06 Dec Reps & Warranties Insurance
The world is a complicated place indeed. However, even more, complicated are the things we humans have designed for each other. To understand one of these interesting situations, we invited Josh Acosta to Exit Your Way Live to discuss reps and warranties insurance for selling a business.
In this week’s Exit Your Way Roundtable, Josh shed light on this technical and valuable subject.
At the beginning of the conversation, josh talked some about the insurance and brokerage business and how he got into it. From an early age, Josh had an interest in sales.
Josh knew he needed some training from the outside world before getting into his father in law’s business. So he first went on to work with other companies. After that, he returned and since, has been a part of UWIB.
According to josh, this company does not just provide sales, they work like a tool in the tool belt, essential and helpful.
Further, into the conversation, josh talks about the way insurance works. He says, that insurance varies from person to person and company to company. A construction company will not need the same kind of insurance as a software company.
When it comes to reps and warranties and other insurances, there are ways to design customized plans. The focus is to understand the client’s business and then designed a tailored plan for them.
For josh, the hardest part of this job is to identify the correct plan for a company. At times, you are not familiar with the particular lingo of a certain kind of business and that makes it hard. Adding to the conversation of reps and warranties when selling a business, Josh elaborates on this type of insurance.
Reps and warranties insurance is mainly used when selling or buying a business. When it is time for a company to sell their business, they share all their asset and liability details with the insurance company. Often times buyers are uncomfortable with the business risk when buying a company. Before reps and warranties insurance these transactions did not get completed. Using reps and warranties insurance a buyer or seller can purchase an insurance policy that covers specific risks associated with the sales of a business. In this the broker helps them identify the right insurance to cover the risk for the transaction. Josh also talked about the deal sizes which are appropriate for reps and warranties insurance.
Ending the conversation, Josh gives a simple example of the reps and warranties insurance. There was a company that bought did a transaction but in had a bad unseen condition that caused financial losses. At this point, the seller would be exposed to legal risk for covering the entire cost of the losses because he broke a lot of reps and warranties were not fully true. The reps and warranties insurance would cover these risks in a transaction.
Josh then shared his contact details with the viewers to get in touch.
Thanks to Josh for sharing his time and information. You can click on the video link below to hear the entire conversation.
Thanks to Josh Acosta for sharing their time and knowledge. Watch the video below for the entire conversation!
Prior to UWIB Josh was a producer for Allstate Insurance
While Josh was in college, he worked with United Agencies as an assistant to the President and the brokers where he was introduced to the world of insurance.
Josh has a Bachelor’s degree in communication studies from Seattle Pacific University.
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Reps and Warranties Insurance
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Josh Acosta, Damon Pistulka
Damon Pistulka 00:02
All right. Thanks again for stopping by the exit your way round table. I’ve got Josh Acosta with me today we’re going to talk about something that many of you may not understand that well, a little bit about some business insurance. And also we’re going to talk about a special kind of insurances, reps and warranties, insurance that helps business sellers and business buyers reduce the risk in a in a business sale. So, Josh, thanks for being with us today.
Josh Acosta 00:34
Of course, thanks for having me. This is great.
Damon Pistulka 00:37
All right. Well, Josh, tell me a little bit about yourself. I always like to learn about people and kind of, you know, kind of what brought you here today? I mean, have you? You’re in Seattle? I’m in the Seattle area. Have you always been a Seattle person?
Josh Acosta 00:53
No, it’s actually grew up in Southern California, Pasadena, California. I kind of spent my whole life down there. All right, moved up to Seattle in 2011 for school, and then kind of just loved it and never turned back.
Damon Pistulka 01:08
Yeah, yeah. Cool. There, there definitely are a lot of people that have done that. I mean, seriously, though, you go around Seattle. And there’s, there’s not that many original, you know, multi generational Seattle families because of the, the influence of Microsoft and Amazon and all the other companies that that came here. So it is kind of a strange thing. To find the native, so to speak. Yeah. But you’ve been here a while now. And, and I can before we got on, I mean, you’ve got a 10 month old girl, that’s gonna be awesome.
I do. It’s in the middle of, you know, the pandemic. She was born in January, early January, before a ball hit. So, you know, obviously, it’s a terrible time, it’s silver lining was able to kind of be home with her more than I would have been, and, you know, kind of be a part of those first few months. So, yeah, it’s been wild, it really has been wild.
Damon Pistulka 02:05
It’s awesome, too. because like you said, if this, if it wasn’t like it was, and you’re probably shut down and stay at home, work at home a lot more even now. You just wouldn’t have seen a lot of things. Yeah, that’s super cool. Super cool, really has been. So well, let’s just ask this. So what has what has been a father for the last 10 months? How has it changed your mind? I said, I should say,
change your mind about what?
