TRANSKRYPCJA 🔗
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Talk for a smidge about how you got
involved in reps and warranty insurance.
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Well, the way I was brought into it,
I've been doing directors and officers
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liability for years, and one of my clients
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was selling his company,
and he was going to take the money
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and move to the old country,
which was to Israel.
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And he when the buyer found out
that he was leaving the country,
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they changed the terms of the payout.
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And they're going to hold back half,
not 10%, but half of the proceeds on a 50
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plus million dollar deal,
they say is nothing personal.
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We don't mean to be adversarial.
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It's just if you leave the country we have
and something goes wrong,
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there's nothing we can do about this
and we can't pursue.
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So I'm sorry we
we have to put this in as a hedge.
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And the client said to me, well, Patrick,
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there's got to be some insurance for this.
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And I said, well, yes,
but it's prohibitively expensive.
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And he said, Patrick Price is no option.
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It's no object. Just go get it.
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And you know, when people come to me
and they're about to close a dealer,
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do some big transaction,
you know, prices no object
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and they honestly mean it
until you've given them the price.
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Then it becomes a really big object.
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In this case, in 2016 is
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when I did my first M&A deal,
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we went out to the ripple warranty market
to get those coverage,
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and it was one fifth
where I thought it was going to cause
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I thought this was going to be
a seven figure premium to insure $50
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million deal,
and it ended up being a fraction of that.
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And when I learned about that, you know,
it was great because by
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getting this insurance, my client,
the seller, was able to leave
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rather than having $25
million held back in escrow.
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He only had $1 million left in escrow.
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That was the deductible for the policy.
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And so he just said, Patrick,
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I got an extra 25, $24 million
in my jeans pocket thanks to you.
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And I was like, from there I decided,
this is my calling.
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This is what I want to do with insurance,
where we can take
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owners and founders
who started with nothing
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and help them realize,
and they create a tremendous value.
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We can help them exit with as much money
as possible.
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As a thank you to them.
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And so it's been nice
rather than waiting for something bad
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to happen with,
which is the case usually with insurance.
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This is something that has tangible,
real benefits.
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You know, once you get the deal done.
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Those of you that are just joining us,
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on touched on talks, this is Patrick
Strath with Liberty Company
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and we're talking today
about reps and warranty insurance.
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Reps and warranty insurance protects
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buyers and sellers in a transaction
similar to what Patrick just described.
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In a way that,
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has historically been
only the big deals, right?
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Your billion dollar, you know, if you're
if your transaction had a B on it,
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then you were getting roughs
and warranty insurance,
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and now we're seeing it
at the lower middle market.
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And so it's important to understand
what it is,
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how we could use it
and why we might want it.
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There are different types.
Tell me, tell me.
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I kind of think of it
like ice cream flavors.
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Tell me about the
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the flavors of ice cream that we have
for reps and warranty insurance.
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Well, thanks for having me here, Deborah.
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And I'll tell you as we talk about
there are two buckets of ripple warranty
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insurance.
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Before I get into that,
let's talk about a more global choice.
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You either have protection, have
insurance, or you go forward without it.
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Traditionally, mergers and acquisitions.
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What would happen
is before the insurance policy came along.
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You know, the buyers as as it is common,
nobody wants to get stuck holding a lemon.
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And so the buyers,
Load full transcript
even though they
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perform due diligence,
you're not never going to know everything.
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And they don't want to find out
after they've already closed the deal
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and the money has been sent out
that they way overpaid
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because there was something
the seller didn't
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tell them or just something to come up.
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So what would traditionally happen
is buyers would hold back.
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Well, first of all, the buyers
would get a money back guarantee clause
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in the purchase agreement.
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It's called an indemnification
or indemnity provision.
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That way the buyer can get their money
back if there's something out there.
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And traditionally,
what would happen is buyers would go ahead
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and have a percentage of the enterprise
value as the amount they can take back.
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They can claw back,
you know, 20, 30, even 100%
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of the purchase price
if certain conditions hit.
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And so they put that in there.
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And usually what would happen is under,
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you know,
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the buyer want to have a little cash
put aside so that in the event
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something bad happened,
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they had ready cash to throw
at the problem to mitigate the loss.
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So they would hold back traditionally 10%
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of the purchase price
into an escrow account.
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It would sit there for a year, 18 months,
and if nothing happened, seller.
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Here's the rest of your money.
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We'll give you a thousand, five,
90% of cash a close.
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You get the rest a little a little later
on, provided nothing happens to wish
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the seller sitting there saying, wait,
I answered all your questions.
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I gave you all the information out there.
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You can't blame me or hold me responsible
for something that wasn't my fault
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that I didn't even know about.
