Although representation and warranty insurance (RWI) is an insurance and risk allocation product that has been available for over a decade, the Canadian M&A deal market has not previously embraced it to the same extent as the U.S. market. However, the situation in Canada is changing and if you are purchasing or selling a business, you should consider it when negotiating your deal. In this post, I outline the key considerations, advantages and what to plan for with respect to RWI.
Why the Practice of RWI is Increasing
As the RWI underwriting market continues to mature and become more competitive, it is becoming more widely used and here’s why:
- More underwriters have entered the marketplace. This has resulted in more competition, a more streamlined process, lower premiums and underwriting fees, lower deductibles and more favourable policy terms.
- Today’s competitive M&A market means many purchasers are competing for relatively few deals from a limited number of vendors. As a result, purchasers are looking for a competitive edge to secure the winning bid.
- Vendors want to ensure greater cash proceeds upfront and limit risk and indemnification exposure. By shifting the risk to the insurance company, vendors are able to reduce amounts held back in escrow and ensure larger percentages of the purchase price are secured and not exposed to future potential indemnity claims.
Why Purchasers Should Consider Using RWI
If you are a purchaser, you may want to consider acquiring RWI for a number of reasons including the following:
- Create a More Attractive Bid. If you are in an auction or competitive process, using RWI can make your bid more attractive to the vendor.
- Close Negotiation Gaps. If you and the vendor encounter negotiation gaps regarding indemnity issues, RWI may provide a solution to facilitate the transaction and deal with such gaps.
- Preserve Your Relationship with the Vendor. In situations where the vendor retains an equity stake and continues in an active role with the business (e.g. a private equity firm purchases a controlling interest from the founder and the founder: (i) maintains a minority ownership position; and (ii) is critical to the successful transition/continuation of the purchased business), it will be important to maintain a healthy working relationship with the founder. That relationship can be jeopardized if there are potential indemnity claims; however, with RWI, the risk is transferred to the insurance company. This makes it easier for you as purchaser to focus on the business and maintain your relationship with the vendor.
- Greater Certainty of Funding Indemnity Claims. If the vendor has questionable ability to fund potential indemnity claims and a significant escrow for indemnity claims is not feasible, RWI may provide a workable solution.
Why Vendors Should Consider Using RWI
If you are a vendor, you should consider acquiring RWI for a number of reasons including the following:
- Greater Cash Amounts Up Front. If there is adequate RWI, you will: (i) be able to receive more cash up front; and (ii) have greater certainty regarding the amount of the purchase price that you will be able to ensure is not exposed to potential liability claims.
- Market Demands of Private Equity Stakeholders. If you are a private equity firm, your stakeholders may expect that you will mitigate risks with RWI when selling a portfolio company. Using RWI also facilitates an accelerated return of capital and profits to the stakeholders.
As insurance premiums and underwriting fees continue to decrease and the M&A market continues to adopt RWI, it is becoming increasingly prudent to consider using it to facilitate your transaction, whether as a purchaser or as a vendor.