Damon Pistulka 02:37
Just in general, just in general, you feel you feel this big responsibility. Now that wasn’t there before.
Definitely, I feel like there’s a working before with a little bit more for myself and my wife, but now there’s a there’s a bigger picture of a family to support. So there’s definitely a little bit of added weight on my chest there. But at the same time, I feel like it kind of, you know, being in a sales role. And, you know, kind of makes me a little bit more hungry. So that’s an a benefit, you know, definitely has been, has been great. And it’s also made me you know, kind of balance my time a little bit better, like, a little bit more productive when I have time. And because I have to so I was forced into productivity,
Damon Pistulka 03:19
I guess. Oh, that’s cool. That’s good. Yeah, I wouldn’t I went through quite the change myself. I don’t know what it was about having children. But I was like, I felt this sense of responsibility. And I was wild and I grew up and I’ll just be real honest about it, you know? And, but, but man, it hit you in the face like that. It’s just like, Okay, I’m getting my shit together. And I want to be good.
Be a good example. And that was my deal. And my kids. And it’s funny now that my kids are older because they’re both over 21 now and you know, they never saw saw dad hardly drink a drop and they’re they’re younger and now they go oh, Dad, you forget it this when you want to be buddy, it’s like yeah, I had to be responsible while we were raising you. So I was wondering that that’s, that’s a little little money take I guess from my experience, but it’s so cool. So cool to hear that and you’re you’re mentioning that she was just about ready to start walking and and
cruising around coffee tables, pushing chairs getting into trouble. She’s while she’s she’s gonna be a handful. It’s, it’s, it’s perfect. Right? I think my mom has been laughing at me because that’s the way I was as a kid. And she’s like, yeah, you know, don’t don’t complain to me, you know?
Damon Pistulka 04:44
Yeah. It’s great. We’re having fun having fun for sure. Yep.
Have your have your error your parents penniless dear.
Both of the family have my my in laws come up a little bit more. Yeah, it’s been great. They’ve been out So COVID put a little bit of a damper on at the beginning, but they’ve been kind of making up for lost time now. Good.
Damon Pistulka 05:07
Good. Yeah. Well, that’s cool. That’s cool. Because, you know, there’s a lot a lot to us as we as I think one of the things that COVID has done that’s been really nice is it’s, it’s brought some humanity back into business, because when we’re doing business from home, I mean, I’m in my home office. And, and, and you see a lot of people now, like yourself, like, if you’re trying to work from home, and your daughter’s around, sometimes it just, it’s going to come into your business conversation is going to happen. There’s nothing you can do about it. I think that’s kind of cool, because it has helped us bring a little more humanity into into what we do
know completely and I completely have seen that over the progression, you know, on conversations and at the beginning, apologizing for dogs barking and the mailman coming knocking on the door. And I feel like now I’m just like, people just are to it. But yeah, not a lot of apologizing. Oh, dogs barking dogs barking? Yeah, you know, so definitely understand that. Yeah,
Damon Pistulka 06:07
there’s a guy that I been, there’s a call I’m on. I think it’s every other week or something like that. But yeah, you can always tell it’s about the time that his kids are going to school. And I think it’s so cool. Because he’s got he got some, you know, they look like junior high high school age kids younger, not older kids, but they always come on to come and give their dad a hug before they go to school. Yeah, I think it’s awesome. I mean, yeah.
That’s great. You Yeah, it
Damon Pistulka 06:32
is it is great.
I mean, I spent,
Damon Pistulka 06:35
I don’t know, three or four years walking my kid back and forth to school, to school in the morning, I was walking to school, and you always walk home. And so I would take that part of my day, and I just wouldn’t schedule anything. And I would, it was a couple mile walk. And it was good for me. I got some exercise. But it was always fun to do that. And I see now people being able to do it more. It’s awesome.
So definitely. Cool. Well,
Damon Pistulka 07:01
you’ve got an interesting background here, Josh, you’ve done a lot of different things. So tell us a little bit about kind of how you got, you know, the progression and kind of how you got to where you’re at today.
Yeah, completely. So I’ve actually had been dating my current wife, right. Then when I was in high school, she also grew up in Southern California. And her father, my father in law actually started and run the owns the brokerage that I work for, work for now. And so my dad is a an RN. So I grew up knowing I wanted to get in some sort of sales, the only thing I really had access to were medical sales. And that’s kind of what I thought I saw them, you know, taking all of the cath lab out to go play paintball, and dinners and things like that. And I thought, you know, there’s a job where I get to go play paintball.
That sounds awesome. I want to sell Yeah, no idea what I was talking about, though. So fast forward, dating my wife, current wife now. father in law was like, Oh, you want to get into sales? I got, I got something for you to sell, essentially. So you kind of started planting that bug early, no one really gets into property and casualty insurance on purpose. I don’t think I think it’s always, you know, some sort of weird story. So he planted that bug early. throughout college.
