Monday, November 19, 2012
In the private company context, buyers usually deal with the problem of inaccurate representations and warranties through the use of an indmenity or escrow. By setting aside a portion of the consideration for a period of say 18 months after closing, the buyer knows that in the event any of the seller's represenations turn out to be wrong, the buyer can get some of the consideration back. This post-closing true up is one way of giving the seller incentives to be truthful in the deal making process.
In the public company context, buyers can't generally get access to an indemnity or an escrow. I suppose this is where M&A/transactional insurance steps into the void. CFO.com has a piece describing M&A insurance:
Such transactional insurance is “for the event that something the buyer was told turns out to be untrue and the buyer suffers financial loss."...
The coverage pays off if seller representations turn out to be false and the buyer discovers this after closing, Schioppo says. On a $100 million deal, the buyer is typically protected by an indemnity arrangement in which the seller might be “on the hook for two years, [during which] the buyer is allowed to come back if something turns out to be false for up to $10 million.”
Sellers can also buy insurance that covers what they might have to pay buyers that they have misinformed. One example of a covered exposure is if the seller says its “20 major customers were in good standing, but one of them was really in bad standing — [and] a month after closing they were no longer doing business with the company,” says Schioppo.
If M&A insurance - essentially third party warranties for seller reps - becomes prevalent, I wonder what effect that will have on the deal making process. Will it generate less incentives for buyers to investigate carefully what they are buying? Will it push the work of due diligence out to insurers who will take on the burden of certifying seller statements, and thus reduce the lawyer work in that area? Especially if M&A insurance moves beyond a niche market, it raises interesting questions about transaction design. Worth keeping an eye on.
Here is Chubb's M&A Insurance (no endorsement) page for a description of the coverage.