Reps and Warranties from a Business Perspective

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Doing very well, thank you.

Kisan, thanks for taking a little time to chat. Can we kick things off with a little bit about your MA background?

So in terms of my background, I have almost two decades of experience working on transactions, which includes either working on acquisitions or divestitures for internal business units, or providing acquisition financing to third party clients such as public and private companies for making acquisitions or funding private equity firms for executing leveraged buyouts. And I'm currently working as a Vice President in Corporate Development and M and A at Visa. I've been in this role for about 10 months now and prior to visa I worked at JP Morgan for over 11 years. Prior to JP Morgan, I worked across various different firms including Bear Stones and ubs.

Pretty Hybrid banking and Corporate development?

Absolutely, yeah.

Let's get into our topic. What is Reps to Warranty insurance and how does it work In M and.

A, I'll start with transactional risk insurance, which has become a valuable tool in mergers and acquisitions to help buyers and sellers facilitate transactions and offset certain liabilities to insurance companies. And and rep and warranty insurance is just one of the three products under the umbrella of transactional risk insurance in M and A, the other two being tax indemnity insurance and contingent liability insurance. And these two cover known or highly probable liabilities. On the other hand, rep and warranty insurance addresses unknown issues or risks, and anything known or uncovered as part of the diligence process is not covered by the rep and warranty insurance. So before I jump into the rep and warranty insurance product, let me provide some background context. So reps and warranties are typically included as a section in the sale purchase agreement that is used to facilitate the sale of a company from a seller to a buyer. And it's a set of statements that are made by the seller regarding the condition of the company they're selling. Could be financial or operational information or something that informs the buyer about the value of the target. The these statements can be things like companies in compliance with law, it's not engaged in any litigation, et cetera. And the buyer relies upon these statements to be true and accurate. And if the seller breaches these statements, the buyer can then seek from the seller indemnification for the financial losses as a result of that breach. And in a traditional deal, seller will set aside 5 to 15% of the purchase price in an escrow for a specified period of time to cover potential breaches of reps and warranties. Now, while the reps and warranties are statements of facts, they're really a means to negotiate allocation of risk, what risks the seller and the buyer are willing to take on in a transaction and then live by them. And if they're wrong, they will pay for those misstatements. So coming to the topic of today's discussion, that is rep and warranty insurance. So through rep and warranty insurance, the buyer or the seller will receive insurance coverage for the financial losses that are resulting from breaches by the target company of reps and warranties contained in the purchase agreement. Now, the insurance really helps protect insured from unknown losses that may arise subsequent to the signing. So if the buyer is able to bind the rep and warranty policy by signing date of sale, purchase agreement and post closing for a certain period of time, so it really preserves the deal value by shifting the risk of loss to insurer for a fixed cost, which is known as the insurance premium.

So instead of having the typical 5 to 15% escrow, we have now get insurance policy.

Absolutely.

What makes you so interested in this? And I'm curious because you don't sell reps and warranties insurance or you're not incentivized on that, what makes you so interested in this?

