Reps & Warranties Insurance: How Does it Protect the Sale Process?

What is representations and warranties (reps & warranties) insurance? Building your business took time and hard work. Selling it requires the same. You can do the research, find the right buyer, and craft a strategy. But what if it screams to a halt when capital gets tied up in escrow? When your retirement is on the line, complications in the sale, questions about representations, and timeline extensions are not ideal. This specialty insurance product covers the seller if the business or the sale agreement is misrepresented to the buyer. Without coverage, the seller might end up financially crippled. When a seller includes reps & warranties insurance, the buyer knows the insurer completed due diligence and indemnified you. Buyers know they can recoup insurable losses. Such assurances speed up the deal. Generally, the bigger the deal, the longer escrow lingers. However, reps & warranties insurance bypasses part of an escrow longer than three months. You get paid sooner.

Shortening or eliminating escrow speeds up the transaction and benefits both parties. If multiple buyers bid, the competition benefits you. After the sale, the policy transfers to the buyer, who finalizes it.

Empower Your Negotiations with Reps & Warranties

Reps & warranties insurance is customizable; you can negotiate coverage for specific risks in specific amounts. An additional retention fee, 1-3% of the enterprise value, compares to a deductible in automobile insurance.

Choose a broker who can provide appropriate coverage, at a competitive price, with limited exclusions. Prime advantages to using reps & warranties insurance when you sell your business:

• Increased transaction speed
• Minimal escrow and indemnity caps
• Extended seller indemnity survival
• A cleaner exit from the business with earlier distribution
• Less chance of damaging your credit reputation

Reps & Warranties Insurance from the Buyer’s Perspective

Reps & warranties insurance protects a buyer’s investment. The coverage transfers the risk of misrepresentation to the insurance carrier so buyers can focus on competitive terms.

Buyers often choose to purchase reps & warranties insurance. When a  buyer brings insurance to the table, the seller knows that buyer will negotiate escrow. Who should use reps & warranties insurance?

Reps & warranties insurance is most appropriate for businesses valued at or above $50 million. The premium is around 3% of the deal, and the premium range should not outweigh the benefits. The broker will help decide whether this strategy applies to a given deal.

Consider this:

If:

• A company is selling a $100 million manufacturing business at auction. The seller wants to sell “as is” with no surviving indemnities or escrow post-closing.

Then:

• Bidders, understanding there are no indemnities, work with the seller and its broker.
• The buyer’s due diligence is simpler because the insurer vets the seller’s risks before agreeing to provide reps & warranties coverage.
• A reps & warranties insurance policy can cover hanging liabilities from prior transactions and representations related to the current transaction.
• The Sale Purchase Agreement (SPA) provides a credit against the purchase price for the insurance cost (1% of transaction value).
• The seller enjoys more bids and a higher price.

Your Competitive Edge

Reps & warranties insurance can provide sellers and buyers significant advantages, but surprisingly, only about 10% of eligible deals use it. You make your business more attractive to buyers by using reps & warranties insurance. Buyers know your company was vetted, and they are protected.

Other Considerations

To sell your business, you have to offer buyers less risk. You may know those risks upfront, but you might not be aware of all risk potential. Known issues with uncertain outcomes cause significant problems. Your insurance broker quantifies such risks and discloses them to the buyer. Then he provides proper protection tools to reduce the buyer’s leverage. The seller can seek discounts against identified risks. The perfect strategy includes an arsenal of insurance coverages:

• Reps & warranties tax insurance
• Litigation insurance
• Environmental insurance
• Fraudulent conveyance
• Successor liability
• Contingent risk on the horizon

As you built your business, you took risks, used the right tools, and created robust strategies. When you are ready to sell, appropriate insurance leaves you prepared for retirement with more money in your pocket.

[Read more: Sleep Better with Reps & Warranties Insurance]

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars:

• Key and Common Negotiated Positions Part 1 and Part 2 and
• What’s It Worth? Valuing a Business for Sale.
• Key Provisions in M&A Agreements
• Post-Closing Issues: Integration & Potential Buyer/Seller Disputes
• What’s It Worth? Valuing a Business for Sale

This is an updated version of an article originally published on April 3, 2015. It has been updated by Nora Willi]

©2022. DailyDAC^TM, LLC d/b/a/ Financial Poise^TM. This article is subject to the disclaimers found here.