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Beach retirement, the outcome of selling your business with representations and warranty insurance

Rep & Warranty Insurance: How Does it Protect the Sale Process?

Building your business took hard work and time. Selling it requires the same. You can go through the research, find the right buyer, craft a strategy, and yet it can all come to a screeching halt when capital gets tied up in escrow. When your retirement is on the line, complications in the sale, questions about representations, and extensions in the timeline are not ideal. Enter “representations and warranty” (rep & warranty) insurance.

What is Rep & Warranty Insurance?

This specialty insurance product provides coverage in the event that some part of the business or sale agreement is unknowingly misrepresented to the buyer. Without coverage, this kind of liability can become financially crippling to a seller. When a seller includes this policy as part of the sale deal, it tells buyers that the insurers completed due diligence and provided this backstop to your indemnification. As a result, buyers have faith that they can recoup insurable losses in a claim after the transaction is complete. Such assurances can speed a deal.

As a general rule of thumb, the larger the value of the deal, the more frequently an escrow will linger for an extended period of time. For escrows lasting longer than three months, rep & warranty insurance lets you receive payment sooner by bypassing a part of the escrow. Shorter, even eliminated escrows benefit both parties by speeding up the transaction. When there is more than one buyer bidding on your business, they can even bid against each other to avoid escrow – to your benefit. After the sale is finalized, the policy is then transferred to, and finalized by the buyer.

Empower Your Negotiations

In addition to adding 1-3% of any given deal, rep & warranty insurance contracts can be negotiated to cover your risks exactly as they are. In fact, many contracts are customized so that you do not need to worry about “cookie cutter” coverage that may not provide the kind of protection you need. A good broker will make sure you have the right coverage, at a competitive price, with very limited exclusions. Further, using Rep & Warranty when selling your business can give you:

  • Increased speed of the deal
  • Minimized escrow and indemnity caps
  • Extended survival of seller indemnity
  • Cleaner exit of the business / earlier distribution
  • Credit-worthy protection

The Buyer’s Perspective

One reason that buyers are so open to rep & warranty insurance is that it protects their investment. This type of policy transfers the risk of misrepresentation to the insurance carrier so that buyers can turn their focus to providing competitive terms.

Buyers may also take the initiative to purchase rep & warranty insurance. If you are selling your business and are approached by a buyer with this coverage, you can be confident that the buyer is willing to negotiate escrow (occasionally for a lower purchase price).

Who Should Use Rep and Warranty Insurance?

Rep & warranty insurance is most often appropriate for businesses whose sale value starts around $50 million. This is because the cost of the policy is typically around 3% +/- of the deal, and the premium range should not outweigh the benefits you receive from the policy. A good insurance broker will help you decide whether this strategy is right for you.

When this policy is a benefit to you as a seller, however, it can be extremely useful to the speed and monetary outcome of your deal. For example:

If:

  • A company prepares to sell a $100 million manufacturing company through an auction process. Seller wants to sell on an “as is” basis, with no surviving indemnities or escrow post-closing

Then:

  • Bidders work with the seller and the seller’s broker during the sale, once the seller and broker make it known that they’ll provide no indemnities
  • The buyer’s due diligence process is smoother and simpler because the insurer will vet the seller’s risks before agreeing to provide Rep & Warranty coverage
  • A rep & warranty insurance policy can cover hanging liabilities from prior transactions and rep related to the current transaction
  • The Sale Purchase Agreement (SPA) provides credit against the purchase price for the insurance cost (1% of transaction value)

Seller achieves more bids and a better sale price.

Your Competitive Edge

Rep & Warranty insurance can be a significant competitive advantage to both sellers and buyers, but only about 10% of eligible deals are actually using it. As a seller, you can stand apart, and make your business far more attractive to buyers by using Rep & Warranty insurance. By providing the backing of an insurance policy, buyers know that your business been vetted, but it also is protected in case of a misrepresentation.

Other Considerations

Reducing the perceived risk that buyers can see in your company is critical to selling your business. You may know the risks facing your company, or its sale, but you may also be aware of everything you don’t know. These “known issues with uncertain outcomes” can cause major problems, and quickly lead to a worst case scenario. However, if you work with a good insurance broker to quantify these risks, and then disclose them to the buyer alongside the proper protection tools, you can reduce the buyer’s leverage, and seek discounts against identified risks. Rep & warranty insurance is one way to do this, but it isn’t complete without considering Tax insurance, Litigation Insurance, Environmental insurance, Fraudulent Conveyance, Successor Liability, and Contingent Risk insurance.

On the Horizon

You took risks, used the right tools, and created strong strategies to build your business. The right insurance products can leave more money in your pocket, and better prepare you for retirement when you are ready to sell.

[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. This is an updated version of an article originally published on April 3, 2015.]

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About Michael F. X. Murdoch

Senior Vice President Aon Risk Solutions / Private Risk Management Michael F. X. Murdoch serves as Strategic Advisor to both Aon’s national and international accounts, bringing global resources to his prospects and clients. Mr. Murdoch’s primary areas of expertise are real estate, family office, media, telecommunications, public entities, financial institutions, hedge funds, waste management, entertainment…

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