Just in terms of the journey that this product has had from being a niche financial product to becoming a mainstream deal tool that has now gained wide acceptance among dental professionals. So it's not really a new product and it's been around since the 1990s. However, it's now gained acceptance in the last five to seven years and the pickup in demand has really been driven by better pricing, increase in the number of insurance companies that are willing to underwrite this product. And now there are like 20 plus insurance companies that provide this product in the market. And the insurers being willing to cover the entire suite of reps and warranties and not really cherry picking them. So that the policy coverage very closely resembles the indemnity package that a buyer would get in a product traditional deal with no reps or warranty insurance. Now just getting into why as a buyer I would be interested in purchasing the policy. So I think it's important to understand the goal of the policy is basically to cover majority of the sellers reps and warranties that are provided in the purchase agreement and to some extent supplement or enhance or replace the indemnification provisions that would be provided in a typical traditional purchase agreement. So some of the benefits to a potential buyer would include increased indemnity or survival period. So buyers typically get a longer survival period of three years for general reps versus the purchase agreement terms of 12 to 24 months. On the fundamental reps, including the tax reps or environmental reps, buyers would get coverage of up to six years, which is consistent with the statute of limitation on many of these reps. Some of the terms buy definitions in the purchase agreement you can get some enhancement in a rep and warranty insurance coverage versus what you would get in a typical indemnity coverage. For example, the loss definition, you can get a stronger coverage of loss under the policy versus a purchase agreement. So consequential damages or multiplied damages may be covered by insurance, while purchase agreement may not allow for recovery of these consequential damages. Materiality scrape is another piece which is heavily negotiated or not included in the purchase agreement. But it's possible to obtain insurance without any materiality restrictions. And that's called a double materiality scrape. And on top of that the reps and warranties negotiated with the seller in the purchase agreement end up being on more buyer friendly terms. It's also a way for the buyer to really distinguish itself in an auction process. So in a competitive auction process with multiple buyers, buyers can really make their bid more attractive because the seller gets a bigger part of the purchase price upfront with insurance, whereas in a regular traditional deal they would be hold back in escrow of up to 5 to 15%. Another advantage to the buyer, and this is an important one, particularly for smaller deals. Some of the deals that I've looked at in the fintech space is that it really protects key relationships, particularly if you're bringing seller or the founders into your company. So you do not want to be in a position where you have these founders that are going to stay on and run this business for you and then a breach happens and now you're sitting on a loss. And so do you really want to go after these founders that you're really entrusting to run your business for you and ruin that relationship that you have with them, or do you want to eat that loss yourself? So by transferring that risk to a third party, you're now solving for that issue as you as a buyer can be made whole while preserving those relationships you're counting on, even from a claims perspective. And I know we are going to talk about the claims in more details just to touch upon those a little bit. So while the process for the buyer to file a claim is very similar in a rent and warranty insurance deal versus a traditional deal, it's a much more sophisticated process if you're dealing with an insurer on the other side versus a small seller. Also, the buyer will have reduced credit risk since any future claims are asserted against an insurance company with a credit rating of A plus or higher rather than the prior owners of the seller firm that you've just purchased. Also, another advantage is that the rep and warranty insurance can provide recourse in a public deal, for example, where there is no recourse available, as reps and warranties typically don't survive post closing in those deals. So I think those are some of the reasons why as a buyer, I would be interested in purchasing the rep and warranty insurance in an M and.

A deal you sold me. You're really good here. I thought this whole time that this is some contraption from the insurance industry that they're really good at making products and selling stuff that you don't really need. But you got a really good business case and how this could add value and essentially make you more competitive. What's the cost of getting coverage for reps and warranty insurance?

So let me go over some of the key economic terms of the policy. So let's take the example of a deal that has a total purchase price of 100 billion. So the amount of insurance coverage that you purchase will really depend upon how much a buyer is willing to purchase in terms of the coverage. So it could be 10% or 20% of the purchase price. Let's say they purchase 10 million, which is consistent with the typical escrow amount that is set aside in a traditional deal with no repo warranty insurance. So the premium cost typically ends up being somewhere around 2 1/2% to 3% of the coverage purchased. And total all in cost is typically three to three and a half percent, which includes the premium, the diligence fees, the taxes, the broker fees, et cetera. And usually the buyer will end up paying for it, especially in an auction process, whereas in a bilateral process it could be a matter of negotiation. Then in addition to the insurance premium, there's also something called retention, which is very similar to the insurance deductible amount. And this is the amount that the insured party has to absorb before the insurer will step in. And the retention amount typically will be somewhere around 1% of the purchase price. And in some deals, buyers and sellers may split that cost 50, 50 buyer retention will get exhausted first and then the sellers before insurance kicks in. But for some larger deals of greater than a billion dollars in purchase price, retention may be smaller, up to 0.75% and it'll drop to 0.5% after one year. And in that case, usually seller's retention will go away and then the buyers will remain. And then there are no seller indemnity deals wherein all the retention is paid.

