M&A Advisors – Why Transactional Insurance (R&W Insurance) Should Be On YOUR Radar
Today I’m going to talk about reps & warranties insurance with a special focus on the small business market, and why it should be on your radar if you’re an M&A Advisor.
Okay, a quick primer on reps & warranties insurance often called R&W insurance.
This form of transactional insurance is used to cover the indemnifications made in a deal that can lead to disputes and litigation post-close.
R&W insurance is essentially a breach of contract coverage that can replace indemnification agreements and escrow holdbacks at closing. It has been used for years in the middle market by both buyers and sellers to smooth out transactions and is now available in the small business market.
Previously, sellers of smaller firms were left out of this form of insurance due to the high cost of the underwriting fees and premiums.
Today, small businesses – those with enterprise values of $15m or less can purchase R&W insurance quickly, affordably, and easily, which is why I think M&A Advisors should have it on their radar.
Why should sellers consider R&W cover?
Two reasons stand out for me.
First is Peace of Mind for the Seller. If the threat of litigation arises due to misrepresentations or breach of contract, the seller has an insurance company behind them to provide vigorous defense and potential settlement amounts safeguarding the seller’s capital.
Entrepreneurs often fear that larger buyers can come back a year or two after closing and threaten them with litigation if they’re unhappy with performance or results. R&W transfers this risk to the insurer.
Second, with R&W coverage the need for an escrow holdback is reduced or totally eliminated.
The seller walks away from the closing table with all their proceeds in their pocket to invest, or start another company.
Leaving ten or 20 percent on the closing table often leaves sellers feeling like they are being held, hostage.
To help smooth out a deal, and give the exiting seller some peace of mind and all their money at closing at a reasonable cost, I think R&W is a good idea for your clients to consider.
What does R&W Insurance cost?
Premiums range from 1 to 3 percent of the limit of coverage purchased. There is no upfront underwriting fee, and quotes are turned around in a few days with just 9 questions answered. Pretty simple.
One thing worth mentioning is the “net cost” of insurance. What I mean by net cost is that when R&W eliminates the need for escrow, those funds can be invested by the seller for gains, and the opportunity costs are reversed.
Here’s an example.
Assume a deal worth $10 million purchases R&W insurance for a premium of $150,000 which is a rate of 1.5%.
The original deal’s escrow of 10% or $1 million is eliminated and now invested by the seller at a 10% return – They make a $100,000 gain. Subtract the premium and that means the net cost of the insurance is only $50,000. I know it’s a bit oversimplified, but it’s an important consideration.
How can a seller get a quote?
Let’s have a conversation, get some details and I’ll submit it to underwriting. As I mentioned it takes just a couple of days to turn around a non-binding premium indication.
If that looks good we’ll need some additional underwriting information to get a firm premium quote but that only takes another couple of days as well. In a rush, it can be moved along faster.
Premiums are paid once at inception and the protection lasts for six years.
Have other questions I didn’t answer here?
Let’s connect. I’d love to hear from you and see if this product is a good fit for your next deal.
Thanks
