Oct 30, 2020
In this episode, Gina Cocking and Jeff Guylay continue their
discussion on deal structuring.
Today, we explore reps and warranties ("R&W") insurance. In
this episode, we cover:
· What is R&W insurance?
· What is the pricing of R&W insurance?
· What is the process to obtain R&W insurance?
Key takeaways from this episode:
· R&W insurance is a tried and true product, and securing it
will not slow down the pace of a deal
· Smaller deals, down to $10 million in size, can still get R&W
insurance
· R&W insurance is a great way for a seller to get more cash at
close, rather than having 10%+ of the purchase price tied up in a
multi-year escrow
Other episodes in our series about deal structuring include price
and terms, earn outs, rollover equity, and roll ups.
Later in this episode, Gina is joined by our guest Mike Wolf, who
specializes in R&W insurance at Willis Towers Watson's M&A
Group.
In this episode, Colonnade Advisors addresses the following
questions as related to R&W insurance:
What is R&W insurance? (00:27)
Jeff: "R&W insurance insures the seller and buyer from a breach
of representation and warranties in the purchase agreement. "
What is the difference between R&W insurance and an escrow?
(01:27)
Jeff: "R&W insurance avoids utilizing an escrow. An escrow is
deferred consideration that is withheld to make sure that these
reps and warranties survive and that they are fulfilled
post-transaction."
How often is R&W insurance used in transactions? (02:38)
Jeff: "R&W insurance is a relatively new concept in the M&A
world."
Gina: "It really came into being about seven years ago. Now, it is
used in almost 95% of all transactions."
What is the purpose of R&W insurance? (02:48)
Gina: "In a purchase agreement, there's always a section called
reps and warranties regarding the company and the seller. The
seller has to represent fundamentals such as that the organization
is in good standing, is licensed in the state, and the sellers have
the authorization to do the transaction and have the consents.
"
What are other typical reps and warranties in the purchase
agreement? (03:45)
Gina: "There is usually a representation that the capitalization is
correct, all subsidiaries are listed, the financial statements are
in GAAP or other accounting standards used, there is an absence of
undisclosed liabilities, the contracts are true and all have been
disclosed, all obligations to related parties have been disclosed,
all real property has been disclosed, all intellectual property has
been disclosed, listed, and truthfully identified, litigation has
been disclosed, privacy and data security representations are made,
taxes have been paid, and employees and labor matters have been
disclosed."
What is the typical coverage amount? (06:12)
Gina: "The coverage is typically 10% to 15% of the purchase price.
For deals under the size of $50 million, the coverage percentage
may go up.”
What is the typical premium for R&W insurance? Are there any
other fees? (07:11)
Gina: "Typically, we see premiums between 3% to 5% of the coverage
amount. Economically, it does get cheaper with more coverage. Small
deals are more expensive on a percentage basis; larger deals get a
break. Another fee is the underwriting fee charged by the insurer,
typically around $50k."
Who pays for the R&W insurance? (08:50) (13:29)
Gina: "This is where the negotiation comes in. Everybody has a
different view. The buyer wants the seller to pay; the seller wants
the buyer to pay."
Jeff: "It is really a buyer's policy. No matter who is paying the
premium or who is paying their share of it, it is the property of
the buyer."
Why do buyers prefer R&W insurance versus an escrow?
(09:51)
Gina: "Buyers do like R&W insurance. A breach of a
representation and warranty can cause a lot of conflict between the
seller and the buyer when there is an escrow, especially when the
seller is continuing to manage the company. It's easier if there is
a breach of representation and warranty and the buyer goes to the
insurance--no conflict."
What is Colonnade's typical process in representing sellers to
negotiate who is paying for the R&W insurance? (11:02)
Gina: "At Colonnade, when we ask for the indications of interest,
the letters of intent, or bid letters, we ask the buyers to
indicate whether they are going to pay the premium for the R&W
insurance. Some buyers will pay the full amount, some won't, and
some will pay a portion of it. It is a negotiated point. Another
negotiated point is who pays the underwriting fee."
What is the process of obtaining R&W insurance? (12:26)
Gina: "The process starts very early. It starts when the seller is
picking their legal counsel. It is important that the seller has
legal counsel that has experience with R&W insurance. Also, the
seller or buyer will need a broker."
Why is the broker's role in obtaining R&W insurance?
(13:37)
Gina: "The broker will work with multiple insurance companies to
get the best rate and the best coverage.”
At what point during the transaction process should buyers or
sellers speak with a broker? (13:37)
Gina: "The proper time to speak to a broker is once the LOI has
been signed and you have entered the exclusivity period."
Generally, how long does it take to obtain the R&W insurance?
(15:31)
Gina: "Generally, it takes only one to two weeks to get through the
underwriting process. For a 60-day exclusivity, contact the broker
day one of 60 days, but probably around day 30 or day 35 is when
the representation and warranty process in terms of getting the
coverage starts."