By the buyer roughly 3% to 3.5% all in for this policy. How do I buy this? Do I have my local rep and give him a heads up and say, hey, I got this deal, I'm working on it, eager to price out for me. What does that look like?

It's a pretty streamlined process. So typically you would have to find a broker that is involved in this particular product. You should not be going to just any insurance broker because this is a very customized product and they may not be familiar with how the product works. Brokers like Marsh, Aon and some other brokers, they really specialize in this particular space. Yeah. So in terms of the overall timeline and how do you Approach or how do you initiate the process? You can typically bind an insurance policy within two to three weeks and it really depends upon the status of your deal documents, the depth of your diligence and the ability to negotiate with the sellers. So as a buyer, you can engage with your broker two to three weeks prior to signing the purchase agreement, and you will still be able to bind the policy at the same time as the purchase agreement execution. But it's always good practice to keep some flexibility and initiate the process once the purchase agreement is being negotiated. The first step, as I said, is as a buyer, you engage an insurance broker and you engage with these specialists who really understand the product. And once you've selected your broker, the broker will then execute a joinder agreement to the NDA which the buyer has already executed with the target company. And once the NDA is executed, the buyer will then share with the broker the required documents. And these will include confidential information, memo, your financials for the target company, indication of interest or LOI that you may have executed with the target buyer's markup of the purchase agreement. And to the extent you don't have any audited financials, which may very well be the case for many of these smaller fintech companies, the broker will want at the minimum reviewed financials or perhaps quality of earnings analysis. Also included in the package will be the buyer's desired indemnity structure, that is how much coverage the buyer really wants to get. The broker will then reach out to maybe four to eight insurance companies and get the initial quote, which usually is in the form of what we call the non binding indication letter or nbil. And this usually comes in within three to four days after the broker reaches out to the insurance companies. The buyer will then review the quotes or the pricing along with the broker and the external counsel and also other considerations that are included in the proposal. And these include things like exclusions to the policy or other heightened areas of risk as provided in the non binding indication letter. The pricing doesn't really vary much and so the focus is usually on the deal, specific considerations and exclusions, or any special treatment of purchase agreement terms. So once you zero in on the insurance company or the underwriter, then the underwriting process kicks off and it typically takes 10 business days from there on to get the policy in place. So once you have the underwriter picked or the insurance company picked as a buyer, you sign your non binding indication letter that you've received from the selected underwriter and then you pay them a non refundable underwriting fees through the broker to make sure that you kick off the underwriting process officially. The buyer will then provide diligence reports to the insurer and request the seller to also provide the insurer access to the data room and all the diligence information, including any internal prepared diligence reports, as well as any external third party reports such as QFE or tax reports. And then the third party consultants, you know, if there are any third party reports being provided as part of the diligence effort. The third party consultants will ask insurers to execute a non reliance letter before they share those reports. And once the insurers have reviewed the diligence reports, digested the information in the data room, the buyer will then schedule underwriting calls with the workstream leads at their end, along with third party consultants to answer any questions that the insurers may have. Once the underwriting calls are done, that's when the negotiation process begins. So here the buyer will receive the policy, which is typically 24 hours to 48 hours after that underwriting call is completed. So buyer receives the policy and any exclusions that have come about as a result of the diligence call and follow up questions. That's when the negotiations really begin, which take about two to five days. The buyer will respond to any follow up questions on open items related to diligence. And if the buyer has presented a diligence report with a lot of open items, follow ups will typically focus on confirming that those items have been closed. And if the buyer is unable to close some of those open items before closing of the deal, these provisions or these open items can be made conditional exclusions. And if you can resolve those immediately after closing, then they will be closed out. So rep and warranty product is very different from other commercial policies. It is much more customized based on a specific deal and the provisions in the purchase agreement. And as such, there's a lot of wiggle room for the insurers, particularly for as it relates to deal specific exclusions. So the negotiations will typically focus on those and the buyers will work very closely with their broker and their counsel to really eliminate or restrict those exclusions. Therefore, it's very important as a buyer to have a very robust diligence process to begin with so that you can reduce those exclusions and the time to negotiate the document sounds like it's a.

