I got a call earlier today… one that I wasn’t exactly happy to receive. But I feel like I should share the situation that I learned about because it showcases the importance of transactional liability insurance to cover M&A transactions.
Here’s the situation…
The caller had sold their industrial supply company in the Midwest for just about $3.5M. But, as the deal neared close, additional inventory, not initially part of the deal, was discovered. Buyer and Seller agreed that this inventory was worth $150,000. And the Buyer suggested that they would pay the Seller in installments of $10,000 over 15 months.
This agreement was documented. And everything was going fine for a year or so.
Then, one month, the Buyer failed to make a payment. The Seller reached out, and the Buyer simply admitted that they didn’t have the money. They commented that they thought the business would be more robust… that it would be doing a lot better.
They also threw in that they felt like it was at least partly the Seller’s fault because, in their view, the Seller hadn’t been totally straight on the financials of the business. In fact, the Buyer planned to look into the situation further to see if the Seller had been hiding something.
As this unfortunate situation unfolded, the Seller reached out to me to talk about Transaction Liability Private Enterprise (TLPE) insurance. If you’re not familiar this is an innovative, relatively new insurance product very similar to Representations and Warranty (R&W) insurance, that is available for deals with a Transaction Value of $1,000,000 to $30M.
While similar to more traditional R&W insurance, TLPE coverage differs in key ways.
One of main ones: TLPE policies are sell-side only, which means they are triggered only when the Buyer brings a claim against the Seller because of a loss caused by a breach of the representations in the Purchase and Sale Agreement. Also, deals can be insured for up to 100% enterprise value.
TLPE insurance can be secured even after a deal has closed – if strict criteria are met. For example, in a similar case from December 2021, I was able to help a client get this coverage for a deal that was even older than that of this caller.
Unfortunately, this particular Seller, thanks to that email notification from the Buyer that they felt something was off and they planned to investigate a potential breach, was no longer eligible. Due to that message, the Seller now had knowledge of a possible breach…any related claims would not be covered by TLPE insurance.
I share this sad story because I want to make sure M&A Sellers understand the protection available to them. With a sell-side TLPE policy in place from closing, if the Buyer had any legitimate claims, they would have sought relief from the insurer. The Seller would not be “on the hook” for anything.
It also underscores the fact that not all Buyers are as sophisticated as you might think. As you negotiate a deal, they may only gloss over the due diligence and not thoroughly vet all the information you’re sharing. As a result, at the end of the day, the Buyer may have different expectations for how this purchase is going to work.
That leaves Sellers stuck with facing Buyer’s remorse. And this remorseful Buyer may feel like they have no alternative but to go after the Seller and clawback some of the purchase price. In some cases, the Buyer simply hits hard times and is looking for someone to blame… some way to recoup their losses… even if it is through no fault of the Seller.
As I say, while it may be too late for this particular Seller who called me, this situation can be prevented with TLPE insurance.
This coverage is particularly important for transactions involving companies under $10M—especially for those under $5M.
If this coverage had been in place for this deal, the Seller would have simply forwarded that email to the underwriters and said, “This Buyer is saying we had a breach of the Seller reps, and we need some protection. We don’t think it’s legit… but they’re coming after us.”
The TLPE coverage would have then swung into action. This is why you buy insurance, after all. A TLPE policy comes with legal defense costs – up to the policy limit – to protect the Seller against allegations made by the Buyer. This is especially important in cases where the Buyer brings frivolous allegations – you don’t want to be on the hook paying your legal costs for no good reason.
Sellers may think they have nothing to hide… that they know everything is on the up and up. But even when it is, that doesn’t stop a Buyer from bringing in allegations… even two or three years post-closing.
That’s why I urge Sellers in this lower middle market to secure TLPE coverage as a matter of routine. TLPE insurance is:
- Affordable, just $15,000 to $20,000 per million in limits.
- Because it is a sell-side policy, the Buyer is not involved at all. No permission needed.
- There is no underwriting fee for TLPE. These policies are underwritten by the Seller completing an application. Underwriters then use that application as a basis for reviewing risk. The underwriting time in TLPE is in most cases a matter of a day or two.
- The retention, or deductible, for TLPE policies is significantly less than a traditional R&W policy.
- The lower deductible enables Sellers to negotiate lower escrows, or withholds, with Buyers. This further increases the amount of cash Sellers get at closing.
Of course, the peace of mind you get with TLPE coverage is priceless.
To get more details on how TLPE might fit your specific deal, be sure to contact me Patrick Stroth, at firstname.lastname@example.org.