Let me say this loud and clear right now:
Every Buyer of a sub-$30M EV target should insist on a sell-side Representations and Warranty (R&W) insurance policy from their counterparty.
This might sound strange. And I know that you’ve probably encountered many Buyers who are reluctant or resistant to the idea of even considering a sell-side insurance policy. After all, the Buyer is not insured under this coverage. The name on the policy is the Seller’s.
A sell-side policy is only triggered when the named insured (the Seller) receives a demand from the Buyer saying there has been a breach and they have suffered a financial loss.
At that point, the Seller will notify the underwriters of that breach. And the underwriters will reach out to the Buyer to negotiate the claim. Straightforward and simple.
So why do I consider it to be so important that Buyers insist on this coverage for lower middle market deals?
Because I consider a sell-side policy to be, in practice, simply the mirror version of a buy-side policy. And sell-side coverage is ideal for those deals that are actually not eligible for traditional buy-side insurance because they are too small or the cost of coverage is prohibitively expensive.
Here’s what I tell reluctant Buyers so they understand all the benefits to this type of coverage – what’s in it for them essentially.
- The policy can incur no cost to the Buyer.
- Unlike buy-side policies, sell-side insurance requires no underwriting fees or underwriting calls.
- Unlike buy-side insurance, there are no extensive third-party requirements for outside diligence to be performed by the Buyer.
- Because the Seller is the named insured on the policy, it is very easy to have the Seller bear the full cost of the coverage. And it’s not a big ask because sell-side insurance is relatively cheap. It will run you $10,000 to $15,000 per million dollars of coverage, which is a fraction of the cost of buy-side R&W insurance.
- With sell-side coverage, there is no deductible for the Buyer on settlement in case of a breach. The policy comes with a $20,000 retention for costs, expenses and charges in the handling of the Claim, which is the responsibility of the Seller not the Buyer.
- There is no need for the Buyer to hold back and ask for 5%, 10%, 15% of the purchase price to be put in escrow.
In this case, because this policy attaches at the first dollar, the Buyer can reduce the escrow amount or the hold back, as much as they want, all the way down to the zero.
When the Seller sees this act of good faith and the fact that they’ll have that much more cash on hand at closing, they’ll be happy to pay the whole cost of the sell-side insurance without question. This goodwill can pay off big time for the Buyer.
- If there is a breach and financial losses… those claims are paid. And there is no need to go after the Seller, who may or not have the cash on hand. The insurer will pay the claim to the Buyer – directly. There is no need to go through the Seller as a “middleman.”
- A Buyer can opt for expanded protection. In a transaction with sell-side coverage, you can insist on 100% cover, a policy with a policy limit that equals the purchase price – up to $20M. So in that scenario, arguably, you can get 100% of the purchase price back in the event of a fundamental breach.
- Thanks to all these benefits – to both Buyers and Sellers – negotiations and the associated legal fees are reduced. Sell-side insurance smooths everything out.
All in all, sell-side coverage to cover a sub $30M EV deal makes sense. And while this coverage has been available for a relatively short period of time under the name: Transaction Liability Private Enterprise (TLPE) insurance , it is increasingly being adopted by those lower middle market deal-makers who are in the know.
It’s my belief that just as M&A deal-makers (and especially their attorneys) came around to the idea of traditional buy-side R&W coverage, they too will come to embrace sell-side TLPE coverage.
If you’re a Buyer and have been reluctant to use TLPE coverage or a Seller who realizes the value this insurance brings to your side of the table, I’m happy give you a full rundown on this unique relatively new product.
Please contact me, Patrick Stroth, at pstroth@rubiconins.com.