Huge part of this is the diligence from the insurance side. But the more you have that prepared to make things smoother for them when it comes to negotiating. I don't know if this is just part of my DNA, being raised by immigrant parents here. But I'm always looking for a deal and everything. I'm trying to get a sense when it comes to this product. Are you trying to get comparative quotes from different vendors? What does that look like?

Absolutely. What happens is Marsh or Aon or whoever is the broker that I have engaged. They typically go out to about five to eight insurers and they get those initial quotes, as I mentioned before. And within those initial quotes they will include the insurers will include exclusions or these heightened areas of risks. And those will be the things that we really focus on to determine which insurance companies we want to hire in the process. Because that's where the negotiation really plays out, which is. Okay, what are the exclusions? We tend to pick those insurance companies that'll provide us with minimal exclusions or heightened areas of risk. That's the first step of getting comparable quotes and then eliminating the ones where we think it just doesn't make sense or they have too many exclusions.

You'll focus on working with one broker to get quotes from multiple different vendors.

That's right.

You get some of these general terms coming back from them, but they're not going through that full on diligence that you described at that point. They're maybe giving you some of this as an early view. Or do they actually go through all that diligence to come up with those terms?

And then you select the initial quotes are primarily based on the initial documents that we've provided to the broker. And then the broker provides those documents to the different insurance companies. And those documents include your confidential information memo on the transaction, the company's financials, the indication of interest letter that we may have provided to the company, or the loi, the buyer's markup of the purchase agreement. And if there are no audited financials, then it'll include the quality of earnings analysis. So those are like the key documents that we provide to the insurers and on the basis of which they will provide us with the initial quotes. And then they'll decide which insurance companies we want to work with.

Do you send counter offers? Do you negotiate the prices they offer?

The negotiation is more around these exclusions worse than pricing because pricing tends to be very similar. And there have been occasions where the pricing was similar. And we ended up going with an insurance company which had a higher pricing but was offering lower exclusions.

Okay, let's talk about exclusions. You mentioned exclusions, sort of special terms. And then you have the open Items as well. Can you give me examples?

Anything that is known to the buyer or is uncovered during the diligence process and or is included on the disclosure schedules of the purchase agreement will obviously get excluded from the rep and warranty insurance coverage. Now, while the insurers will cover a full suite of representations, they want to make sure that those representations are within a reasonable bound. For example, the purchase agreement will typically have the knowledge qualifier around litigation. Now, unless provided in the disclosure schedules, there should be no material threatened litigation to sellers knowledge. That's how the provision would read. Now, for any reason, if the knowledge qualifier was missing from the purchase agreement, the insurers will have to qualify it in the rep and warranty insurance policy and they'll put the knowledge qualifier back to make it a reasonable representation. Then some other exclusions which are very typical in this product are cyber risk, which is excluded from coverage because the insurers maintain that they don't have expertise to underwrite that risk. And the insurers will take the position that they will cover a cyber breach to the extent it's in excess of an underlying cyber insurance policy that's already in place at the target company and will continue as a tail policy. Or they would suggest that maybe the buyer can fold the target into its own insurance policy. And that's something that I don't find very beneficial as the deductible. And the overall coverage for large buyers like Visa or JP Morgan or any other large firm is so high that they'll never be able to access rep and warranty insurance on top of that existing coverage that they already have at the firm. Exclusions can also relate to the amount of available NOLs or similar tax attributes. Exclusion can be also related to business interruption or losses arising out of COVID 19. And we've seen that during the pandemic this was a new exclusion that was added related to COVID 19. Other exclusions could also include wage and labor misclassification of contractors. So I think those are the things that come to mind in terms of the exclusions. And as I said, the insurers will submit a non binding indication letter that will provide for any exclusion or heightened areas of risk. And as a buyer, we are super focused on what those exclusions are before we select an insurer.

