Many Canadian companies’ approach to financial growth is through acquisitions and mergers (M&A). According to Bennett Jones , in Canada, there is an appetite for acquisition growth, but with caution; and there is no longer an attitude of buying at all costs. But the trends forecast leads to a “not when, but if” trend to increased M&A activity. This trend is driving the increased use of Representations & Warranties insurance (RWI)
With rising interest rates, inflation, a recession on the horizon, and global uncertainties, companies need to enter acquisitions with caution. One way to mitigate risk in an unpredictable global economy is to apply principles of risk management and have a Representations and Warranties insurance policy.
In 2019 Forbes reported, “There is a significant emerging trend in the use of M&A representations and warranties insurance in mergers and acquisitions of privately held companies. Both strategic acquirers and private equity buyers have gotten increasingly comfortable in using such insurance for their acquisitions, providing meaningful benefits to both the buyer and seller in an acquisition.” Since that time, the use of Representation and Warranties has increased. And with proven case studies, this insurance is critical to expanding business through M&A.
What is Representations & Warranties Insurance?
RWI is an insurance policy used in mergers and acquisitions to protect against losses arising due to the seller’s breach of certain representations in the acquisition agreement.
Normally the process starts with the buyer (and sometimes the seller) obtaining quotes from an insurance broker who specializes in Representations & Warranties insurance. The process requires key information and supporting documentation regarding
- Parties involved: buyer, seller, legal and financial advisors.
- Coverage sought: sales and purchase agreement and a high-level overview of what is being sold.
- Buyers’ due diligence report: details on sellers’ disclosure statement connected with the acquisition agreement.
Real life examples of how RWI works to protect the parties involved
Often through the course of a negotiation, material changes can occur in a seller’s business that can affect the outcome of the deal and future exposures and revenue forecasts. These can include:
- A substantial change in key customers relationships
- Breach of material contracts
- Compliance with laws
- Indemnity obligations
- Tax exposure
- unordered list item one
- Unknown litigation
- Breach of the sales and purchase agreement
- Financial loss post close
- Financial statement unknowns
The advantages of Representations and Warranties Insurance
R&W is used to shift certain transaction-related risks from buyers or sellers to a third-party insurer. It is a win-win for both buyers and sellers.
- The buyer’s bid may be more attractive to a seller if there is limited, or no escrow or holdback required since the buyer will rely on the insurance for indemnification protection.
- The use of Reps & Warranty insurance simplifies and can accelerate the negotiation process.
- Defends the buyer if sued by a third party for loss resulting from the seller’s breach.
- Eases the ability to collect on the sellers’ indemnification.
- Reduces holdback by allowing a lower than customary indemnification.
- Extending the duration of representations and warranties, buyers gain additional time to detect and report problems.
- Protects relationships with the sellers or executives who may be staying on.
How is Representations & Warranties priced?
Once the insurer has reviewed the documentation and completed their due diligence the specific terms of the policy will be negotiated, such as the scope of losses included within coverage and the items excluded from coverage. Premiums are calculated on a percentage of the coverage limits. The good news for buyers, is more underwriters are in the R&W arena, so costs have dropped in recent years. Additional costs may include an underwriters fee based on the complexity and the value of the acquisition, premium taxes, and a brokerage fee.
-
- FACTS: According to AIG the top incidents by breach type;
Financial Statements 21%
Tax 19%
Compliance with laws 16%
Material Contracts 12%
- FACTS: According to AIG the top incidents by breach type;
The future of RWI
According to The Lawyer Daily: RWI Insurance, Today, Tomorrow, and Beyond, the following are predictions for RWI:
- Increased penetration into the Canadian M&A market – specifically increased use of RWI in private deals.
- Industry sector focus and impact on RWI – increase in use of RWI, in sectors where RWI was less common
- RWI carriers will likely expand their critical review and assessment of cybersecurity and data privacy matters
Reliance Insurance has a wide variety of experts to help you with your M&A due diligence. We will work with your legal and financial teams to get the correct RWI policy in place for your next acquisition.
