Understanding Representations and Warranties and RWI
In an M&A transaction, representations and warranties are statements issued by a seller to a buyer. They disclose material information about the company and its assets, liabilities, and operations. The purpose of representations and warranties is to ensure that the transaction is fair for all parties. Representations and warranties insurance, or RWI, is exactly what it sounds like — an insurance policy that protects the parties involved regarding the accuracy of those statements. However, not every transaction is an RWI deal.
A Non-RWI Deal vs. a RWI Deal
In a non-RWI deal, the seller makes representations and warranties to the buyer with respect to the condition of the business. There are fundamental reps and non-fundamental reps, which you can learn more about here. While there is no insurance policy covering the reps and warranties, there is an indemnification escrow and a basket.
- Indemnification escrow — This is an amount of money set aside with an escrow agent that is paid out for breaches of reps and warranties. It could be anywhere from 5% to 15% of the purchase price depending on the size of the deal.
- Basket — Think of the basket as the deductible in an insurance policy. There are two types: 1) a tipping basket, in which once the claims exceed a certain amount, it “tips” and the buyer can make a claim with the escrow agent back to dollar one, and 2) a deductible basket, in which there is no liability until the collective claims exceed a certain amount.
Ultimately, a non-RWI deal is a more straightforward approach because there is no insurance policy or additional due diligence required by the insurance company. Non-RWI deals are more common with smaller M&A transactions. However, they do not provide complete protection.
In an RWI deal, an insurance policy is purchased — typically by the buyer, but more on this shortly — to provide protection in the event of a breach in the reps and warranties. Unlike a non-RWI deal, there is no significant injection of capital into an escrow account. Instead, only the deductible on the insurance policy is escrowed (think $500,000 instead of $5,000,000). This deductible is referred to as the “retention.” Once claims exceed the retention amount, the insurance policy would pay out up to the policy limit.
- Benefits of an RWI deal — For the seller, taking this approach results in a cleaner deal overall and reduced liability exposure. For the buyer, the benefit of an RWI deal is that they make a claim with the insurance policy provider.
- Noteworthy challenges — While an RWI deal does provide greater protection for both the buyer and seller, it’s important to note that because an insurance policy is being taken out, additional due diligence will be required. Insurance providers will do their own due diligence as well as review the due diligence completed by the buyer. The result is that a deal can take a few additional weeks to close. There are also underwriting costs, which can add to the expense of a deal.
Navigate Your Critical Transaction with Expert Guidance
MelCap Partners supports organizations across numerous industries with their buy-side and sell-side M&A transactions. From helping companies achieve their strategic growth goals to assisting sellers with what is often the most significant liquidity event of their careers, our expert team is proud to guide our clients toward positive outcomes.
To that end, we recommend that organizations navigating an M&A transaction consider using RWI. We have had great success in working with buyers and sellers to split the costs of underwriting, the retention, and the premium to make the transaction more equitable and fair for both parties. From there, we assist with the due diligence process and advise our clients — whether buyer or seller — to make the best decisions possible for the best possible results. Learn more about our experience in executing successful transactions here, and browse our recognitions and awards for those transactions here.