How do you negotiate exclusions?

I think to the extent there are these standard exclusions, I think we are totally fine with those exclusions. But if an insurer is including something that is atypical, we would either just not accept their offer or if we really want to work with them, then we would go back to them and we would tell them that look, your pricing is competitive. All the other exclusions make sense to us. However, this particular exclusion is something that's unacceptable to us. Can we do something about it? And usually we are able to reach some kind of middle ground in terms of some of those exclusions and make the deal work. And if you can't, then we just don't work with that insurer.

I think you got the option, you can work with your broker, find the next one until you really have those terms you're comfortable with.

Exactly. And I haven't taken rapid warranty insurance on some of my smaller deals. I think that's where you may not have as much leverage as a buyer because there may not be too many companies that are willing to cover those smaller deals. But on the larger deals where we typically end up or where I have typically ended up using weapon warranty insurance product, we, we usually get about four to five quotes and so we can pick and choose which insurer we want to work with.

The buyers of this product started with the PE firms, now we're seeing strategics using it. Is there a difference between when a PE firms buys a reps and warranty insurance versus a strategic or is it pretty much the same thing?

I think it's pretty much the same thing. So I think it's interesting that the demand for the product was primarily driven by private equity sponsors who wanted a quick and clean exit following a sale. So they are definitely very high up in the adoption curve for this product. However, in the last three to five years the strategics are beginning to catch up too. And one of the reasons being that it has been a seller's market for several years now and sellers have been demanding that the buyers use rep and warranty insurance in a competitive auction process. And most auction packages or bid instruction letters that we see today will include a requirement for the buyer to provide this product as such. Product that started as a sell side product is now firmly entrenched as a buy side product. And we definitely see more buy side policies in the market today than sell side policies. Yeah, we've definitely seen a pickup in the product from the strategic side as well.

Okay, so we seeing this evolve and really becoming a tool on the buy side. But you're coming across instances where you're essentially required to include this product. How about the proprietary deals? When you're working on those transactions, is it still a default type of thing or may you fall back on just doing A traditional escrow. What is the thinking there? You know, you mentioned some of the small deals you don't utilize it.

It just depends. It's very deal specific, it's very transaction specific. We don't use it on all the deals, but we'll use it on the ones where we feel that we need to close the deal quickly. So I remember I worked on a transaction where we were really running against time and this is back in 2020 where we were trying to close the transaction before the year end because we knew that the tax laws or we were worried that the tax laws could potentially change in 2021. And so we had to close the deal before the year end. So we wanted to make sure that the negotiation process went smoothly and that we were able to accelerate that timeline. So that was one deal where we ended up using rep and warranty insurance as a way to just help us smooth out that discussion process with the seller.

How does it help you save time? Is it I have to do less diligence now because we have this product.

The diligence work is still the same, but I think in terms of the back and forth with the seller, it does smooth out the process. And you do end up getting to some extent more buyer friendly reps and warranties in the purchase agreement than you would otherwise get in a typical traditional transaction.

I have some questions here about why would a buyer want reps and warranties or would a seller want it, which I feel like you already talked about in pretty good detail. I want to make sure I get it right though, from a buyer. They would want reps and warranties mainly to be competitive now because it's more attractive to the seller because they're going to get all their money. They don't have this holdback to worry about. And then you got a protection plan that there's something material that pops up after the close, somebody wants to execute recourse, this insurance kicks in and then from the buyer's position, it's more attractive. So it helps them be more competitive. What are the other key benefits as a buyer? Is it because I would look at the fees you got to pay as something that would have me reconsider and try not to use reps and warranties? What would be the key benefits as a buyer that you'd want to use reps and warranties?