That’s kind of the plan. I get out of college. And he says, great, go cut your teeth somewhere else, you know, so like, Oh, sweet, you know? You mean, you have a, you have a company that I could go work for, and you’re gonna make me go work hard somewhere else first. Yeah. I’m like, hands down the best decision he ever made. He’s a very smart guy. I am very appreciative. But that’s the route he took, because it forced me to go out on my own kind of make my own path start that way, not just something new. It also gave me a lot more respect from you know, my current colleagues now that I wasn’t just, you know, the bosses. Yeah.
Yeah, whatever. So I work at from a carrier perspective, I work at Allstate Insurance for a few years out of college, kind of just in the grind, trying to figure it out. I was offered a position to kind of leave something else with a different agency. And that’s when my father in law stepped in and said, Now, you know, you’re, you’re coming over to my side, so I’ve been with him ever since. We’re a united Western insurance brokers is the brokerage we we have. We are we two offices, Southern California, and then up here in Seattle. I’m the president of the Pacific Northwest region up here. So we kind of manage and run this operation.
There’s another guy down south who’s doing same type of thing. We’re licensed in all 50 states. We are a mainly commercial Insurance Brokerage. So we work with business owners to manage and offload risk, essentially, right so we do it from a competative perspective. We’re not your traditional sales person that sells a policy and walks away. We we are there kind of throughout the year for you as a tool in your tool belt to help you manage risk from contractual basis or offloading it to an insurance carrier or internal best practices to kind of help mitigate that risk. And so that’s kind of what we do.
That’s what we work with. And within that I’ve been up in Washington, I’ve kind of started to focus and how I got into backing into this reps and warranties discussion, I kind of got into a lot of tech business, just being prolific up here in Seattle. And it was a nice fit that the client tells us to kind of, you know, we see eye to eye on a lot of topics. And so that’s how I got my start in the tech business, the tech world has a lot of m&a is going on. And I kind of just weaseled my way figured out a way to kind of get into this side of it. Again, wasn’t my purpose wasn’t wasn’t because I, you know, tried to it just one thing led to another and, and it kind of just worked out well now.
Damon Pistulka 10:58
Yeah, yeah. Well, that’s cool. I mean, yeah. And I can see now you probably met Ruben Ortega, the person and introduced us through through the tech stuff, because I know he does a lot of deal work in the, in the tech industry. And, you know, he’s got such awesome experience in in business transactions. And he’s a good lawyer. He’s a good lawyer. Yeah. It’s so your, your insurance.
Now, when you when you look at this, this is back up to the hoelscher the entire scope of insurance for businesses, because I think there’s, there’s a lot of people that that that have businesses really kind of get caught in the trap of thinking that insurance is kind of like your home or your car insurance for business.
And it? It isn’t, there’s a lot of things that each individual business needs. That, you know, I’ll say a construction business is much different than a retail business, then. And that is a dentist’s office. And can you explain some of the some of the intricacies that you you’ve just gone and saw that, oh, this this policy was way wrong, you know, without giving away anything? And it shouldn’t. But I think it’s interesting for people that really understand about insurance and how it helps you.
Yeah, no, completely? And that’s a that’s a huge question. Right? And it’s a great, it’s a fantastic question. And that’s really what each industry, when we look at it, you mentioned construction, versus if we just look at construction versus let’s say, tech, right? two totally different industries. There isn’t a cookie cutter policy that’s going to fit, if not, you know, what’s your age?
What’s your date, what’s your driver’s license number, and what car you’re driving, you know, on a personal auto policy, it’s completely different. And so what you’re looking at is, is from a construction standpoint, you have multiple lines of business, you have the general liability. So if they, you know, cause damage, then there’s the workers compensation, if their employees get hurt, there’s the bond to ensure that they’re actually doing the work.
And there’s pollution coverage and commercial autos, I mean, there are a handful of different policies that a construction company would need. The width within all of those lines of coverage, there are, you know, specifics that we need to build, dive into exclusions on policies, and is it the right coverage for you? And so the, the how broad and the scope of coverage on the policy is a whole nother discussion. So, it really, why you need a broker who specializes in this business insurance because there’s, there’s a million questions to ask. And there’s a construction manager guy running a construction company is great at building things. That’s what they do, right?
He’s not supposed to be able to look at his insurance policy and look at I mean, the insurance companies make these insurance policies. So difficult to read, it’s what I do. And I still get confused when I’m reading insurance policies. And that, you know, no one wants to read them anyways. So it’s, it’s really, you can’t just, it’s not cookie cutter, right? It has to be pieced together, and it has to be done appropriately. And then it has to be a relationship. And that’s where we come in on this competative standpoint is, I’m not just going to sell you a policy I need to know about your business.
