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16 Nov Reps & Warranties Insurance: Protecting Both Buyers and Sellers in M&A

When a loss is experienced by a buyer of a company, the repercussions can be costly – both for the buyer as well as, potentially, for the seller.

For the buyer, there may be a challenge in recovering losses, while the seller may be at risk of having to pay back a portion of the purchase price.

But there is a way to protect both the buyers and the sellers from incurring a financial loss – representations and warranties insurance (RWI). In fact, RWI has become a go-to tool in bridging negotiation gaps in private equity transaction.

So what, exactly, is RWI?

RWI is a type of insurance that can adhere to either the buyer or seller in an M&A transaction, and protects them against breaches of the representations and warranties. In fact, RWI may even reduce, or eliminate, the need for escrows or purchase price holdbacks and indemnity retention limits. The result is a far more expedient and streamlined M&A transaction.

While RWI may not be the perfect fit for every deal, it’s something that every middle market M&A seller, buyer, and advisor should consider.

What to know about RWI

A typical RWI policy will include the following terms:

  • Premiums from 2-5 percent of the limit of liability purchased
  • Limits of up to $50 million for one transaction
  • Deductibles ranging between 1-3 percent of the transaction value

Buyers may also be able to recover losses without having to pursue remedies against the seller. Sell-side policies won’t protect against seller fraud, but could possibly provide third-party coverage (for example, losses asserted by the buyer).

A good option for PE buyers looking for protection

It’s becoming more and more common for sellers to offer PE buyers no (or very little) seller indemnity. This shift is a result of a demand for good acquisitions exceeding supply. In these instances, RWI might offer a level of protection while still allowing PE buyers to make their purchase offer competitive.

RWI can also be an asset to PE buyers because it can offer a longer protection period than what is typically obtained from sellers. Furthermore, RWI provides coverage limits that aren’t necessarily tied into a percentage of the purchase price. This allows the buyer to get more coverage than what would typically be offered from the seller.

With so many benefits tied directly into M&A transactions, RWI is certainly something worth considering for both buyer and seller.

  • Alex Sierra

    RWI definitely is always something worth considering. There are clear benefits for the buyer like the ability to have long-term protection while maintaining a competitive purchase price. However, because it streamlines the entire M&A process, sellers are also likely to find them acceptable. With so much competition out there for good deals, seeking high returns will continue to involve more and more risk. RWI is a great tool to mitigate some of this risk, and will mostly likely continue to be a go-to policy in the M&A world.

  • Dominic Niolu

    Very informative. RWI is necessary for any transaction large enough to warrant this type of potential risk. As you said, the processes of M&A transactions can be streamlined by it’s implementation. This brings a whole other value to RWI as completing a transaction is a very lengthy process.

  • John Hosmer

    Thanks again for the share! I have a few questions.

    How did RWI become a certain standard among acquisition activity? How long would you say, does it take for a buyer and seller to agree on specific RWI terms? Also, are there any specific examples that clearly illustrate when an RWI has been used effectively (also a time that resulted in failure) from both the buyer and seller perspective?

    From what I understand, potential earn out agreements can also be used to bridge negotiation gaps during an acquisition process. I’ve noticed that sometimes, metrics used in these agreements can be manipulated by the buying company following acquisition in order to depress the overall potential earn out owed to the seller. Are there any cases or circumstances where RWI has been manipulated too?

  • Shelby G. Norton

    Some homeowners get frustrated by a home warranty because they assume they can hire anyone they want to make a repair and that if something is broken or old they can simply have the item replaced by the warranty policy.