The critical one for me in some of the deals that I have looked at has been the fact that it really helps protect those key relationships. As I mentioned, you're bringing in these founders into your company, which is often the case when you're acquiring private companies. So you don't want to be chasing after those founders and asking them to make you whole on some of the breaches that have happened. You rather go to a third party like the insurance company and ask them to pay you for any breaches that have happened versus these founders so that you can continue to preserve those relationships, continue to have them scale the business for which you provided them with that retention package, and continue to grow that business versus trying to make them pay for any breaches that have happened as a result of misstatements related to reps and warranties.

You got any big cons for reps and warranties insurance?

I don't see a lot of cons other than what I talked about in terms of the exclusions. You need to make sure that when you're looking at any policy that you're aware of all the exclusions that are there in the policy, because those are the things that you really need to negotiate hard with the insurer and you want to make sure that you're getting those right. But other than that, I don't really see any real cons to the insurance policy. The cost of it, except for the cost of it.

Yeah, but you're really in good case to rationalize it. These are really good, valid reasons. How often are these policies actually paid out? Because we know insurance is extremely lucrative industry. Is this something that it's there, people pay for it, and companies make a lot of money selling these policies or do they actually get redeemed and paid out on?

One of the challenges in terms of obtaining any claims data is that most of these policies, they have an arbitration provision which means that they never get litigated. And so there's virtually no case law. So since these are arbitrated, they are all private outcomes. So all we can do is really rely on reports by the insurers and the experience of the brokers to tell us what is the claim history. So one insurer, aig, provides consistent and very valuable data about claims. So I've looked at the claim study that they've done for the last six years, and the last one they did was back in 2021. And so the rap and warranties, the breaches for which claims were made were as follows. So you had the financial statements breaches, which were about 21% of the claims made. Tax breaches were next about 19%, compliance with law, 16% of the claims, followed by material contracts breach, which is 12%, and then employee related breaches, 8%, litigation, 5%, IP, 5%, et cetera. And then AIG report also indicates that one out of five policies result in a claim. So in terms of the deal sizes, I think the deals in excess of $1 billion, they usually have 24% of the policies are 1 in 4 policies that file for claims and they have the highest claims being paid out, as you can imagine. And then deals below $100 million purchase price, they say about 20% of the claims getting paid out. With respect to making claims, it's very important to keep in mind that a lawsuit that's filed against the seller company after the acquisition is not necessarily covered unless the buyer can provide that the seller company knew about the breach but did not put it in the schedule. As such, the buyer has to prove that a breach occurred and the losses the buyer suffered arise out of that breach. So a lot depends on the type of claim being presented. So for example, a third party claim, like a breach of contract or allegation of unfair trade or trademark infringement, those are very easy to quantify in terms of the loss a buyer would suffer. So you have a settlement that you arrived at and it's finite and it's not going to the buyer, but to the third party. Those are easier for insurers to wrap their hands around with respect to the amount that they owe. And therefore the claims are paid out sooner, usually within three months. On the other hand, first party claims tend to be more difficult to process. For example, buyer claims that a breach of financial statements rep has occurred. So if you're really relying on multiples to prove the damages, it really starts to get tricky and the buyer will perhaps get a forensic accountant to assist in the valuation. An insurer will do the same. And therefore those claims can really get drawn out. And it can take anywhere from 12 months to even longer to actually get paid out. But that said, I think the claims process certainly is much more efficient and streamlined with the rep and warranty insurance in place. Because you're dealing with a sophisticated insurer on the other side versus a representative of the seller who may not be as well versed in the process.

This is real. People actually do put claims and redeem on these policies. Yeah, I'll surprise them. The different cases.

Absolutely. These are very different from, let's say your auto insurance policy. It's a mandatory policy. People are actually taking it because they think it works, the product works. And so the insurers have this motivation to make sure they make good on the claims. Otherwise no one's Going to use the product.

You want to buy a policy with intention to find a way to make a claim to get your money back. Would you?

