Transaction Liability Private Enterprise insurance (TLPE) is taking the lower middle market M&A world by storm.
Unlike traditional R&W insurance, TLPE is a Sell-Side policy where the Seller, rather than the Buyer, is the policyholder. The policy is triggered when the Buyer makes a claim against the Seller. Instead of going after the Seller directly, the Buyer simply collects from the insurer.
Sellers benefit from this insurance as well, with TLPE effectively reducing escrow levels in deals from 10% to 1% of the purchase price. (The cost of TLPE is only $10,000 to $20,000 per $1M in Limits.) You can check out a great case study of TLPE coverage being used by a Strategic Buyer here.
But there is a downside to TLPE…
TLPE, like all Sell-Side transaction liability policies, has an inherent weakness.
If the Seller does not disclose something to the Buyer intentionally, that known item is excluded and not covered by the TLPE policy.
This is the polar opposite of Buy-Side policies, where if the Seller commits fraud or intentionally doesn’t disclose an issue, the Buyer is still covered because they are the policyholder.
This key difference has made some Buyers suspicious, and reluctant to go with Sell-Side policies that might exclude Seller breaches. Let’s say, TLPE insurance isn’t the first choice of many to cover their transactions. They’d prefer to keep a chunk of the Seller’s proceeds in escrow.
But understandably, Sellers have been all over TLPE coverage because it offers protection, reduces the amount held in escrow, is easy to qualify for, and has a low cost.
Enter a new insurance product to save the day…
The Nondisclosure Policy, as its creator, CFC Underwriting, puts it “covers the Buyer for loss as a result of a breach of Seller’s representation caused by the Seller’s nondisclosure of known matters.”
As you can see, this new coverage fills the whole left by TLPE quite nicely.
The cost is a $10,000 premium per $1M limit, plus a $500 policy fee. And if the Seller gets a TLPE, the Buyer can then seek a Buy-Side Nondisclosure Policy.
Then, in the event that the Seller does not disclose a bad thing in their history intentionally, the policy pays. There is no deductible.
To be clear, unlike other Representations and Warranty-type policies, the Nondisclosure coverage states that if the Buyer suffers a breach and the TLPE coverage excludes it because it was prior knowledge of the Seller… the insurer will pay. However, the Buyer must give subrogation rights to the insurer, so they can then go after the Seller.
A breach could be something as simple as out of date license or permit. Or a past indiscretion that seemed minor at the time and was felt to be a nothing issue not worth bringing up… and then it blows up big time. Of course, an innocent Seller has nothing to worry about and there’s no risk to them.
The Nondisclosure Policy helps both parties with these claims.
Please understand that this specialized coverage does not insure intentional fraud, simply issues not disclosed intentionally by the Seller.
No insurance company will willingly insure against fraud. It’s a moral hazard. However, the Buyer isn’t committing fraud, they are suffering from fraud. Buyers get protection from fraud with a traditional R&W policy. Insurers are willing to do this because diligence is so thorough it’s hard for Seller to hide something.
However, in a Sell-Side TLPE policy, much less diligence is done. If a Seller chooses to withhold key information, the Underwriters might not catch it. That’s why they don’t pay these claims. And then the Buyer is out of luck.
Again, that’s where the Nondisclosure Policy kicks in. And it’s important to note that the Seller must have TLPE insurance in place before the Buyer can seek this other coverage to protect themselves.
It’s cheap and the Policy Limit can go to $20M, with a six-year policy period.
When you have TLPE coverage in the deal, it’s a good idea to throw in a Nondisclosure Policy as well. Policies can be issued within 24 hours of submission…in conjunction with the TLPE Policy.
As far as who pays, this is negotiable. But for many Sellers, it’s worth footing the bill to dissuade the Buyer from holding back a portion of their proceeds in escrow. The Buyers have the leverage here.
I understand TLPE inside and out. As this new insurance product has rolled out, it is becoming a go-to for many of the smaller deals out there and something I’ve been specializing in.
Please contact me, Patrick Stroth, for more information on TLPE and other M&A insurance options.
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