W&I Insurance in a Company Sale: Cost, Process and Limits

A holdback ties up your money for two years. A W&I policy ties it up for one morning at the notary.

For owners running an actual process, our approach to selling your company sets out how the mandate works.

In most company sales the seller is liable for the warranties given in the sale and purchase agreement — on the accounts, on tax, on contracts, on litigation. Traditionally the buyer secures that liability through a holdback or an escrow account: part of the purchase price stays tied up for one to two years. W&I insurance — warranty and indemnity — replaces that holdback with a premium. The seller receives the full purchase price at completion; the insurer carries the liability risk.

What was almost exclusively the preserve of large transactions some twenty years ago is now a realistic option for mid-market sales too — within limits.

What a W&I policy covers

The policy steps into the place of the seller liability arising from the sale and purchase agreement (SPA). If a warranty — on the accuracy of the annual accounts, the completeness of the contracts, or compliance with employment law — is later contradicted by reality, the insurer pays instead of the seller.

Cover expressly extends to unknown risks: matters that neither buyer nor seller knew, or could have known, at signing. Known risks are excluded as a matter of principle — whatever was disclosed in due diligence remains a matter for the parties to the contract, not for the insurer. Individual insurers now also offer cover for identified but improbable risks. That is the exception rather than the rule, and it is priced accordingly.

Defects fraudulently concealed are excluded in every case. Anyone who knowingly gives false information remains personally liable without limit; the policy changes nothing about that.

Buy-side or sell-side policy

In practice the buy-side policy dominates: the buyer takes out the insurance and brings claims directly against the insurer rather than against the seller. That is one reason why W&I insurance today tends to work in the seller favour — the buyer gives up a large part of the classic warranty catalogue and the long renegotiation around it, because the protection he actually needs sits with the policy.

Who pays the premium is a matter for negotiation. Often the buyer does; sometimes it is split between the parties or priced into the purchase price discussion. For the seller the outcome is usually cheaper than a comparable price reduction achieved through a long holdback.

What the cover costs

Premiums are typically between 0.65 and 2 per cent of the limit of cover — markedly lower than some twenty years ago, when 2.5 to 7 per cent was usual. The market has matured since then and competition among insurers has increased.

The limit of cover itself is usually between 10 and 30 per cent of the purchase price. On top of that comes a retention of typically around 0.5 per cent of the limit of cover, which the seller — or, under a buy-side policy, the buyer — bears before the insurance responds.

Synthetic W&I policies for smaller transactions have also established themselves in the market. They work without a full warranty catalogue anchored in the sale agreement and are in individual cases already offered for enterprise values in the low single-digit millions of euros. Whether the effort — broker costs, underwriting, minimum premium — pays off on a given transaction depends heavily on the individual case, and it is a question to settle early in the process with a specialist broker.

From what transaction size a W&I policy is worthwhile

For a long time the rule of thumb ran: from an enterprise value of around 20 million euros. That threshold is moving — downwards. For smaller mid-market transactions the arithmetic nevertheless differs from that of a large deal: minimum premiums and broker fees weigh more heavily against a purchase price of a few million euros than against a deal in the hundreds of millions.

The relevant question is therefore not only whether a W&I policy is possible in principle, but whether the premium replaces a holdback that would have been more expensive anyway — through the capital tied up, through the renegotiation, through the credit risk on the seller himself. For a well prepared, clean business with robust due diligence, that calculation comes out in favour of the policy more often than for a business with open flanks.

The precondition: clean due diligence

An insurer takes on no risk it cannot assess. Every W&I policy therefore rests on careful due diligence — usually the exercise the buyer has commissioned in any event, supplemented by the insurer own underwriting, which reconciles the warranties in the agreement with the diligence findings.

The better prepared the documents and the more complete the disclosure, the smoother the underwriting and the smaller the risk that individual warranties are carved out of cover. Owners who prepare the process themselves, rather than letting the buyer set the pace, have the greater leverage here. What a vendor due diligence achieves is set out under vendor due diligence; the fundamentals under what is due diligence?

How W&I changes the purchase price mechanics

Without insurance, securing the liability is part of the purchase price mechanics: a holdback or escrow ties up part of the price for months or years. With a W&I policy that tied-up amount largely disappears — the seller receives the agreed purchase price at completion, less a token residual amount for cases of intent.

That also changes the tone of the negotiation. Because the buyer meets his need for security through the policy, the pressure to push through as many warranties as possible, running for as long as possible, falls away in the agreement itself. Precisely for that reason the market trend has been regarded as seller-friendly for some years: shorter liability periods, leaner warranty catalogues, and in return an insurance premium that feeds into the overall economics of the transaction. What otherwise belongs in the agreement is set out under the share purchase agreement.

Signing, closing and the right moment for the policy

The W&I policy is as a rule negotiated and placed between signing and closing — that is, in the phase between execution of the sale agreement and its actual completion. Signing fixes the terms of the contract and with them the warranty catalogue to be insured; closing is the date from which the policy actually bites. The sequence of a company sale and the remaining process steps are set out under the company sale process.

If the policy is only commissioned after signing, things get tight: underwriting takes time, and a short run-up drives up either the premium or the exclusions. Anyone considering a W&I policy should therefore factor it in early in the process — not once the sale agreement has already been negotiated.

FAQ

What is a W&I insurance policy?

A W&I policy (warranty and indemnity) assumes the financial liability for breaches of the warranties given in the company sale agreement. Instead of the seller standing behind that liability through a holdback or an escrow account, the insurer pays where a claim is valid.

What does a W&I policy not cover?

Known risks that were already disclosed in due diligence are excluded as a matter of principle. Defects fraudulently concealed are likewise excluded — for those the seller remains personally liable without limit.

Who pays the premium for a W&I policy?

That is a matter for negotiation. In practice the buyer often pays; sometimes the premium is split between the parties or priced into the purchase price discussion.

From what company size is a W&I policy worthwhile?

The rule of thumb for a long time was transactions from an enterprise value of around 20 million euros. Synthetic policies for smaller deals have brought that threshold down in recent years, but it remains a case-by-case calculation of minimum premium, broker costs and the value of the holdback being replaced.

What does a W&I policy cost?

Premiums are typically between 0.65 and 2 per cent of the limit of cover, which itself is usually 10 to 30 per cent of the purchase price. On top of that comes a retention of typically around 0.5 per cent of the limit of cover.

Does a W&I policy replace due diligence?

No — it presupposes careful due diligence. The insurer reconciles the warranties in the agreement with the diligence findings; without robust documentation the underwriting becomes harder and the cover patchier.

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A company sale is the most important transaction of an owner life. Take independent, discreet advice — IGCP Capital Partners. igcp.at