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Reps & Warranties Insurance
Reps & warranties (R&W) insurance is a specialized type of insurance that protects buyers and sellers in mergers and acquisitions (M&A) transactions from financial losses due to breaches of the representations and warranties made in the purchase agreement. This insurance is a critical tool for facilitating M&A deals by bridging the gap between a seller’s desire for a clean exit and a buyer’s need for protection against unforeseen liabilities.
What Is Reps & Warranties Insurance?
Reps & warranties insurance is a powerful tool in M&A that provides a layer of financial protection against inaccuracies in the representations and warranties made by a seller to a buyer. This coverage can protect either the buyer (as a buyer-side policy) or the seller (as a seller-side policy), though buyer-side policies are far more common.
An R&W policy is distinct from other types of business insurance, such as general liability, because it is designed specifically for M&A transactions. While a general liability policy protects a company from lawsuits related to its operations, an R&W policy covers the financial fallout from a seller’s misrepresentations in a deal.
For example, imagine a company being sold makes a representation that it has no undisclosed lawsuits. If, after the sale closes, a major lawsuit is discovered, the buyer could face significant financial loss. An R&W policy would kick in to cover this loss, protecting the buyer and preventing the need to claw back funds from the seller.
Reps & Warranties Coverage
R&W insurance is not legally required, but it is a critical component of most modern M&A transactions. The policy can cover a wide range of misrepresentations, and its use has become standard practice, especially in private equity-backed deals.
Who Needs Reps & Warranties Insurance Coverage?
The parties that can benefit from this coverage are diverse:
Financial Sponsors
Private equity firms and other financial sponsors use R&W insurance to protect their investments and ensure a clean exit from a portfolio company.
Strategic Buyers
Companies acquiring another business to expand their operations can use R&W insurance to mitigate the risk of undisclosed liabilities.
Corporate Sellers
Companies divesting a subsidiary or a business unit can use a seller-side policy to cap their post-closing liability and facilitate a clean break.
Family-Owned Businesses
Owners of a family business can use R&W insurance to avoid potential post-closing claims and ensure the sale proceeds are fully distributed.
What Does Reps & Warranties Insurance Cover?
While you’ll need to consult the specific policy documents to confirm your coverage, here are a few scenarios that are typically covered:
Financial Statement Misstatements
Covers losses resulting from inaccuracies in the target company’s financial statements.
Tax Liabilities
Protects against undisclosed tax liabilities or a breach of tax-related representations.
Legal & Regulatory Compliance
Covers losses if the target company was not in compliance with relevant laws or regulations.
Undisclosed Contracts or Leases
Protects against losses from material contracts or leases that were not disclosed in the due diligence process.
Reps & Warranties Insurance Policy
R&W insurance covers:
How Can I Manage My Reps & Warranties Policy and Risks?
Navigating an R&W policy is essential, as this coverage is a highly customized and negotiated product. The cost of your policy is tied directly to the specifics of the M&A transaction, which is why a thorough due diligence process is the best way to secure a favorable policy.
This strategy includes a comprehensive review of the target company’s financial statements, legal contracts, and operations. The more due diligence a buyer conducts, the more confident the underwriter will be in the representations and warranties, which can lead to lower premiums. If a covered breach is discovered after the deal closes, the R&W policy will step in to cover the financial losses, protecting the buyer’s investment and ensuring the seller’s proceeds remain intact.
What Does a Reps & Warranties Policy Not Cover?
Like all insurance policies, R&W insurance has exclusions. For example, it doesn’t cover the following claims:
Remember, R&W insurance focuses purely on protecting buyers and sellers from financial losses stemming from a breach of the representations and warranties made at the time of the deal.
Reps & Warranties Insurance Cost
The cost of an R&W policy depends on several factors, including the transaction size, the industry, the due diligence process, and the policy’s coverage limits. Premiums are typically very affordable when compared to the value of the deal and the potential financial losses from a breach.
Reps & Warranties Insurance Cost Factors
Premiums are a function of the risk the insurer is taking on, as well as the amount of coverage you desire. Deals with a thorough due diligence process and a clean history will have lower rates than those in a high-risk industry or with a history of claims.
How carriers determine premiums depends entirely on the specifics of the transaction, for example:
- Transaction Size: The total value of the deal is a major factor, with premiums typically a percentage of the policy limit.
- Due Diligence: The quality and scope of the due diligence performed by the buyer will directly impact the premium.
- Industry: Certain industries, such as technology or healthcare, may have higher premiums due to the unique risks involved.
- Retention/Deductible: The amount of risk the buyer is willing to retain will impact the premium.
Additionally, many major insurers will customize an R&W policy, which impacts the premium. Some of the most prominent enhancements include:
- Tailored coverage for specific risks identified during due diligence.
- Policy extensions for post-closing indemnification.
Reps & Warranties Insurance Claim Examples
During due diligence, a seller represents that all taxes have been paid and all filings are up to date. After the deal closes, the buyer discovers that the target company has a major undisclosed tax liability from a prior year. The R&W policy would cover the financial loss from this breach.
A buyer purchases a company based on financial statements that show a certain level of revenue and profitability. After the deal closes, it is discovered that the revenue was inflated due to improper accounting. The R&W policy would cover the buyer’s financial loss from this misrepresentation.
The seller represents that a major customer contract is in good standing. After the deal closes, the buyer learns that the contract was terminated prior to the deal closing, resulting in a significant loss of revenue. The R&W policy would provide coverage for the financial damages.
During due diligence, a seller represents that all taxes have been paid and all filings are up to date. After the deal closes, the buyer discovers that the target company has a major undisclosed tax liability from a prior year. The R&W policy would cover the financial loss from this breach.
A buyer purchases a company based on financial statements that show a certain level of revenue and profitability. After the deal closes, it is discovered that the revenue was inflated due to improper accounting. The R&W policy would cover the buyer’s financial loss from this misrepresentation.
The seller represents that a major customer contract is in good standing. After the deal closes, the buyer learns that the contract was terminated prior to the deal closing, resulting in a significant loss of revenue. The R&W policy would provide coverage for the financial damages.
Insurance Brokers For Reps & Warranties Insurance
Founder Shield is a data-driven insurance brokerage serving high-growth, innovative industries. We have a passion for creating and developing innovative risk management products across emerging industries and work hand in hand with clients and underwriters to ensure transparency, efficiency, and reliability every step of the way. Our team has specialized expertise and experience in providing R&W insurance services.
We partner with the leading professional liability insurance carriers to craft tailored risk management programs for public companies and venture-backed companies preparing for funding rounds. With R&W insurance a major budget item, we understand that companies look for new and creative solutions to help manage increasing costs while also securing best-in-class coverage.
Reps & Warranties Insurance FAQs
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