Representations and warranties insurance “provides insurance coverage for the breach of a representation or warranty contained in a purchase and sale agreement in addition to or as a replacement for contractual indemnity” (dandodiary.com). In today’s challenging environment, we hope that this article will help you win bids and find the means for closing deals.
When should I use reps and warranties insurance?
Deals valued between $20 million and $1.5 billion will benefit the most from reps and warranties insurance. This is based on insurance pricing and the size of a general escrow or indemnity requirement. In addition, the type of deal is important, because you can obtain reps and warranty insurance much easier on a privately owned company than you can a public company. This is because the insurance companies prefer transactions with an identifiable seller who stands behind the representations of the target business over a diverse stockholder base.
Examples for Sellers
If you’re selling a business or assets, the following types of situations may require reps and warranties insurance:
- To decrease sellers liability. If you are a private equity or venture capital seller near the end of your funds life, you’ll want to limit post-closing indemnification liabilities on the sale of a portfolio company so that you can safely distribute deal proceeds to the Limited Partners. When the buyer requests a high cap on potential indemnities or long survival, insurance can help save the deal.
- To remove tax contingency from the negotiations. For tax purposes a seller restructures itself immediately before the closing of a deal. Even though both the seller and buyer’s tax advisors agree that the deal should be reorganized as a tax-free organization during the due diligence phase, the IRS could take a different position. This could result in a significant tax consequence to the buyer. If the seller wants to retire with the proceeds from the deal and does not want to provide an indemnity to the buyer for the potential risk, reps and warranties insurance will remove the risk from the scope of the deal.
- To minimize the successors liability risk. When a buyer purchases assets that remain in the possession of the seller, the buyer would have no control over what the seller does after the closing. In the event the seller does not wish to provide an indemnity, insurance could be put in place to resolve the issue.
In our next blog we’ll discuss how reps and warranties insurance can help buyers.
Call us today for more information or contact us for a free business review.