I need to know what risks you face and how you’re covering those risks. Right? Do you want to insure it? Do you want to just take it on the chin if something were to happen? Do you want to offload it contractually by your you know, your agreement with your client or, you know, how are we going to handle all of this and so that’s where we then learn about our client understand what they’re facing, what they want, what their goals are, what they They’re risk tolerances. And then we back into it and say, here’s how we create a plan for you. Here’s what we should do with this, here’s how we do this, and so forth.
And the same approach goes for all types of business. But again, it’s just the risks they face, it’s going to be completely different from a tech company, a lot of cyber, a lot of, you know, cyber liability, or cyber crimes or data breaches, those are big, professional liability. So there’s no or errors and omissions exposure is large. So it’s a little bit different than what a construction is that the same approach is taken of, let’s dive in, I want to learn about what you do. Use my expertise in managing risk, and help you then create a tailored program and portfolio that’s going to seamlessly address all areas of the risk that you have.
Damon Pistulka 15:51
Yeah, there’s a couple and now it you started, you started mentioning some terms that got me thinking right. Can you explain there’s a couple of types of insurance? You mentioned? No, what is no insurance? And what’s it typically used for?
Yeah, you know, errors and omissions? So errors, omissions, professional liability is another term that they’re synonymous. Also think of malpractice from a medical standpoint for medical malpractice. So when you’re looking at an errors and omissions, it’s, it’s something that you in your professional work caused damage. So for instance, I don’t have insurance broker, I tell you, you don’t need cyber liability.
You don’t have an exposure, don’t buy it. Right client says Josh does professional and he’s, he’s the one I should be listening to, I’m not going to buy cyber six months down the road. He has a cyber loss. He says, Hey, Josh, you told me, You made an error. In your judgment. Here’s a lawsuit. Right. So I personally, we have an errors and omissions policy to cover airs, I make an omission I make if I forget to mention something that’s from no exposure from like a professional standpoint. So a lawyers, same type of thing. An architect, so forth.
Damon Pistulka 17:15
Okay, so that’s what that is. It’s more for a professional liability kind of thing. Yeah. There’s another one that I’m familiar with. And that’s directors and officers insurance. Now, how is that used?
So directly with officers is going to be used to protect the directors and officers of the corporation, if they were to be sued by an outside third party and an investor. If, if they make a decision, or if they do something, essentially right big picture that adversely affects the company, that there’s a policy to protect them as they were to be dragged into litigation.
Damon Pistulka 17:59
Okay. So we decided that we’re going to handle this situation this way. And it backfires or whatever. And it’s it’s aboveboard, it’s ethical. Everything we’re doing was right, but it just didn’t work out. And a customer or somebody outside the business, for whatever reason sued us because of that decision. That’s that’s what that covers.
Roughly. Yeah, yeah. around the idea. Yeah, this is all rough.
Damon Pistulka 18:27
Okay, cool. Because I think there’s, I think there’s a lot of that stuff, a lot of this terminology. I mean, you have to spend a lot of time with your clients just going over terminology. Because there’s so much lingo in the insurance business,
there is a ton and I’m still learning lingo, I still have to shoot back, you know, questions to carrier, the underwriters, like, what is f IR? fill me in on what you meant by that. So there are things like that, right, that happened. And that’s the hard part of our businesses is tailoring a very complex, hard, big industry and making it accessible to our clients. Who are, you know, in the same way, I don’t understand all the construction lingo or the golly, start talking about like, the tech world and what they’re talking about, like? Yeah, you know, so for being able to explain it in a, in an easy, simple way. But still getting the the severity and the complexity through is definitely a challenge.
Damon Pistulka 19:30
Yeah, very cool. Very cool. So you and I connected on on a deal that we were doing a business transaction, where we were talking about and considering reps and warranties, insurance. That’s what kind of started off the thought of maybe we should talk about it because I don’t think that many people selling a business, really even understand what rep representations and warranties are in the transaction and we can talk about that.
A little bit. But I know even if they understand that they probably don’t understand that there’s insurance to help in that situation reduce the risk there as well. So, if you can, let’s talk about representations and warranty, and I’ll try to explain it. And I’d like you to fill in if if,
yeah, I’d love for you to go first. This is your focus here.
Damon Pistulka 20:25
Yeah. Well, my understanding of representations and warranties is, is that the fact of the matter is, is when you sell a business, you’re going to say that, Listen, I’ve got these assets I’ve got, these are my customers, and here’s some customer contracts, or here’s agreements with suppliers, or here’s employment agreements, whatever, and you’re Shawn, there’s a ton of this information, it could be, you know, I don’t have any tax liabilities. And and, you know, or things like that have no outstanding litigation is a big one in these.