No, you bring up a good point, which is this provision called anti sandbagging probation in the purchase agreement. So typically the purchase agreement will say that between signing and closing, if the buyer discovers a breach has occurred and the buyer still goes ahead and closes the deal, the buyer cannot come back and claim against that breach. But that's on the purchase agreement side. But sometimes the purchase agreement negotiations proceed in a way that the anti sandbagging provision doesn't get covered in that purchase agreement. But the insurers will make sure that they will include that provision in their policy because they want to make sure that it shouldn't be the case wherein a buyer discovers a breach. Between signing and closing. The policy has already been signed, like the insurance policy has been signed at the signing of the purchase agreement. And then the buyer has knowledge that this breach has occurred, they still close the deal and then they go ahead and try to claim that breach from the insurance company. So they put this anti sandbagging provision in the policy to make sure that never happens.

If you keep it under the rug so that you don't have it till after close, then you can put your claim in.

The claims process is such that you have to provide evidence that you were not aware of it. And on the other hand you have to provide evidence that the seller was aware of it. So there's a lot of back and forth that happens before you can actually get paid on the claim that you've made. So I'm sure somewhere along the process will figure out that buyer knew about it or buyer was aware of the claim because again, it's related to something for which Bayer has done some diligence, buyer would have worked with a seller and then unless both the buyer and the seller agree to collude, I don't know if that happens. But yeah, I would think the circumstances of something like that happening would be very less.

I think what you're saying is do the right thing, don't be shady.

Absolutely. But then again, any kind of insurance frauds can happen, right? It happens under home insurance, it happens against auto insurance. So there are always ways to get around these products. But you would hope that the documentation is solid and there's a very robust process in place through which the claims can be made.

Is there a certain price point that you should really consider this product? Are there deals that are generally too small for it?

Usually if it's A small deal. In most cases, you want to stay away from buying insurance because at a certain point, price point, the economic starts to break down. But at the same time, I would say if a buyer wants to obtain insurance, it should not assume that a deal may be too small to obtain the insurance or is in an industry that is not covered because coverage continues to expand. And as such, a buyer in a small transaction may not be able to get that standard package, but may be able to get a more customized deal. So it's certainly worth exploring the options. Now, whether it makes economic sense for a buyer to take out rep and warranty insurance for a particular deal is more a matter of the policy size or the coverage that's being obtained than the purchase price of the deal itself. So, for example, you have, if you're working on a $50 million size deal and you want to get 20% coverage, which is $10 million, pricing will usually normalize and rep and warranty insurance will work. However, if for a $50 million deal size, you want to get 10% coverage, which is only $5 million coverage, the economics will start to break down because the insurers have minimum premium requirements. Typically, the insurers would want to be able to charge a premium of at least $150,000 to $200,000, which may be high for a $5 million policy. Because if you think about it, the insurers will charge the same premium for an $8 million policy. Therefore, if you really want rep and warranty insurance on a $50 million deal, you would be better off as a buyer to really overinsure and maybe take out an $8 million coverage policy instead of $5 million, which would make more economic sense. The other issue is the retention amount, which is your deductible. So insurers usually are looking for a minimum retention amount of $800,000 to $1 million, which is if you calculate it's 1% on an 80 million or 100 million purchase price deal. So on a $50 million deal, the retention amount at 1% would be 50,000, which again becomes too low for relative to the insurer's expectations.

Okay, that explains that I need to be mindful of the total amount that I'm looking to pull a policy on, as opposed to the purchase price itself.

Absolutely, yeah.

Any advice? First time doing this, when we do the first acquisition for M and A Science and I have to pull one of these policies out, hopefully it's a big enough deal to do that. Any advice to make sure I don't Screw that up.

My advice would be to make sure you're working with the right broker. Very important, because they will connect you with the right insurance companies. They will advise you throughout the process in terms of what pricing makes sense, whether the quotes that you're getting are reasonable or not. They'll also advise you on some of the exclusions because they see a lot of deals. So they'll be able to advise you what's market, what's not and if there are certain exclusions that were not present in the deals prior. For example, the COVID exclusion was very new and so we had to seek advice from our broker in terms of whether or not it made sense to have that exclusion or should we be pushing back. So very important to have the right broker broker to work with on any weapon, warranty, insurance.

