Amid the COVID-19 pandemic, the mergers and acquisition (M&A) landscape has changed drastically. It’s not only business and market uncertainties causing massive upheaval as in the dot-com bubble or the Great Recession. The entire due diligence process is metamorphosing. As a result, the demand for representations and warranties (R&W) insurance has surged. This post offers a closer look at the factors influencing the M&A landscape and the part R&W insurance plays.
What Is Representations and Warranties Insurance?
Companies are bought and sold every day, making M&As nothing unique in the business world. Every year more companies are involved in a merger or acquisition. Not only does this “joining forces” approach strengthen many businesses, but it opens the door to plenty of expensive lawsuits relating to corporate transactions.
Representations and warranties insurance protects buyers and sellers from costly litigation by covering legal fees and settlements. On the one hand, suppose a seller’s representation was inaccurate, and that misrepresentation caused the buyer financial loss. On the other hand, consider if a buyer sued the seller, claiming a breach in the agreement terms. R&W insurance covers:
- Breaches of the purchase agreement
- Pre-closing tax indemnities
- Seller fraud
R&W insurance often makes a buyers’ bid appear more attractive. It can also extend the time for duration and enhance protection. Buyers benefit from this coverage because it usually improves the deal’s conditions and ensures a cleaner exit while offering more extensive coverage sans the many qualifiers. Both parties favor R&W insurance as a negotiating tool, mainly because it can speed up the entire process.
Why Is R&W Insurance In High Demand?
As mentioned, the COVID-19 pandemic has altered the M&A landscape in addition to nearly every portion of our lives. What’s more, the social distancing and face-to-face restrictions have carved out their set of problems for businesses hoping to buy or sell. Let’s explore three reasons why the demand for R&W insurance is surging.
1. Litigation Environment
The legal environment surrounding M&As is red hot. Some professionals believe that the increase in litigation is due to our litigious society. Others chalk it up to the disruptive COVID-19 pandemic. We fall somewhere in the middle, voting that both factors contribute to the current M&A litigation environment.
Keep in mind; corporate transactions occur with small private companies and multinational public companies alike. From tens of thousands to deals mounting more than $100 billion, each transaction faces unique challenges and risks.
Unfortunately, the 2020 pandemic has presented M&As with plenty of hoops to jump through, such as uncharted representation and warranties issues, the lack of in-person deal sessions. The “getting everyone in the same room” approach has been highly unsuccessful, and it’s created loads of uncertainties and hold-ups. Not only do these problems ripen the environment for costly litigation, but they inhibit companies from moving forward on deals. Consider Xerox dropping the $34 billion deal offer for HP, for example.
2. Collateral Instrument Substitute
As mentioned, the M&A environment typically favors sellers — and it always has. In fact, R&W insurance was first created as another way to protect sellers. Over the years, though, it’s transformed into a helpful product for buyers.
But let’s back up; financing a loan for an M&A deal is no small feat. After all, no money means no deal. Although pools of capital are increasing, it’s an ongoing challenge to secure innovative financing for M&A deals. On that same note, leveraging a corporate transaction also presents complicated challenges. But solutions are surfacing, namely R&W insurance policies.
For example, collateral instruments are most often Letters of Credit or Performance Bonds. Nowadays, buyers can use R&W insurance as an alternative collateral instrument. Of course, R&W coverage works better in some contracts than others, but it’s being considered as a more viable option.
3. Affordable Option
Although buyers and sellers need protection during corporate transactions, it’s safe to say that the M&A environment is mostly seller-friendly. Buyers have historically had limited insurance choices: self-insure or buy an R&W insurance policy.
Fortunately, many factors have put pressure on the market, pushing prices down and encouraging broader insurance coverage. Not only does this trend make R&W insurance more affordable, but it offers more protection with fewer exclusions. In short, it’s one of the best options (especially for more significant deals) as opposed to the traditional approach of escrow holdbacks.
Is R&W Insurance Right for You?
Deciding whether to self-insure or purchase an R&W policy might seem like a tough choice. Several factors weigh into your decision, including your risk-appetite, transaction details, industry, etc. It’s beneficial to team with a seasoned insurance professional who knows the market and your unique situation.
After recently closing one of the most dreadful years this century, 2020 has taught us that unexpected events occur, and we aren’t always immune to catastrophic loss. M&A deals go sour sometimes, and it’s often because something or some event reduces the value of the buyer’s investment. However, R&W insurance was developed to cover these types of devastating losses. As a result, it only makes sense to evaluate situations on a per-case basis.
Understanding the details of what coverage your company needs can be a confusing process. Founder Shield specializes in knowing the risks your industry faces to make sure you have adequate protection. Feel free to reach out to us, and we’ll walk you through the process of finding the right policy for you.
Want to know more about R&W insurance? Talk to us! You can contact us at firstname.lastname@example.org or create an account here to get started on a quote.