And these are all representations and warranties. And I don’t know the exact term and and we could get Ruben to help us on this sometime. But that is my understanding of representations and warranties are kind of the the overall those those details that you’re sharing with somebody in the transaction representation that I make about the business, and Is that how you see it as well?
Yeah, that’s correct. So it could be the organization standard, it could be the capital structure, so stock or membership interest. Like fees, so finders fees or broker’s fees that they’re paying, like title to securities or stock and membership or interest sales. I mean, exactly what you talked about, are, its representations are what the seller saying, here’s what my business is doing. Here’s X and Y, and Z about my business and all of the details that are pertinent to the sale, right? Or the purchase of the deal.
Damon Pistulka 22:05
Yeah, yeah. So so that is the representations and warranties that we’re talking about, or reps and warranties as people in the m&a investment banking insurance world talk about. So when we talk about reps and warranties, insurance, now explain the insurance a little bit and then we’ll talk about where it’s appropriate maybe, or the not, you know, depending on deal size and things like that. So let’s talk a little bit about reps and warranties, insurance, and really, how that reps and warranties insurance helps the seller. And also sometimes it helps the buyer.
Yeah. So from a from a high level, right reps and warranties, representations and warranties, all those same things. It’s designed specifically right to cover the losses resulting from unknown breaches of the sellers, representations and warranties kind of what we just talked about. And in in a private acquisition agreement, so between a buyer and a seller, it’s not a new product, it’s been around for about 1920 years or so. There have been some one off deals kind of I’ve heard dating back into the 90s.
But again, it it’s been around for about 19 years. The product, I mean really from So 2000 was kind of formally introduced, was kind of a slow growth of it there in that private equity boom, it took off a little bit. And then it gained a ton of traction and kind of 2005 2007 range is when the product really kind of started to make sense for some. At that point, though, in 2000 5007, it was just very expensive. That was a new product. It was expensive. So not a lot of people could afford it. And at the same time, the the scope of coverage wasn’t great on the policies.
So it really didn’t make sense for a ton. What actually what really changed the rep and warranties industry was so in the 2008 recession hit the market tanked for from an insurance standpoint. And so to be competitive, the carriers who were kind of big players in the game at that point flashed the rates on it, essentially cut them in half, they were about trading at four to 6%. And that was like two to three. So essentially cutting it in half and making it accessible to a lot more people. Once the market picks back up, it they kind of stayed at that same pricing standpoint, because they realized that it was more accessible and more people were interested in purchasing the coverage.
And since then, it’s been huge in the past, you know, five years or so it’s really become a very common policy in the m&a world for these transactions. From a scenario standpoint of who’s buying it and when they’re using it. We primarily see it 90% of the time it’s going to be from the buyers perspective. So it’s gonna be a buyer, the buyer is purchasing the policy. Okay? Sometimes within that in that 90% range that we’re talking about, sometimes a seller will pay the cost of the reps and warranty policy, but they’ll be buying it for the buyer. So it’s still a buyer side policy, not in the seller standpoint. So again, about 90% is what we’re seeing.
Damon Pistulka 25:23
So when you say that when you say that, though, that means that if there is a claim, the buyer gets paid.
Correct. And that’s why it being purchased. So that way, it becomes that first party lost, they are filing the claim against their insurance policy, because they see a breach in the reps and warranties that were made. Okay. Yeah. So I think we were talking about kind of the who’s buying it, why they’re buying it from the scenarios. It, it’s really I mean, there are kind of three main points of who why why these policies are being purchased.
One of them is to supplement the buyers existing indemnification limit. So there might be an indemnity cap, or if survival periods written into the contract until the buyer is wanting to like that they want to supplement what they can get back from indemnification agreement. If they don’t feel like there’s going to be enough. Okay with us, there’s policy. So they could essentially have access to more
Damon Pistulka 26:32
money in the situation where they put so much money into escrow, because that’s that’s really where the seller was comfortable. So the seller wanted to leave a million dollars in escrow. And they said, Well, I’d really like to have $2 million, in case there’s more, or $5 million, whatever the number is, they could buy insurance to cover that gap.
They could and that’s actually a little bit separate of a scenario. So the first one that we were talking about is in the contractual agreement, there may be an indemnity cap. So the seller may have a limit on what they can indent what what their indemnity agreement is.
And so if the buyer is saying, I don’t feel comfortable with capping my indemnity at 5 million, right, I feel like there’s a little bit you know, I might be out of pocket more in the event something were to happen, they’d be purchasing the policy to give themselves a little bit bigger of a buffer. The point you just brought up is essentially backstopping the existing asset grow or indemnification obligation to the buyer. So second type of thing to lessen the escrow upfront and fill it with essentially an insurance policy.