How do I go make friends with them? Do I just call them? What's a good way to find a good broker?

You could just call them and tell them that you're interested in this product. They're not the right contact. They should be able to connect you with the right person at their firm who deals in this kind of product. And again, these are specialists, they are SMEs in their field. So they have people, these firms like Marsh and Aon, they have dedicated people working on this product. So they should be able to put you in touch with the right people.

Geetha, what's the craziest thing you've seen in M and A?

There's so many crazy stories in M and A, honestly. So the one that comes to mind is from my investment banking days when I was in leverage finance. It's an example of deal obsession amongst bankers or amongst M and A practitioners. We were in a very strong LBO market with lots of deals happening and all of us were like super busy. So one of my colleagues was working on a transaction and he was updating a deck for one of the directors on the team. So one evening on 7pm, he ordered dinner on Seamless and then he got into the elevator to pick up the food from the lobby. And then suddenly the power went out for the entire building and he found himself stuck all by himself in the elevator. So he tried to call security, but the response time was pretty bad because there were several people stuck in various elevators and various elevator be. So security was really giving priority through those elevators with more people. So he was stuck in the elevator for at least an hour and it was pitch dark in the elevator. So then he decided to call the director he was working with on this particular transaction on the deck to just let him know that he was stuck in the elevator and he wasn't sure when he would be able to get out or complete the deck. So the director asked the associate if he was able to read emails on his BlackBerry. The way he described it, he said it was super dark in the elevator. The associate thought that the director was being very considerate and perhaps wanted to make sure that he was fine in case he needed to get in touch with people using his BlackBerry. So the associate replied that yeah, it's dark, but he can read emails and other things on his BlackBerry. The director replied, good, why don't you open the deck on the BlackBerry and I can give you my comments on the deck, which you can turn once you're out of the elevator.

Wow.

I know. This incident has really stayed with me for a long time because it really represents the kind of deal obsession amongst deal practitioners. It's a way for me to remind myself that no matter how busy you get or how senior you become in the organization, you should always treat your colleagues and clients with respect. Being successful as an M and a practitioner is not just about having that right skill set or quantitative knowledge or the IQ for the role, but also having the right EQ and empathy for the people that you manage.

Comments in the elevator I got them for you. Just open up your BlackBerry. Was that your cue to get out of banking? Because I feel like that's very much an IV type of I have I've seen it mainly there private equity. It somewhat can be tense, depends on your role, depends on the firm. It not as much as the banking world. And then corp dev is obviously a different beast of its own.

Yeah, the culture is different and the things there are a lot of similarities between investment banking culture or even the work that you do in investment banking versus corporate development. But then again I think there are a lot of differences too.

Yeah, that's a great story. That's funny. I'll remember that one. Geetha, thank you so much for the time today. I enjoyed this conversation. I learned a ton about reps and warranties. You're helping me become a better M and A scientist.

Great, great to hear that and thank you so much for having me. Kisan.

Cheers. And those of you listening, here's to the deal. Thank you for taking the time to explore the world of MA with our podcast. We love hearing feedback. Tag us on a LinkedIn post, add a review on Apple podcasts or we'd love to hear from you. If you need help standing up an M and a function or optimizing one that you already have. We're here to help, and if we can't help you, we probably know someone that can. You can reach out to me by email Kisan K I S o n a science.com or you can text me directly at 312-857-3711. If you just want to keep learning at your own pace, visit mascience.com for a lot more content and resources. That's where you can also subscribe to our newsletter. Again, that's mascience.com here's to the deal. Views and opinions expressed on M and A Science Reflection Only those individuals and do not reflect the views of any company or entity mentioned or affiliated with any individual. This podcast is purely educational and is not intended to serve as a basis for any investment or financial decisions.