RWI usage is declining[1] for deals closed in 2024, including among Private Equity buyers.[2] When an M&A deal requires more carveouts for things like survival periods and caps and special escrows to cover RWI policy exclusions and limitations, deal makers are reevaluating the structure and cost of indemnification. Additionally, RWI may not provide a safety net expected by the sellers.
The Bottom Line
Deal parties have learned from the data that using RWI can add time and complexity to an M&A deal, both in negotiating the indemnification provisions and navigating post-closing indemnification claims. Every M&A deal is unique, and whether RWI is right for a transaction should be a case-by-case evaluation. Deal parties are now taking a closer look at whether RWI is best suited to meet their respective needs.
What the Data Says
Fewer deals today use RWI. After a high-water mark in 2021, a year when buyers often needed to find ways to sweeten their bids in a very competitive M&A landscape, RWI has been purchased on fewer deals each year. So far in 2024, RWI usage is down across all buyer types and deal sizes.[2]
Not all M&A deals are a good candidate for RWI. RWI is more common on “cleaner” M&A exits, such as deals with higher values, a higher return-on-investment, longer exit timelines, fewer management carveouts, and “no survival” of the seller’s general reps & warranties.[5]
Indemnification provisions between buyers and sellers are more carefully negotiated as buyers seek additional protections.
Deals with RWI are more likely to have special escrows[3], typically to cover policy exclusions and caps. This data can be especially helpful when setting expectations with sellers during deal negotiations. Deals with RWI tend to have smaller escrows, and the median size of the general indemnification escrow is 0.5% of transaction value. However, when you factor in additional special escrows, and that buyers are successfully adding such escrows on nearly 50% of deals with RWI, the median aggregate amount escrowed on these deals is 2.5% of transaction value.[4]
Last but not least, deals with RWI are more likely to have post-closing indemnification claims, especially because of the way these policies are structured: buyers (i.e. the insured) are motivated to burn through the retention (i.e. insurance deductible) quickly.[6] When coverage under the policy does come into play, indemnification claims run through RWI take longer to resolve. Whereas about half of claims handled by RWI are resolved within 12 months, closer to three quarters are resolved within that time when handled by a professional shareholder representative.[7]
Buyers are Reacting, Adapting
Smart and agile M&A deal parties evaluate market data, like that above, and stay ahead of emerging trends. In 2021, a record-setting year for M&A deal volume, buyers were often faced with expedited timelines and may not have been able to perform full due diligence. A few years later, deal parties are experiencing the effects of lax diligence (e.g., a huge increase in post-closing indemnification claims for breach of the “no undisclosed liabilities” seller representation [8]). Lessons were and continue to be learned.
Declining RWI usage indicates that the M&A market is still adapting, with deal parties carefully assessing the use of RWI on a case-by-case basis.
With the pace of dealmaking significantly slower these past two years, buyers have taken advantage of the time to conduct more thorough due diligence, to which RWI underwriters are also privy. As a result, indemnification provisions between buyers and sellers are more carefully negotiated as buyers seek additional protections. RWI can sometimes provide coverage for the additional matters uncovered during due diligence, but not always. Sellers can find themselves agreeing to carveouts and special escrows for which they are still directly responsible in addition to the cost of RWI.
Private Equity Buyers and RWI
It is no secret that PE buyers are more likely to consider RWI when compared to other buyer types. Changes in RWI utilization, and related trends for deal terms relevant to RWI, are less dramatic year-over-year with PE buyers. It’s worth noting when there are shifts involving PE buyers.
For example, when strategic buyers were using RWI less and less in 2022 and 2023, PE buyers remained relatively consistent, with RWI identified on about 65% of deals. So far in 2024, however, RWI usage among PE buyers is down.[2]
One thing is clear, deal parties are getting more efficient at identifying when RWI might work as intended and when it might not.
Interestingly, several M&A practitioners have recently mentioned cases where PE buyers negotiate the deal as if there will be RWI, but at closing the PE buyer elects to skip the premium cost to purchase the policy and instead essentially decides to self-insure. (i.e., carefully evaluating the structure and cost of indemnification).
Going Forward
Declining RWI usage indicates that the M&A market is still adapting, with deal parties carefully assessing the use of RWI on a case-by-case basis. Lessons emphasizing the importance of due diligence suggest that buyers will maintain thorough diligence practices, even as market activity increases. Meanwhile, indemnification provisions are expected to remain a focal point of negotiation
As we begin to see more deal activity in the latter part of 2024 and into 2025, especially from PE buyers and sellers, it will be even more important to keep an eye on these RWI trends. The market is adapting and adjusting as more information and data about RWI becomes available. One thing is clear, deal parties are getting more efficient at identifying when RWI might work as intended on their M&A deal and, perhaps more importantly, when it might not.
About the Author
Kip Wallen is a senior director leading the SRS Acquiom thought leadership practice. He leverages his extensive expertise and SRS Acquiom proprietary data to produce resourceful content regularly utilized by market practitioners. Kip has broad experience in M&A and provides guidance on market standards and trends.
Previously, Kip was a Director with the SRS Acquiom Transactional Group, where he collaborated with clients and counsel to negotiate M&A documents including purchase, escrow, payments, and other transactional agreements. Before joining SRS Acquiom, Kip was an attorney with a Denver-based boutique business law firm where he assisted clients with M&A transactions as well as general corporate governance and securities matters.
Kip is an avid supporter of the Colorado Symphony, serving on the Associate Board and Colorado Symphony Fund Board, and the Colorado Rockies. He is an active participant on the American Bar Association’s M&A Committee. In 2016, Kip completed Leadership 20 with the Denver chapter of the Association for Corporate Growth.
Kip received his J.D. from the Sturm College of Law at the University of Denver and an M.S. in Economics, B.S. in Economics and B.A. in International Relations from Lehigh University. He is a member of the Colorado bar.
Footnotes:
[1] Source: 2024 RWI Highlights: Effect of Reps and Warranties Insurance on M&A Deal Terms (“SRSA RWI Highlights”).
[2] Source: 120+ deals closed in 2024 on which SRS Acquiom serves as the Shareholder Representative. Some 2024 data is available at SRS Acquiom MarketStandardTM
[3] Source: SRSA RWI Highlights.
[4] Source: SRSA RWI Highlights.
[5] Source: SRSA RWI Highlights.
[6] Source: 2024 SRS Acquiom M&A Claims Insights Report.
[7] Source: SRSA RWI Highlights (including data from the presentation “Aon R&W Insurance Claims”).
[8] Source: 2024 SRSA M&A Claims Insights Report.
© 2024 Private Equity Professional | December 20, 2024