Damon Pistulka 27:41
Yeah, that’s what we were looking at in the transaction, because in that transaction, the buyer wanted to put a significant amount into escrow because of several reasons in and we’re looking at it for that. So. So the indemnification, I see how that works.
Now on the second one, like we just talked is for backstop to help. So in that situation, though, the seller may even want to do it just because if the buyer, if the buyer wants you to leave 5 million in in escrow for a year, 18 months, or whatever it is, and they say, No, I really don’t want to do that. You could buy a policy and maybe get by leaving a million in there or something like that. And you can get the money out now.
Correct? Yeah. And we see that happening a lot. So definitely that.
Damon Pistulka 28:35
Okay, that’s a common use for it and stop the escrow. All right. Oh, you said there were three what’s the 30 minute
run into? Yeah, exactly. So 31 is essentially similar to the first, right, it’s provide coverage to the buyer in lieu of a traditional indemnification limit. So it’s essentially replacing the buyers remedy for the breaches related to the reference reps and warranties on the policy. So in lieu of a traditional indemnification limit, it would just be an insurance policy. So similar rather than in the lesson name, or adding on top of the indemnity cap in lieu of the indemnification limits.
Damon Pistulka 29:18
Okay, so rather than put anything in there, the the policy says it’s covering you for this amount of an indemnification and that’s, that’s where it’s okay. Okay, so when we, when we talk about these three different situations and this type of insurance, I mean, you’re not talking about you’re going to do this for a $500,000 deal. Where does this start to make sense? And where does it really make a lot of sense to use this type of insurance and from a size standpoint?
Yeah, no, completely. So really, it starts to make sense. It doesn’t come Doesn’t make sense to under about a $5 million deal size. So the deal is gonna be about 5 million and under doesn’t really make sense. Yeah, for a few reasons, and we can kind of get into the structure of the policies and the cost associated. At that 10 million mark and above, it is definitely something to consider.
You know, 10, really 10 and up all the way into, you know, there are companies in the billions, right, that are dealing with these, and I don’t have too much, you know, you bring me a billion dollar deal, Damon, and I’m gonna have to, you know, get a little bit album that one, but, you know, so definitely the 10 and above it, definitely, seriously consider it, or at least talk to a broker or talk to someone about the policies and the terms and to just get a little bit more info on it. under five, it doesn’t make sense. Yeah. Yeah.
Damon Pistulka 30:50
Yeah. Okay. So you got to be, you know, 10 lines of nice spot, if there’s something that that you need to talk about with indemnification escrow backstops, or, or eliminating your escrow to a certain point, that this would be something to look at, as an alternative. So when you talk about these kind of policies, what what how do you how does it work? I guess, how does it work? How do you get started? If somebody says, I want to look at this?
Yeah, of course. So the underwriting process is a little bit different than some, because we know the traditional rate structure. So essentially, we can, if you came to me with a deal, we would be able to get a very rough understanding of what this is going to cost.
And is this going to make sense? Yeah, so from a, from a, building the policy perspective, right? So it’s going to be about like we said, that deal size range above 10, the average limit bought of insurance. So when we’re looking at deals from that 10, and above range, typically, we see people buying about 10 to 20%, of the deal size. So on a $10 million deal, they’re traditionally buying about a million dollars of reps and warranties, coverage, okay?
Again, that’s a loose number, it can be tailored to what needs to make the deal work and fit, but roughly, we see about 10 to 20%, the premiums are about two and a half to 3%. of the limit bought. So, again, a little bit higher, that 3% range is what we’re going to be looking at for these deals in that $10 million range. And then as we get, you know, as we get higher and more premium is purchased, or excuse me more at the limit higher, the premiums drop to the two and a half 2.6 range. So, again, to our $10 million scenario, you know, the the buyer is buying a million dollars of insurance, their premium would be about $30,000. For that policy.
Damon Pistulka 33:03
Yeah, 30 k for a million bucks coverage,
the deductible on those is about one to 1.51 and a half percent of the deal size. So that’s how they work. So in this scenario, we just went off of 1% to the, you know, yeah, take the conversation, we’re looking at the deductible about $100,000. So insured would be out of pocket $100,000.
At that point, then the policy kicks in to the limit of insurance that they bought. What’s a little bit different, excuse me. A little bit different about these types of policies versus a lot of other types of insurance policies is there’s going to be a large underwriting fee, which is a non refundable fee, yeah, paid, that the insurance company then takes that money, and pay the team of lawyers to do the due diligence on top of the due diligence.
