Inside Representations & Warranties Insurance for Mergers & Acquisitions

Representations & Warranties Insurance (RWI) has become an increasingly popular purchase among private equity sponsors and strategic acquirers in mergers and acquisition (M&A) of privately held companies. RWI offers protection against financial losses, including costs associated with defending claims, for certain unintentional and unknown breaches of the seller’s representations and warranties made in an M&A purchase agreement.

An M&A purchase agreement includes representations and warranties by the seller – these are statements of past, present and at times future facts regarding the status, business, assets, liabilities, properties, condition, operating results, operations and prospects of the seller. These representations will cover subjects related to capitalization and ownership; financial statements; inventories; real property; intellectual property; material contracts; tax matters; environmental, health and safety compliance with the law; customers and suppliers; product warranties; product liability; insurance; and much more. For example, the seller of a company may represent that the company’s underground storage tanks are in good repair.

Part of the purchase agreement includes a provision that, if sometime in the future after the M&A transaction is completed there is a breach in one of the reps or warranties, the seller will indemnify the buyer (subject to caps, exclusions, and time limits) for the breach. This indemnity has been traditionally backed by an escrow of a portion of the proceeds, which is payable at the closing (typically 10% to 15% for one to two years). The increased demand in RWI over the last several years provides a viable alternative to escrow funds and has changed this traditional structure and the need to tie up significant monies in escrow.

How RWI Works

A buyer or a seller can purchase RWI, however, the “buy side” policy is more prevalent in the marketplace. The policy limit is typically a dollar amount equal to approximately 10% of the Enterprise Value (EV), or purchase price, of the company. If a company is purchased for $100 million, this translates to $10 million of coverage. There is a retention or deductible of 1% of the purchase price of the company, which is typically split between the buyer and seller; in this example the retention is $100,000. The premium payment is a one-time fee (typically ranging between 2.5% and 3% of the amount of coverage purchased, depending on the size and risk of the deal) paid up front. The policy term is typically three years for general representations and six years for fundamental and tax-related representations. 

Every policy is manuscript-based and fully negotiated depending on what is specifically outlined in the purchase agreement. 

Although the average RWI policy covers deals in the $150 million EV or more range, at Owens Group, we focus on providing RWI for middle-market transactions, deals that represent less than $150 million EV. 

Recently, for example, a private equity sponsor for which we assisted placement of RWI on an acquisition it made last year needed another policy for an add-on acquisition it was making. Even though the add-on target only had an EV of $20 million, we were able to secure $5 million of coverage for the typical minimum premium of $120,000. 

For more information about how we can assist you with RWI coverage, please contact Joe Ehrlich at 201-408-3512 or Dorene Stockman at 201-408-3504.