If you are the owner of a staffing firm considering a sale of your company or a first-time buyer, you may never have heard of Representations and Warranties Insurance (RWI). However, experienced buyers, sellers and M&A professionals know RWI is a frequently used tool for facilitating transactions that can benefit both buyers and sellers.
In every sale of a business, sellers will be required to make specific written statements in the purchase agreement about their businesses (representations) and warrant that those representations are true (warranties). Those representations and warranties usually relate, among other things, to corporate organization, compliance with laws, financial statements and liabilities, customers, contracts, intellectual property, liens, litigation and claims, taxes, employees and benefits. In a typical deal structure, if those representations and warranties are inaccurate, sellers must then indemnify (make whole) buyers for any resulting losses buyers suffer (subject to customarily negotiated survival periods for claims, deductibles, caps and other limitations on recovery).
What Is RWI?
RWI is a form of transaction insurance that is usually purchased by a buyer, although sell-side policies are also available. RWI can be used either to supplement a traditional seller indemnity for breaches of its representations and warranties or to fully replace a seller indemnity. In such a “no seller indemnity” structure, which has become more prevalent in recent years on larger deals, a buyer looks only to the insurance, and not to the seller, to recover losses arising from breaches of seller’s representations and warranties (unless the seller commits fraud).
The use of RWI has become increasingly popular in the past ten years by both private equity and strategic buyers, is the norm in deals over $50 million in value across all industries and transaction types, and is currently available in sales as low as $20 million in value.
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What Are the Benefits of RWI to Sellers?
- Sellers have very limited post-closing exposure for breaches of their representations and warranties (typically one-half of the RWI deductible; subject to agreed-upon caps, certain matters that are excluded from RWI coverage and losses in excess of the RWI coverage amount; and fraud). In a “no seller indemnity” structure, a seller can have no exposure for breaches of its representations and warranties, except for its fraud.
- Sellers do not need to leave a meaningful portion of the sale proceeds in escrow for 12-24 months (escrow amounts are often limited to one-half of the RWI deductible).
- RWI makes negotiation of the purchase agreement easier. Sellers do not need to strenuously negotiate for “qualifiers” to their representations and warranties (such as “materiality” and “knowledge”) since buyers will primarily look to insurance for losses they incur.
What Are the Benefits of RWI to Buyers?
- Buyers can make more competitive offers due to reduced escrow amounts and reduced seller exposure for indemnification.
- Buyers do not have to make claims against or sue sellers who are continuing as members of the acquired company’s management team.
- Buyers can get coverage for greater amounts than sellers might agree to be liable without RWI and for longer time periods than sellers might agree to be liable without RWI. RWI makes negotiating representations and warranties in the purchase agreement easier since sellers, for the most part, will not have to stand behind them.
Availability of RWI on Smaller Deals
RWI is generally not available on deals under $20 million in value for several reasons:
- Underwriters are reluctant to issue policies without certified financials or a quality of earnings report, which smaller businesses may not have.
- Minimum fees (approximately $150,000-$250,000 for insurance coverage, underwriting fees and broker’s fees) can make RWI not cost-effective.
- Additional professional costs for buyers to prepare comprehensive legal, accounting, tax, and insurance due diligence reports required by RWI insurers, and respond to underwriting questions that arise.
- Buyers’ belief that in smaller deals sellers should have “skin in the game” and be responsible to stand behind an indemnity for buyers’ losses.
In today’s competitive M&A market, savvy dealmakers know the importance of using all available tools to get deals done. In transactions above $20 million in value, the benefits of RWI to both sides can justify its cost and help facilitate an amicable sale.