So we see the procedure from 25,000 to $40,000. Again, that range is a range based on the complexity of the deal, and how clean the financials are, and so forth. So, again, we look at that. So the typical structure of how this would work is with knowing these these sliding scales. You would say, Josh, I think I have a deal that makes sense. What’s the next step? So what we would do is we would essentially, I would need, we would take a buy sell agreement, financial from the seller. Most carriers want audited financials, some carriers will accept non audited, again, depending on the size of the deal in the scope. Any deal marketing material available.
Yeah, we turn that all over to a handful different insurance companies, we have about 10 or 15. I forget it’s kind of sliding, who do this and it would take them about two to three business days to give us a non binding indication. So essentially what they would be saying is for Your million dollar limit is going to be 30,000, the underwriting fee is going to be $25,000. And there’s going to be a deductible of 100,000. Right, we would decide which company we think is the best fit. And then we would go and do a full underwriting on it, that’s when you cut the check for the $25,000, the insurance companies spends about five to 10 days, again, depending on the complexity of the deal.
And they take those 510 days to do their due diligence on all of the information. At that point, you know, if it comes through, and, you know, if we get the non binding indication, it rarely, I mean, we I’ve seen it once out of all that were at the end of their underwriting, they said, not all of them will fake, you know, this was a completely different than what you’ve turned in. So if we get a non binding indication from the carrier, it’s usually ready to go, you know, but we still need that formal approval after that, you know, five to 10 business day review from their their legal team.
Damon Pistulka 36:03
Yeah, that’s, that’s, yeah. Yeah. I mean, when you’re sitting here thinking, I listen to your talk, I’m thinking about someone that is listening to us thinks that is a lot of work for an insurance policy on on a business sale. But I it’s, to me, it’s just an indication of the complexity, overall complexity of a business sale in and of itself, because when you think of doing a 15 $20 million transaction, $10 million transaction, the complexity really doesn’t change a hell of a lot, until you get really big.
There is a ton of this kind of work that has to happen, this is just one of those pieces that that could could drop him into, into and make a lot of sense, because if I’m sitting there in this transaction, and I, it’s, it’s a, it’s a difference between I could potentially, as a buyer, my in any of these transactions, correct me if I’m wrong, but most of them are investment buyers, they’re trying to prevent the loss of an investment, they really need this kind of insurance, because it is a backstop for them not to have too many losses, for whatever reason, on a transaction.
And, again, it’s just one of the pieces in the due diligence process for the purchase of a business that an investment buyer will probably go through or a strategic buyer, but these buyers have to go through because often understanding the risk that someone is going to take on by writing a check for 15 or $20 million, or whatever the number is, because they’ve built this business over time. It’s kind of like if you’re if you’re a weightlifter and you can you can you know, you’re like the world champion weightlifter, well to you. You’ve been working on that for years and years and years. And it’s not that big a deal to you anymore. Because you’ve worked at it for years and years and years.
But when you have to look at from beginning to end, that’s a big, it’s a big change. Yeah. And but this is really cool, because it’s a nice kind of thing. And it really, there’s a lot and people understand it, because there’s a lot of people and and to from a seller side I can imagine to from from the person selling the business, there are some times when it makes sense for them, like you said, to buy the policy that pays the buyer of the business so they can get a deal done. Have you run into that situation?
We have? Yes, I’ve ran into a situation where I know traditionally, and you can correct me if I’m wrong. It’s a seller’s market right now in m&a. Right. I mean, completely. We ran into a deal where the seller it wasn’t a super clean transaction, and the seller was needed to sell. There were some things in the business that made it seem a little bit hairy, right. And so he decided to front the cash to pay for a policy because he wanted to get the deal done. He wanted to alleviate any sense of worry from a from a buyer’s perspective on a clean deal.
It rarely is like we said the the seller buying it. But But again, it really just depends. It changes on a case by case basis and the industry and the deal size. But from what I’ve seen with a seller’s wanting to buy it was in this scenario, and this isn’t always the scenario but it was just a little bit a little bit hairy of a of a transaction that he wanted to make sure to just kind of alleviate some of the concern.
Damon Pistulka 39:55
Yeah, yeah. But if you’re looking at it, if I’m selling the business, right, it is a little bit bit hairy, there’s something that makes it kind of not right and get a little bit more risk than you. If I had to spend, if I were selling a business for $10 million, and I had to spend 70 K or something like that to make sure I could get the deal done, then I think that’s it. I’m going to $10 million or nothing more, or maybe $7 million, even 100 k out of that, just rough numbers if it’s gonna be less than that, but that’s well worth it in some some situations, I think.
Yeah. And like you said, right, if it adjusts your multiple on that purchase on the sale and warm and how clean and yeah, how attractive of a buy it is, then it’s completely worth it. Yeah,
Damon Pistulka 40:45
yeah. That’s what I and that’s what I was thinking about too. And like I said, the situation we’re in it was to backstop an escrow. They didn’t want to leave that much into escrow. We’re looking at some other things. But I really think that in the situations where you’re selling a business where, you know, whatever kind of risks that’s there that that would potentially make, like you said, drop your multiple little bit or not allow you to get a deal done. It would be relatively inexpensive.
