Business owners' guide to Warranty and Indemnity Insurance
Warranty and indemnity insurance (W&I insurance) is another name for mergers and acquisitions insurance. But what is it? What does it cover? And what are the benefits of having a policy in place when you’re selling your business?
By Alan Boswell Group
What is warranty and indemnity insurance?
When selling a business, buyers usually demand that you provide representations and warranties. These are legally binding assurances which provide the buyer with protections from any misrepresentation that can lead to a financial loss. If any of these assurances are incorrect and the buyer suffers a loss, they can make a claim for financial compensation against you. Claims can be made up to six years after you have sold your business.
Warranty and indemnity insurance is there to protect you from the financial loss associated with claims while providing both parties with additional peace of mind.
What are warranties and indemnities?
A warranty is a written statement provided to the purchaser to back up claims you have made about the business during the sales process. Examples include:
Accounting and other financial information;
Employees and pensions information;
Indemnities offer security for the buyer from known and specific circumstances. Examples include:
Ongoing legal disputes;
Existing employee tribunals.
What does W&I insurance cover?
When you provide the buyer with these warranties and indemnities, you are accepting responsibility for any financial loss that occurs due to misrepresentation. So, if the accounts are found to have been misrepresented, for example, you are liable for any loss sustained, even if such misrepresentation has been provided to you by others.
Failure, properly, to disclose against warranties can result in large compensation claims enabling the purchaser to recover the diminished value of the company it has purchased. W&I insurance provides cover for losses arising from a breach of a warranty or indemnity.
A W&I policy will help protect your business sale proceeds and provide cover for defence costs arising from the claim of an inaccurate warranty.
Who can purchase W&I insurance?
Both the seller and buyer can purchase W&I insurance. While it is usual for the seller to purchase the insurance, ‘buy-side’ polices are still common-placed. If a buyer has any concerns about the sellers financial standing post-closure of the transaction, they may seek to purchase W&I insurance to provide the necessary financial protections.
Benefits of W&I insurance
The obvious benefit is the removal of the financial risks associated with a claim against you. However, there are other, less obvious benefits.
For the seller:
Clean exit – Maintaining W&I insurance reduces the need for the buyer to ask for part of the sale proceeds to be held in escrow. This allows the seller to realise the full proceeds from the sale and make a cleaner exit. This is particularly attractive to people looking to retire, those looking to subsequently re-invest, or private equity sellers.
Attractive purchase – By offering W&I insurance as part of your sale you are providing further assurances to the buyer that they will not be left financially out-of-pocket if any of the warranties or indemnities prove false. It provides peace of mind for the buyer, as they know valid claims will be paid. Making your business a more attractive proposition.
Growing market – Insurer appetite has led to lower premiums and wider cover.
For the buyer
Relationships – Avoids risk of the buyer potentially having to bring a warranty claim against a seller who continues to be employed by the business after completion, therefore protecting the relationship with valuable staff as a claim is instead made under the policy.
Protection – A claim may be larger than any monies held in escrow. A W&I policy removes the risk that the seller is unable to pay should a claim occur.
Improves offer – W&I cover can improve the buyer’s negotiating position, as a seller may be willing to consider a lower offer if they know that the sale proceeds will be immediately available to them, rather than waiting for a warranty period to expire or having money held back in an escrow account.
Important considerations
W&I insurance is not a substitute for due diligence. It is designed to cover unexpected issues that arise post-sale and this assumes that the buyer has performed thorough due diligence, both financial and legal. Any indications that this due diligence has been anything less than robust and complete could lead to a lowering of cover or an entire policy denial. W&I cover is not a complete solution.
Certain losses are unrecoverable through a W&I policy, including any excess, investigation costs, claims below any de minimis thresholds in the policy, disputed claims, or losses which come from something not covered under the warranty.