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Middle Market Mergers and Acquisitions by Colonnade Advisors

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:

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.