Understanding R&W Insurance
What is Representations and Warranty Insurance?
Representations and warranty (R&W) insurance is a powerful tool in mergers and acquisitions (M&A) that covers unknown and unintended breaches of representations and warranties made in business agreements. This type of insurance, also known as warranty and indemnity (W&I) insurance, has become increasingly popular in recent years due to the litigious environment surrounding M&A transactions.
Benefits for Sellers
Maximizing Returns and Reducing Risk
R&W insurance offers several advantages for sellers in M&A deals. It allows sellers to maximize their internal rate of return (IRR) by reducing or eliminating the need for contingent reserves or holdbacks, enabling immediate distribution of proceeds to stakeholders. Additionally, sellers can negotiate more favorable terms, as buyers may be willing to waive certain liabilities in exchange for the coverage provided by the insurance.
Advantages for Buyers
Competitive Edge and Enhanced Protection
Buyers also benefit from R&W insurance. It enables them to make more competitive bids by recovering from an insurance policy rather than relying on traditional holdbacks or escrows. This makes the buyer’s offer more attractive in auction scenarios. Furthermore, buyers can protect their ongoing relationships with sellers and management teams by reducing the likelihood of pursuing indemnification claims directly against them.
Policy Structure
Limits and Retentions
Coverage limits for seller-side policies typically mirror the transaction’s indemnity exposure, while limits on buyer-side policies depend on their unique risk appetites. Policy retentions often range from 1% to 2% of the enterprise value, with the retention usually shared between the buyer and seller.
Market Trends
Growing Popularity and Accessibility
The use of R&W insurance has expanded significantly in recent years, becoming more accessible for smaller M&A transactions. Recent studies show that R&W insurance is now used in 20-25% of U.S. private company acquisitions. This trend has made R&W insurance a common feature in the private company M&A landscape.
Considerations and Potential Drawbacks
Policy Exclusions and Costs
While R&W insurance offers numerous benefits, it’s essential to carefully examine and understand the scope and exclusions of the policy. Premiums typically range from two to four percent for each dollar of coverage, with buyer policies generally being more expensive. It’s crucial for both buyers and sellers to weigh the benefits against the costs when considering R&W insurance.
A Valuable Tool for M&A Success
Representations and warranty insurance has become an essential tool in M&A transactions, offering significant benefits for both buyers and sellers. By shifting financial risk to insurance companies, R&W insurance can facilitate smoother negotiations, provide greater certainty for sellers, and offer enhanced protection for buyers. As the M&A landscape continues to evolve, understanding and leveraging R&W insurance can be a key factor in achieving successful outcomes for all parties involved.