Compared to being able to get something done or not. Of course, yeah. And and a lot of these people are in the situation where they, you know, yeah, they just want to get it done. Quite honestly. Yeah. So that’s interesting. Well, you know, Josh, what, what happened when we talked about on on reps and warranties insurance? Do you think we should?
Um, I, I have a little bit of claims examples. I know that that kind of makes it a little bit. Yeah. Yeah. What applies? Why, why this is important, right? So he is a massive player, massive insurance company, they’re a huge player in reps and warranties work. And they just came out in 2019. With a study. They’ve been tracking since the beginning, the deals and we’re on an upward trajectory of claims, it’s rising, essentially, and the severity of claims is also increasing.
So just make sure, yes, they have bigger, they’re getting bigger, the claims are getting the claims are getting bigger. So from 2011 2017, AIG wrote 2900 of these policies. And of those 2900, they had about 580 claims. So about 20% claims rate is what they’re taking on these policies. The it the frequency increases on the deals between that 500 million and a billion range, it jumps up a good portion. Again, not really the realm I’m playing and everyone day, but no,
Damon Pistulka 43:02
but they have more lawyers to figure out they should make a claim or not.
So the what has been interesting is so large losses, what they consider a large losses over 10 million is the loss, those have jumped from 18 or 78%, in 2017, to 15% or in 2019. So in three years, I went from 8% to 15%, that they’re seeing claims that are coming in about 10 million. So that was a that was a big a big hit two, the industry seen those claims job, essentially. And the average loss in that realm of that above 10 is about 19 million. Okay, so again, some big numbers Let me see if I have some other statistics that that don’t make sense for what we’re talking about.
Damon Pistulka 44:01
It shifts it just this this type of insurance and non deals and going through them it’s it is interesting. You know, I big deals are interesting, but just just the way that you could shape your risk with this.
Yeah, and know exactly. And, and so here’s a fantastic and I’ve kind of prepared this one because I knew that when I have these conversations with insurance, it’s easy to think that’s never gonna happen. Yeah, that’s big. And so bringing it kind of tangible event. So we had we processed a claim about eight months into a transaction. Let me see associated buyer completed the testing of physical assets. So they said they made a representation of the physical assets of a purchase.
I know that you deal with a lot of tangible property companies and the in their testing to demonstrate that one of the assets Had purchase was in poor condition and required a ton of repair and possibly being replaced. So talks with their lawyers talk to the insurance company, and they constantly there was a breach of representations of warranties on the sellers side, essentially, at a $5 million policy, and after all sudden done, it was essentially covered in full to replace the the equipment. Yeah, that they had not deductible.
So, from a physical standpoint, back to what we were talking about in the representations, they said, This machine is in this, you know, condition. Yeah. And it wasn’t done
Damon Pistulka 45:40
that you deal. Yeah, yeah. In some of these manufacturing companies, I mean, you have multi million dollars and even multi 10s of million dollars, pieces of equipment or production, whatever it is that I see that would be a big deal. In situations. Yeah. Yeah. Yeah. Ah, that’s that’s, that’s, that’s cool to hear about. I mean, it is something that I know that the sellers of businesses, this is so far afield from what you normally would be would be thinking about it.
Hopefully, you know, if we can get get this information out to somebody, they go, Ah, maybe I should consider that. And it does help them and be really cool. Yeah. Yeah. Well, Josh is awesome talking to you about this. I know that it’s a it’s fascinating to me, and I like just because I like deal work. But if people want to get a hold of you, what’s the best way to get ahold of you? So
yeah, completely. You can reach me by email or phone call. And I give you now if you want to publish it later, I’ll
Damon Pistulka 46:48
put the links in the in the thing and in the both in the comments. And then I’ll drop it into our LinkedIn as well here so people can can hit you there LinkedIn. Artie about this because
email or call?
Damon Pistulka 47:00
Yeah, email or call, we’ll do that. But yeah, Josh, thanks so much for stopping by today. Because I know that you know, our last chance because we needed to talk about something that we met, but it’s I really appreciate you explaining this to me, and I’m sure others that you’re gonna watch this to get some good out of it, too. So thanks a lot for stopping by. Thank you all for watching. And we will be back again, Josh cost us a Costa. And it’s united. It tell me the name of the
United Western insurance brokers, you w ibm.com uwv.com. Very good.
Damon Pistulka 47:39
And we will have that in the notes. But thanks for being here.
Of course. Thank you.
Damon Pistulka 47:45