Because strategic acquirers are beginning to use Reps and Warranties insurance with more frequency, risk managers are taking on an emerging role in the M&A process. This article is intended to address common questions from risk managers about R&W insurance, negotiation point, and coverage nuances.
Question: Why are my deal teams now using Reps and Warranties insurance? What has changed?
Answer: The competition for acquisitions has increased drastically over the past several years, driven mostly by the increase in private equity buyers. Private equity buyers began using R&W insurance as an ordinary course deal product several years ago as a mechanism to present a more competitive offer to Sellers. Sellers favored the use of R&W insurance because it replaced the escrow mechanism, thus releasing purchase price proceeds. Strategic acquirers are now competing with more private equity buyers than ever before and have had to adopt the R&W product in order to win deals. R&W insurance has become so common that sellers are inserting it into first drafts of term sheets.
Question: I understand that most of middle market M&A uses R&W insurance, but does it make sense for my company? How do I know that this is a better solution than escrows or self-insurance?
Answer: Remember that every deal is different. The risks presented on some transactions don’t always exist on other transactions. The decision to self-insure or seek an escrow depends on the risk involved, the likelihood of recovery under indemnification provisions, and the effect on bid competitiveness. It’s important for you to have open dialogue with your deal team and transaction attorneys to understand specific deal risks and the best ways to cover them.
Question: My broker has presented me with a number of non-binding indication letters. The coverage options look similar. What kinds of questions should I be asking to choose an underwriter?
Answer: Your questions should include both what is most important to you (e.g., coverage terms and claims history), as well as underwriting efficiency and deal team history with a given underwriter. Huddle up with your deal team and law firm – they might already have experience with a particular underwriter and have a policy form on file. Find out whether a particular underwriter went above and beyond on a past deal. Ask the broker about the underwriter’s claims history.
Question: What do you think of Managing General Underwriters? I haven’t worked with one before, but they have submitted a competitive indication letter.
Answer: MGUs are a fixture in the Reps and Warranties insurance market. Just like traditional carriers, MGUs hire former M&A attorneys to underwrite deals. They are also managed by experienced insurance industry executives and place coverage with well-known, A-Rated insurers. They are an important part of the R&W Insurance market and, similar to traditional carriers, it is worth your time to build relationships with them.
Question: I’m on the sell-side and I’m being asked to place coverage. Is this right?
Answer: Reps and Warranties insurance is almost always a buy-side product. If you are on the sell-side of a transaction and you are being asked to find coverage, now is probably the time to push back. Sell-side coverage exists in special situations but is difficult to underwrite and will most likely take you down a rabbit hole. Talk to your insurance broker and try to move the conversation back to buy-side coverage.
Question: Who pays for coverage? Who pays for the underwriting fee?
Answer: There are many different ways to pay for the coverage. Sometimes the buyer pays, sometimes the seller pays, and sometimes the parties split the cost. These are issues to be negotiated with your deal team. They are usually one of many negotiated points in an M&A deal.
Question: We performed a lot of diligence internally and don’t have traditional third-party reports. Can we still find coverage?
Answer: Yes, but let your broker know immediately if you are using internal reports. Some underwriters are willing to work with internal diligence from strategies (?), provided it is written and the parties who took part in the diligence take part in the underwriting call. Other underwriters are less willing to consider internally prepared diligence reports.
Question: Who should be added as a “knowledge party” to my policy?
Answer: Typically, the primary members of your deal team are added as knowledge parties. As a rule of thumb, even though 30 people within your organization took part in the diligence process, many of them do not belong in the “knowledge” definition. Talk to your broker about putting together a list of the primary deal team.
Question: Does R&W insurance affect the mechanism by which target’s policies are “tucked in”?
Answer: It is fundamental to the R&W coverage that insurance exists at the target. In many cases, the corporate policies at the risk manager’s company will “tuck in” target’s pre-close exposure, but a tail policy will be required in some cases. Your broker should be able to help you plan and explain to the R&W underwriter.
Question: How do I choose the right Reps and Warranties broker?
Answer: Check out this recent blog post by my colleague, Josh Warren. In this post, Josh outlines the key questions risk managers should be asking themselves when selecting or evaluating their broker.
About the author:
Matt Somma is a Vice President in the ABD M&A Advisory Practice. Matt focuses on Transactional Risk solutions such as Reps & Warranties, Tax Liability, and Contingent Liability. Prior to joining ABD, Matt was a corporate attorney specializing in M&A and project finance, as well as a Transactional Risk Underwriter. As an attorney, Matt was Of Counsel at Hunton Andrews Kurth LLP, where he represented private equity sponsors and energy project developers in M&A and project finance transactions. Matt also served in an in-house capacity as M&A counsel to the Corporate Development team at Nielsen Holdings Plc (NYSE: NLSN). Matt began his legal career at Paul Hastings LLP and Locke Lord LLP, where he handled middle market M&A, commercial lending, and bankruptcy matters. He can be reached at firstname.lastname@example.org or 203-585-3552.