due to misrepresentation. True or not, this is a risk hanging over the head of the seller. Not only is the collateral at risk, but the potential for litigation is always present, so R&W insurance provides peace of mind for the seller, knowing that if a claim arises, they have an insurance company providing defense and support.
These risks for the seller are heightened when the buyer is a private equity firm or other large financial sponsor with the resources and power to crush a seller in litigation.
What Does R&W Insurance Cost?
Underwriting M&A Insurance in the upper middle market usually involves an upfront underwriting fee of around $30,000. The premium is typically around 2.5% of the policy limit, which is usually 10 percent of the deal value. So, if you’re selling a company for $100 million, you’re buying a $10 million R&W policy and paying an estimated premium of $250,000 and an underwriting fee of $30,000 for a total cost of $280,000. Those are all rough estimates.
In the small business market, deals under $25 million in enterprise value, which we focus on, there is NO underwriting fee. An initial premium indication (a non-binding cost estimate) can be returned in 3 or 4 days after submitting a short-form application.
The premium range is one to three percent of the enterprise value (sale amount) of the company being sold. Lower-risk industries and deals typically see premiums in the 1 to 1.5 percent range. So if you’re selling a company for $10 million, the premium may land in the range of $100,000 to $150,000.
If a seller goes without R&W insurance, they face potential litigation risks on their own, out of pocket, and would face a collateral holdback of anywhere between $1 to $2 million. If that collateral is held for two years, there’s a significant loss of ROI on those funds, which usually exceeds the amount paid for R&W insurance.
The bottom line is that R&W insurance makes economic sense for the seller and, more importantly, gives them peace of mind when exiting their business.
One last point that I’m often asked is: “Does the premium need to be paid every year?” No, unlike other business insurance, R&W insurance is paid once at the policy’s inception and is in effect for six years, matching the indemnity period in the purchase and sale agreement. No other payments are required.
Why Get Reps & Warranties Insurance from The Coyle Group?
In the small business R&W market, few insurance brokers even know this policy exists! We at The Coyle Group are adept at working with our underwriting partners, know the policy form and endorsements, and can work quickly and efficiently with you or your deal team to arrange protection tailored to your needs.
It all starts with a phone call or even completing this form, which is returned to me for handling.
Ready to learn more about Reps & Warranties Insurance?
Complete this form for us to provide you a premium indication for R&W Insurance. Once submitted, it takes about 3 days for us to return pricing to you.
Reps & Warranties Non-Binding Indication Request Form
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