There is a relatively new but very effective insurance product perfect for lower middle market deals.
Transaction Liability Private Enterprise (TLPE) is a Sell-side Representations and Warranty (R&W) insurance offered by CFC Underwriting.
With these policies, the Seller is the Named Insured. The policy is triggered when the Seller receives notice from the Buyer that they have suffered a financial loss resulting from a breach of the Seller reps.
Following notice of the breach, Underwriters appoint counsel to represent the Seller and negotiate a settlement with the Buyer. Upon agreement, the insurer pays indemnity owed to the Buyer, making the Buyer whole and providing the Seller with a clean exit.
As you can see, TLPE provides an elegant solution for transferring risk for both Buyers and Sellers.
The Four Main Benefits of TLPE
Following several successful recent closings, we have observed the following four benefits to Buyers which showcase exactly why they should require TLPE from every target company priced under $20M in EV.
- More Protection for Buyers
TLPE provides more protection than an escrow/holdback. Most escrow/holdback amounts are set around 10% of the purchase price. A TLPE policy can insure a transaction to the full purchase price (up to $20M), so Buyers can avoid incurring losses that exceed the escrow level.
- Lower Cost of Risk Transfer
Buy-side R&W policies are subject to a $100,000 minimum premium, plus a $30,000 underwriting fee. This does not include the cost of the third-party diligence reports to meet underwriting criteria. TLPE rates average $15,000 per $1M in limits and require NO underwriting fee, making TLPE an unbeatable option cost-wise.
- Ease of Execution
Underwriting for Buy-side R&W policies concentrates on the depth and quality of the Buyer’s diligence, so review of the target is only available through the filter of the third-party diligence reports. This review can take weeks and is reliant on when third-party reports are available.
There have been Sell-side R&W policies offered by Buy-side R&W insurers. Those policies were underwritten much the same way, which ended up being more cumbersome and provided a more limited scope of coverage. This experience has colored peoples’ opinions of Sell-side policies, which explains why some initial resistance comes when a Sell-side R&W policy is suggested.
Unlike the prior versions of Sell-side R&W, TLPE utilizes a streamlined application process that is completed by the owner/founder of the target company. This direct access to the prospective Insured enables the underwriting process to be completed in a day or two without incurring separate underwriting fees. TLPE requires no input from the Buyer, so Buyers don’t have to do anything to secure TLPE.
- Removes Friction From Negotiations
The value of reducing/eliminating tension and stress during the negotiations process can’t be understated.
Considering the lack of experience lower middle market Sellers and their counsel have in negotiating the terms for selling their “life’s work,” there’s tremendous emotional pressure where fear and greed are present. The purpose of TLPE is to remove a substantial amount of the financial risk from the parties transferring that risk.
Removal of the financial danger to Sellers elegantly reduces the temperature in the room, particularly when addressing key, sensitive terms such as indemnification provisions, indemnity caps, survival periods and escrows/withholds.
Buyers unanimously told us that the presence of TLPE enabled everyone to avoid what used to be an unpleasant, acrimonious phase in the negotiations process. Having a risk transfer tool available immediately converted negotiations from confrontational to collaborative.
Knowing TLPE was included in the transaction, Sellers stopped being defensive and were motivated to work with the Buyer to get the transaction adequately insured and closed. This cooperative environment reduced the frequency of turns in drafting/redrafting agreements, saved legal costs, and expedited the schedule for signing/closing.
Avoiding contentious negotiations sets the stage for smooth, productive post-closing integration, which can be the difference in a successful acquisition.
It’s no wonder that TLPE coverage has become increasingly popular among deal-makers in the lower middle market. It gives deals in the range of $1M to $30M to access the same risk transfer tool that almost all PE-driven larger M&A transactions currently use. Plus, TLPE is low cost, and it is easy to obtain coverage.
At Rubicon, we can turnaround a proposal for coverage in two business days. All that’s needed is an application, the target’s financial statements, and the LOI. If the deal is eligible, terms can be available in one or two days; two days if Underwriters need clarification on items.
If you are ready to see how TLPE can apply to your particular deal, contact me at: pstroth@rubiconins.com or 415-806-2356.