Using Representations and Warranties Insurance to facilitate M&A.
Read more to find out about ASR’s Representations and Warranties insurance capabilities.
Representations and Warranties insurance has been around for many years, but over the past 18+ months, the market has evolved considerably. The London market in particular has begun to offer many more creative and price competitive alternatives to both buyers and sellers. Although global M&A activity has decreased since 2008, the number of Reps & Warranties insurance policies being placed have increased significantly due to improvements in the overall insurance market.
Reps & Warranties insurance can be used as both a bid differentiation tool and as an aid to sellers in what is an increasingly difficult environment to make exits from investments. The following is a brief look at how Reps & Warranties insurance can be used by both buyers and sellers.
Seller Side Insurance
Through the protection of a Reps & Warranties policy, the seller can agree to the following:
- Provide larger limits of indemnity - a Reps & Warranties policy may allow the seller in a transaction to increase the warranty caps beyond what they might otherwise be prepared to do. With an insurance policy behind them, the seller can be secure knowing that its indemnity will be capped, allowing them to offer larger warranty caps. Alternatively, a Reps & Warranties policy can be used to "top-up" the liability of the individuals actually providing the warranties, which may be particularly useful when members of management are the sellers.
- Provide longer warranty survival periods - limiting the survival periods of warranties, especially for tax purposes, has always been a high priority for private equity sellers. In the current investment environment; however, scarcity of buyers makes this difficult. Reps & Warranties insurance allows sellers to offer longer survival periods in the knowledge they have the protection of the policy behind them.
Being able to provide larger limits of indemnity and/or longer warranty survival periods, enables the seller to reach out and access a larger pool of buyers than it would otherwise be able to do as buyers - and the shareholders and debt providers that support them - will receive greater levels of financial protection. Of course, with access to a larger pool of buyers and the ability to provide greater financial security, the seller will likely be able to demand a higher price for their transaction.
The general pricing of Reps & Warranties insurance has become much more competitive in the past 18+ months, which means that the cost of insurance is now more than offset by the higher price that can be attained from a sale due to the enhancements achieved with the backing of the Reps & Warranties insurance. These benefits are in addition to the traditional risk mitigation and clean exit capabilities offered by such policies.
Buyer Side Insurance
Unlike a Sell Side policy which must remain confidential, a Buy Side policy can be disclosed to both parties and can be used to negotiate the underlying terms of the Shareholders' Purchase Agreement (SPA). Essentially, a Buy Side policy allows buyers to do the following:
- Approach deals in a more conciliatory manner - a buyer can approach a seller and be less demanding with their terms in the SPA in the knowledge that they can extend the warranty caps and survival periods through the use of a Reps & Warranties policy. In such cases, the seller does not need to know about the presence of insurance, which optically, can help in overall negotiations. For example, the buyer can simply request a smaller cap or limit the survival period to levels that are more agreeable to the seller. Alternatively, the insurance policy can be bought to "top-up" or seemingly extend the contractual obligations in the SPA without the seller being aware.
- Provide the seller with the confidence to extend the warranties - the presence of the policy gives the seller more confidence in providing the warranties knowing that they have a policy that will defend and settle claims on their behalf and that the buyer has a policy that they can claim against in the event of a loss. The seller therefore knows that their liability is limited to the deductible of the policy, or in some cases, even less.
Whereas traditionally Reps & Warranties insurance has primarily been used to mitigate risk, relatively recent improvements in the insurance market means that it is increasingly being used to act as a bid differentiation tool and to ease post pre-closing and post closing friction points in order to facilitate deals and maintain working relationships.
If you haven't explored some of the more creative approaches to Reps & Warranties insurance or haven't reviewed the improved pricing and availability in this market, call us today to find out more how ASR can help you and your private equity and M&A attorney clients.