Case Study: A Strategic Buyer and TLPE Insurance
It took years for Representations & Warranty insurance (R&W) to gain the trust of the M&A community.
For years, lawyers argued that nothing was more sure than cold- hard cash sitting in an escrow account.
But PE firms, seeing the value of R&W’s ability to successfully transfer risk at a reasonable cost propelled the use of R&W to where it’s present in far more deals than not.
It’s puzzling that it took so long to transition to TLPE insurance when you consider all the benefits this coverage provides.
The Buyer can recover any losses from a breach of the Seller reps without doing so at the expense of the Seller. The Buyer simply makes a claim with the insurer. Plus, the cost is discounted significantly or is nullified because the Seller will eagerly cover it rather than incur a large escrow.
Sellers love it because they take home more cash at closing and the indemnification risk is transferred to a third party – the insurance company, resulting in a free exit. Plus, they have zero fear of future claims if there is a breach.
I believe that just as R&W coverage has gone “mainstream” and is now a go-to in M&A transactions, the same will eventually be said of the newest R&W product: Transaction Liability Private Enterprise (TLPE).
TLPE insurance is designed specifically for sub-$20M EV transactions, which are generally not eligible for R&W. A policy retention with TLPE in place is only 1% of enterprise value or $10,000, whichever is higher.
It is a Sell-Side R&W policy where the Seller, rather than the Buyer, is the policyholder. TLPE policies are triggered when a Buyer brings a written demand for damages from the Seller.
Some Buyers are concerned about collecting from TLPE policies, citing lack of control, as compared with Buy-Side R&W policies. In many cases, the Buyer is hundreds of times larger than their target and looks to use its leverage to compel their target to forego TLPE and either secure R&W insurance or accept an escrow.
Here’s a scenario our firm just worked through that serve as an ideal case study of TLPE coverage in action:
A sizable Strategic Acquirer wanted to buy a media technology company with a $10M EV. The Buyer, primarily, wanted to acquire the target’s highly talented team. Although the asset values and IP were well-vetted, and the true goal was an acqui-hire, the Buyer insisted on a $1M (10%) escrow.
When presented with the TLPE coverage proposal, which offered coverage for the full $10M purchase price, the Buyer found reason after reason to resist the proposal. Finally, the Buyer countered and told the target to secure a traditional Buy-Side R&W policy, which they would consider.
In our response to the Buyer’s demand, we countered that TLPE insurance would be preferable to R&W coverage for both parties. Here’s our reasoning:
- The cost of an R&W policy would amount to more than double the cost of TLPE coverage. This was a non-starter for the Seller, as they would bear the full cost.
- Moving from TLPE to R&W would delay the deal for at least two weeks. At the time, we were looking at a closing in two or three days.
- Responding to R&W Underwriter requests for information would add at least 10 billable hours to the Buyer’s counsel. With TLPE, no underwriting of the Buyer’s diligence is required.
- The Buyer’s team would be tasked with participating in the R&W underwriting call – wasting time and money.
- The Buyer would have to share all their diligence materials with the Underwriters and make their team available for additional queries.
- The Underwriter’s review of the Buyer’s diligence could lead to additional exclusions on the policy—exclusions which would not be present on a TLPE policy
These are not the only merits of TLPE.. Eventually, the Buyer and counsel were satisfied with the TLPE coverage and the deal moved forward with the Seller benefiting from both the enhanced protection and a $900,000 savings on their escrow.
As more TLPE policies are written and this coverage becomes more common, I believe we can avoid the debate between R&W and TLPE coverage. The benefits of TLPE will be clear to both Buyers and Sellers, and soon, this type of insurance will be just as mainstream as an R&W policy.
That’s great news for SME Sellers because TLPE insurance coverage was created for them.
If you have any questions or would like to explore the protection TLPE coverage can provide for your upcoming transactions, please contact me, Patrick Stroth, at email@example.com.