What is Representation and Warranty Insurance?

Representation and Warranty insurance (RWI) insurance is a tool used in M&A transactions to protect the buyer from losses arising from breaches of the seller's representations and warranties in the purchase agreement. 

In the lower middle market, where companies typically range from $5 million to $100 million in enterprise value, RWI can play a crucial role in facilitating transactions by addressing concerns of both buyers and sellers.

R&W insurance covers financial losses resulting from breaches of the representations and warranties made by the seller in the purchase agreement. 

This includes inaccuracies in financial statements, undisclosed liabilities, legal compliance issues, and other material misstatements or omissions.  Most policies are buy-side polices, but not exclusively, and the parties can negotiate regarding associated costs.

RWI policies can help negotiations, decreasing negotiations over the reps and warranties themselves and indemnification provisions, as well as decrease the need for escrows and holdbacks.

The policies also give buyers more protection against risk, as well as give sellers peace of mind.  

Also, if the seller is continue in the business post-closing or has rollover equity, it’s beneficial for the buyer to be able to look to the insurance company rather than the seller to be made whole.

Coverage limits are typically around 10-20% of the transaction value.  Costs associated with RWI include:

• Underwriting:  Usually,  from 25-50k

• Premiums:  Usually 2-4% of the coverage limit

• Retention (Deductible): Typically 1-3% of transaction value

RWI is present in close to half of middle market transactions.