Representations and warranties (R&W) insurance is a policy purchased in connection with a business sale that protects the buyer from financial loss if the seller's representations in the purchase agreement turn out to be inaccurate. It's increasingly common in lower-middle market deals ($25M+ purchase price) and allows sellers to receive a clean exit with minimal indemnity hold-back, while giving buyers more comprehensive protection than a typical seller indemnity.
Without R&W insurance, business sale agreements typically include a seller indemnity, the seller agrees to compensate the buyer for losses arising from breaches of representations made in the purchase agreement. This indemnity is usually backed by an escrow holdback (typically 5-10% of purchase price held for 12-24 months) and is capped at some percentage of the purchase price (often 10-20% for general reps, higher or unlimited for fundamental reps and fraud).
R&W insurance shifts most of this protection from the seller to an insurance carrier. The buyer purchases the policy (sometimes the cost is split with the seller via negotiation), and the carrier covers losses arising from rep breaches up to the policy limit. The seller's escrow holdback can be reduced or eliminated, and the seller receives more of their proceeds at closing without the multi-year clawback risk.
Cost: typical R&W premiums are 2.5-3.5% of the policy limit. A $50M deal with a $5M policy limit (10% of purchase price) might cost $125K-$175K. The premium is paid one time at closing. Retention (deductible) is typically 0.5-1.0% of deal size. R&W policies have exclusions, known issues, certain regulatory matters, environmental conditions known at signing, so they don't replace careful due diligence.
When R&W makes sense: deals over $25M, deals with private equity sellers who want a clean exit, deals where the seller is moving on (not staying with the business), and deals where the buyer wants longer/broader rep coverage than a seller would agree to. For smaller deals (under $15M), the premium-to-policy ratio is less attractive and R&W insurance is less common, though it's increasingly available even at the $10-15M deal size.
Key facts
- Typical R&W premium: 2.5-3.5% of policy limit (paid one-time at closing)
- Typical retention (deductible): 0.5-1.0% of enterprise value
- Policy limit: typically 10% of purchase price (negotiable)
- Coverage period: typically 3 years for general reps, 6 years for fundamental reps and tax
- Exclusions: known issues, certain environmental matters, COVID-related impacts (varies by carrier), pension underfunding
- Most common in: deals over $25M; private equity sellers; deals where seller fully exits at closing
Who pays for R&W insurance, buyer or seller?
It's negotiated. In a competitive seller's market, buyers often pay 100% of the premium as part of their bid. In a buyer's market or for less competitive processes, the cost is sometimes split (typical 50/50, sometimes seller pays portion of the retention). The economic incentive: the seller benefits from R&W because it reduces escrow and shortens indemnity tail; the buyer benefits because R&W often provides broader coverage than seller indemnity. In well-run sale processes, R&W is usually a buyer-pay item bundled into the offer.
Does R&W insurance cover known issues?
No. R&W policies specifically exclude any matters disclosed in the seller's disclosure schedules or known to the buyer's deal team during due diligence. The policy covers unknown issues, risks that neither side identified at signing. This is a critical point: if due diligence uncovers a problem (a customer dispute, a tax position the IRS might challenge, an employment claim), that issue can't be insured under R&W and must be addressed through specific indemnity, escrow, or purchase price adjustment.
