If you are selling a business or acquiring one, particularly in the middle market or large-cap space, you will likely hear the term representation and warranties insurance (RWI). It is a common tool in mergers and acquisitions (“M&A”) that can protect both buyers and sellers while making the deal process smoother for all parties.
RWI protects buyers and sellers against financial losses from breaches of the representations and warranties in a purchase agreement. Representations and warranties are the seller’s statements about the business and covers items such as financial accuracy, taxes, contracts, litigation, and compliance. The accuracy and scope of a seller’s representations and warranties influence several critical aspects of an M&A transaction, especially the purchase price, indemnification terms, risk allocation, and the buyer’s focus during diligence review. If any of these statements turn out to be incorrect after the deal closes, the buyer could suffer financial losses. Traditionally, the seller would be on the hook for any post-closing losses the buyer suffers due to a breach of representations or warranties. The purchase agreement usually includes detailed indemnity provisions, and the buyer would hold back a portion of the purchase price in escrow and could recover funds from the seller. However, RWI shifts that post-closing risk from the seller to an insurer. The seller may still have some limited liability (often matching the policy retention), but it’s dramatically reduced or even eliminated altogether in “no-seller indemnity” deals.
RWI is most commonly seen in deals valued over $50 million, with an increasing prevalence in deals as small as $20 million. Typically, the buyer takes out the policy and is the insured party. If there is a breach of a representation or warranty, the buyer files a claim directly with the insurer. This gives the buyer more control as they do not need to rely on the seller to recover. Sell-side RWI is an option but is much less common. In sell-side RWI, the seller is the insured party and uses the policy to cover the buyer’s claims. This is less common because buyers generally prefer to control their own recovery process; however, it may be selected when the seller wants protection for indemnity obligations but the buyer will not accept a buy-side policy so the seller elects to purchase one to cover their potential exposure. In either case, the cost is often shared or negotiated as part of the purchase price. In seller-favorable markets, the buyer might cover the full premium to win a bid.
The cost of RWI includes several components, and pricing can vary by deal size, complexity, and market conditions. Typically, the cost is 2.5% – 4.0% of the coverage amount. For example, in a $100 million deal with $10 million in coverage, the premium would likely be between $250,000 and $450,000.
RWI has become a standard tool in middle market and large M&A transactions, offering a less risky and more efficient way to allocate risk between buyers and sellers. By replacing or reducing traditional indemnity structures and escrows, RWI allows sellers to achieve a faster and more secure exit while giving buyers meaningful post-closing protection. As deal dynamics continue to evolve, RWI will remain a key feature of well-structured transactions. Understanding when and how to use it effectively can give both parties a strategic edge and help get deals over the finish line with fewer roadblocks.
