When looking at options to cover a M&A transaction in the past, we’ve always said that you could either use traditional Representations and Warranty (R&W) insurance or… nothing.
Nothing would often be the case for deal sizes under $20M, where R&W coverage simply does not extend these days except in very special cases.
Now, we have a compelling third option, an innovative Sell-Side policy, for the smaller acquisitions out there. It’s called Transaction Liability Private Enterprise (TLPE). It was created just a couple of years ago by London-based CFC Underwriting but is now gaining ground in a serious way as more M&A players wake up to its potential, especially for covering smaller deals where traditional R&W does not apply.
If you’re a regular Buyer of companies and familiar with Buy-Side insurance and the advantages it offers, you already know the value of rep and warranty to protect yourself in deals. Now you should know that there are certain scenarios, as you’ll see in just a moment, in which these new Sell-Side policies offer even better coverage.
Let’s take a look at an example deal to explore these options in depth.
Consider an e-commerce business of $25M enterprise value.
Coverage
In a deal like this, the most coverage a Buy-Side R&W policy will give you is 20% – which is a $5M limit policy. This would come with a retention of 1% of purchase price, so $250K would likely be held in escrow.
However, a TLPE policy will cover up to the whole $25M. Assuming the terms include a Buyer’s basket of .5% or $125K, there would be NO retention, except for a $20,000 Seller’s retention for defense costs, charges and expenses.
Premium Cost
For a traditional R&W policy the premium rate charged will be 3.75%, or $37,500, per million in coverage. For that $5M policy that works out to $188,000.
With TLPE, the premium rate is, 0.7%, or $7,000 per million. For the $25M policy that comes to $175,000.
That’s $188,000 versus $175,000, which may not seem like a big difference until you remember that the vast difference in Policy Limits (5x the coverage of Buy-side R&W).
Underwriting
With traditional Buy-Side policies, underwriting can take seven to ten days and cost about $50,000.
In TLPE, there is no underwriting fee because… there is no outside underwriting required. They do charge a policy fee, which is $500. The processing time, because there is no underwriting call or diligence reports, is just 24 hours.
It Boils Down to This
In this scenario, the parties have the choice of spending more ($223,000) for a $5M Limit Buy-side R&W policy as compared with the $175,500 on a $25M Limit Sell-side R&W policy. While the Buy-side policy is arguably broader in coverage scope, it provides a fraction (1/5) of the protection available from a Sell-side policy.
Sellers should consider the amount of uninsured risk when only 20% of their transaction is covered under Buy-side R&W as opposed to 100% of the purchase price is covered with the Sell-side policy. There’s always the chance a Buyer may pursue you for losses that exceed their Policy Limits.
The advantages of TLPE are clear. This coverage won’t be right for every deal. But for smaller deals out there, of which there are many, it’s the obvious choice.
If you are a Buyer or Seller of SMBs I would love to chat with you about this innovative coverage option that is TLPE insurance. You can email me, Patrick Stroth, at pstroth@rubiconins.com.