Jeff: "The timing is really important. Brokers and carriers are
pretty aggressive these days, so they will move pretty
quickly.”
Who are the dominant carriers and brokers for R&W insurance in
recent years? (19:19)
Gina: "For brokers, two that I've seen a lot are Willis Towers
Watson and Lockton. There are many carriers, including AIG, Zurich,
Hartford, Allied, and Berkshire. The brokers will know who the
right carrier is for the right types of companies.”
Gina invites Mike Wolf, who specializes in R&W insurance at
Willis Towers Watson's M&A Group, to share his insights.
What is the typical cost of R&W insurance? (21:40)
Mike: "Similar to other insurances, there is the premium, which is
usually 2.6% to 3.3% of the limit purchase. Second, there is the
underwriting fee, which is generally $30,000 to $50,000. Third,
there are surplus lines, taxes, and fees, which is another 2% to 5%
of the premium. Lastly, there is a fee to the broker to facilitate
these products."
What items are not covered by R&W insurance? (25:21)
Mike: "There are the standard exclusions such as asbestos and PCBs,
underfunded pension plans, certain types of NOLs and tax
attributes. Right now, COVID-19 has become an interesting
exclusion. Transfer pricing is sometimes an exclusion. In addition
to the standard exclusions, there are deal-specific exclusions.
Deal-specific exclusions arise either at the stage of getting the
quotes or during the underwriting process."
What are the common things that come up during underwriting?
(30:38)
Mike: "It depends on what the target does. The common themes are
wage and hour, employee independent contractor issues, SLSA issues,
anti-corruption and bribery."
What size deal is too small for R&W insurance? (32:15)
Mike: "Everybody will tell you something different, but I think $10
million."
What is the typical brokerage process? (36:15)
Mike: "Phase one is going out and getting the quotes, which doesn't
take very long, and we don't charge any money for that. The first
non-refundable fee is once the client selects an insurer, which is
when the process really gets started."
Featured guest bio and contact information:
Scott Wolf:
Email: scott.wolf@willistowerswatson.com
Scott Wolf is a Client Relationship Director at Willis Towers
Watson. Scott specializes in assisting strategic and financial
buyers and sellers with transactional insurance, including reps and
warranties insurance, tax insurance, and contingent liability
insurance. Since joining Willis Towers Watson in 2017, Scott has
worked on over 100 transactions involving representations and
warranties insurance, ranging in enterprise value from
approximately $9 million to $3 billion. Scott's prior experience
includes working as an associate at DLA Piper, an associate at
Gould & Ratner, and an associate at Kirkland and Ellis.
Host Information:
Gina Cocking:
Gina Cocking serves as the Chief Executive Officer of Colonnade
Advisors. She returned to Colonnade as a Managing Director in 2014.
Gina began her career in investment banking at Kidder Peabody, was
an analyst at Madison Dearborn Partners, and an associate at J.P.
Morgan & Co. She was a Vice President at Colonnade Advisors from
1999 to 2003. She left Colonnade to gain operating experience as
the Chief Financial Officer of Cobalt Finance, a specialty finance
company. She went on to become the Chief Financial Officer of
Healthcare Laundry Systems, a private equity-backed company for
which she oversaw the successful sale to a strategic acquirer. Gina
served as the Line of Business CFO – Consumer Banking and Lending
at Discover Financial Services. Gina serves on the Board of
Directors of CIB Marine Bancshares, Inc., a bank holding company
based in Waukesha, Wisconsin, that operates banking offices in
Illinois, Indiana, and Wisconsin. Gina received her BA in Economics
and an MBA from the University of Chicago. Additionally, Gina holds
the Series 24, 28, 79, and 99 securities licenses.
Jeff Guylay:
Jeff Guylay is a Managing Director of Colonnade Advisors. Prior to
joining Colonnade in 2000, Jeff was an investment banker at J.P.
Morgan in the firm's Mergers & Acquisitions and Fixed Income
Capital Markets groups in New York. He also spent several years in
J.P. Morgan's Chicago office. Jeff has over 20 years of M&A and
investment banking experience and has served as lead execution
partner on over 25 M&A and financing transactions at Colonnade.
Jeff received an MBA from Northwestern University's Kellogg
Graduate School of Management and a Master of Engineering
Management from the University's McCormick School of Engineering.
Jeff received a BA from Dartmouth College and a BE from Dartmouth's
Thayer School of Engineering. Jeff holds the Series 7, 24, 63, and
79 securities licenses. Jeff serves as a director of the non-profit
Nurture, an organization dedicated to enhancing the nutrition and
wellness of children and families.
About the Middle Market Mergers & Acquisitions Podcast
Get the insiders' take on mergers and acquisitions. M&A
investment bankers Gina Cocking and Jeff Guylay of Colonnade
Advisors discuss the technical aspects of and tactics used in
middle market deals. This podcast offers actionable advice and
strategies for selling your company and is aimed at owners of
middle market companies in the financial services and business
services sectors. Middle market companies are generally valued
between $20 million and $500 million.