Representation and Warranty Insurance: What Sellers Should Know

If you're selling a business for $5M or more, there's a good chance Representation and Warranty Insurance (RWI) will come up during negotiations. Once reserved for large-cap deals, RWI has become increasingly common in middle-market M&A — and it's something every seller should understand.

What Is Representation and Warranty Insurance?

In any business sale, the seller makes representations and warranties (R&Ws) — formal statements that certain things about the business are true. These might include statements about the accuracy of financial statements, the status of customer contracts, compliance with laws, the condition of assets, and more.

If a representation turns out to be false and the buyer suffers a loss as a result, the buyer can make a claim against the seller for damages. Traditionally, this risk was managed through escrow holdbacks — a portion of the purchase price (typically 10-15%) held in escrow for 12-24 months to cover potential claims.

RWI replaces or reduces the escrow holdback by transferring the R&W risk to an insurance carrier. Instead of holding back $500K–$1M+ of your proceeds in escrow, the insurance policy covers the buyer's losses if a representation is breached.

Why RWI Matters for Sellers

More Cash at Closing

The most immediate benefit: RWI dramatically reduces or eliminates the escrow holdback. Instead of 10-15% of the purchase price sitting in escrow for 18 months, you might have a minimal escrow (1% or less) or none at all. For a $10M deal, that's potentially $1M+ more in your pocket at closing.

Cleaner Exit

Without RWI, you're exposed to indemnification claims for 12-24 months (or longer for fundamental reps). A buyer who has a bad quarter might go looking for R&W breaches to offset their losses. RWI shifts that dynamic — the buyer makes claims against the insurance carrier, not against you.

Competitive Advantage in Bidding

In a competitive process, a buyer who offers an RWI-backed deal is offering the seller a cleaner exit than a buyer proposing a traditional escrow. Some sellers actively prefer RWI-backed bids, all else being equal.

PE Standard Practice

Most institutional PE firms now use RWI as standard practice. If you're selling to private equity, expect RWI to be part of the conversation.

How RWI Works in Practice

Who Buys the Policy?

In most middle-market deals, the buyer purchases the policy, though the cost is sometimes split or allocated to the seller as a deal expense. Buyer-side policies are more common because they give the buyer direct recourse against the insurer.

What Does It Cost?

RWI premiums typically run 2.5-4% of the coverage limit. For a $10M deal with $3M in coverage, the premium might be $75K–$120K. There's also a retention (similar to a deductible), typically 1% of enterprise value, that the buyer absorbs before the insurance kicks in.

What's Covered?

RWI covers losses arising from breaches of the seller's representations and warranties in the purchase agreement. Standard coverage includes reps about:

• Financial statement accuracy
• Tax compliance
• Material contracts
• Employee matters
• Intellectual property
• Environmental compliance
• Legal proceedings

What's Not Covered?

RWI policies have exclusions, and understanding them matters:

• Known issues — anything disclosed in the disclosure schedules or known to the buyer before closing
• Purchase price adjustments — working capital disputes are typically excluded
• Forward-looking statements — projections and forecasts
• Specific exclusions identified during underwriting — the insurer conducts its own diligence and may exclude specific risks they identify
• Fraud — intentional misrepresentation by the seller is never insurable

The Underwriting Process

The RWI carrier conducts its own diligence, which typically takes 2-3 weeks and runs in parallel with the buyer's diligence. The insurer reviews:

• The purchase agreement and disclosure schedules
• The buyer's diligence reports (financial, legal, tax)
• Any QofE report
• Industry-specific risk factors

Based on this review, the insurer decides what to cover and identifies any exclusions.

How RWI Affects Deal Negotiations

Indemnification Terms

With RWI, the seller's indemnification exposure is dramatically reduced. Typical terms with RWI:

• Seller's indemnification cap: 0-1% of enterprise value (vs. 10-15% without RWI)
• Escrow: 0-1% of enterprise value (vs. 10-15% without RWI)
• Survival period for reps: May be shorter, since the insurance policy provides the buyer's protection
• Fundamental reps (ownership, authority, capitalization) may still have direct seller indemnification

Disclosure Schedule Strategy

Since RWI doesn't cover known issues, the disclosure schedules become even more important. Everything disclosed is excluded from coverage, so buyers have an incentive to push for broad disclosures. Sellers should be thorough but precise — disclose what's necessary, but don't over-disclose in ways that create unnecessary exclusions.

Negotiation Dynamics

RWI generally makes negotiations smoother. Many of the most contentious deal terms — indemnification caps, baskets, escrow amounts, survival periods — become less adversarial when an insurance carrier is absorbing the risk.

When RWI Doesn't Work

RWI isn't appropriate for every deal:

• Deals under $5M — The fixed costs of RWI (underwriting fees, minimum premiums) make it uneconomical for smaller transactions.
• Distressed businesses — Insurers won't cover businesses with significant known risks or financial distress.
• Incomplete diligence — If the buyer's diligence is thin, the insurer will either decline coverage or add broad exclusions.
• Highly regulated industries — Environmental, healthcare, and financial services companies may face difficulty getting coverage for industry-specific regulatory risks.

What Sellers Should Do

Understand RWI basics before entering a sale process. If a buyer proposes an RWI-backed structure, you should know what it means and how it benefits you.

Negotiate who pays. While the buyer typically purchases the policy, the premium allocation is negotiable. In a competitive process, buyers may offer to absorb the full cost.

Review exclusions carefully. The devil is in the details. Make sure you understand what the policy excludes and whether those exclusions create residual risk for you.

Coordinate with your M&A attorney. The interaction between the purchase agreement, disclosure schedules, and RWI policy requires experienced legal counsel.

Don't assume RWI eliminates all risk. Fraud carve-outs and specific exclusions mean you may still have some residual indemnification exposure. Understand where the policy stops and your personal risk begins.

Next Steps

RWI has fundamentally changed middle-market M&A by reducing seller risk and making deals cleaner for both parties. If you're preparing for a sale and want to understand how RWI might apply to your transaction, schedule a call and we can discuss your specific situation.