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Months, even a year later.
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So I'm sorry.
We're not going to have that.
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And so that's the friction or the dilemma
between buyer and seller is reasonable.
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And so the insurance industry came along
and said to tell you what
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let's look at the reps.
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Let's look at the diligence that's there
for a couple of bucks parties.
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Rather than go pointing at each other.
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If something blows up, you come to us
and then we will go ahead and take a look.
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And, you know, buyer,
we will pay your loss.
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So we're hedging your exposure.
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We're limiting your risk seller.
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You don't have to deal with this
big escrow.
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You can get off and get a clean exit.
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And so the traditional in about ten years
ago, 11 years ago in the middle market,
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this tool came in and you know, to
to take a look at the impact.
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You have $100 million deal. Okay.
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Well there's going to be a $10 million
held back in escrow.
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And the seller city, there's a
I want my $10 million today.
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And well, what happened
is with an insurance policy came in.
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All of a sudden
that $10 million rescue was reduced to
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just a 10th of that, down to $1 million.
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So $100 million deal.
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You're exiting with 99 million
at closing buyer.
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They're still protected because they would
have up to $10 million policy.
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And so it worked out great.
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And from 2016 to probably about 2024,
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the usage of reps and warranties
went from less than 5% of deals
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to well over 90% of middle market deals
have some form of this warranty insurance.
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And it's been very, very effective.
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And what has happened, as Deborah said, is
it was reserved for massive accounts,
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massive transactions, usually, you know,
nine and ten figure transactions
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because you had you had audited
financials, you had extensive diligence,
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you had a lot of background stuff
the underwriters could look at.
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Over the years,
as diligence has gotten more
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sophisticated, the parties understand
what's going on.
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The threshold for eligibility for Reps
and Warriors has come down, down, down
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to where there are, in some cases, deals
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that can be insured
under $10 million in
enterprise.
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Five.
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There's actually another one for even
smaller deals we'll get into later.
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But that's been the process.
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You know, the concept with having
insurance is you want to go ahead
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and take that risk away from the deal
parties.
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They've got enough other friction
to deal with.
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But if we take some of that financial risk
away from them, it can move forward.
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And so that's how reps and warranties
insurance came about.
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And that's what it does.
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It essentially stands in the shoes
of the seller to pay the buyer
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that indemnity exposure
to cover the buyer's law.
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So again buyer is guess remedy
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seller gets a clean exit.
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Why this is gone very very successful.
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Oh sure.
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So many of our many of our listeners
are likely
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not at this point of a transaction yet.
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So let's let's take a step back even with,
you know,
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we've done a couple of different podcasts
on reps and warranty
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and why they're, you know, what,
what's going to be asked of them.
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But let's just remind everybody
that, you know, indemnification is
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is promising that what you have said
and what you've put in
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your legal schedules in, in the contract
is accurate, valid and provable.
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So you
as a seller have to say to your buyer
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that, yes, I have told you everything
that could go wrong,
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everything that I know to be true,
everything about my whole company.
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That's a lot to sign off on.
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Because you've been working
in your company
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probably 20, 30 years,
maybe your third generation.
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Right.
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So you're saying that to your knowledge,
all of this is accurate,
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and reps and warranty insurance can help
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step in in situations
where maybe you haven't been operating it
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for the last five years
and your CEO has been operating it, or
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your granddaughter
has been operating it, or.
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Right.
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So there are times that as an owner,
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this isn't all in your knowledge base.
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And your buyer is looking at it as you're
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the expert, and you should know it.
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All right.
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So this is by, by bridging that, you know,
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practical knowledge basis.
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It gives
it gives a platform to help de-risk it.
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Absolutely.
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And you have to understand that the,
the buyer's perspective on
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this is when they go ahead
and they put this onus on the seller,
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like, look,
I've told you everything I know,
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and the buyer is going to come back
and say, yeah, well, I'm
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betting tens of millions of dollars
sometimes that your memory is perfect.
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And you told me everything.
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And when you go through the day to day
grinding on operations,
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even if you're not directly involved,
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you're being held to a standard
that you are directly looking at.
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Every invoice,
every expenditure out there,
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every contract and and contracts either
with key customers or key suppliers.
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They they can change.
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Or employees. Or employees. Yes.
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And and some standards can change.
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And some things in regulatory
can change without your knowledge.
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And there are things with permitting
and other laws
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where a company may be grandfathered in
with whatever they're doing.
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They don't have to upgrade
whatever policy, procedure or permit.
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And then there's a change of control.
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And suddenly nobody thought that
there was going to be any impact on this.
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And all of a sudden it happens.
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And, you know, for the seller,
unfortunately, you're going to be held
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to the standard
that you should have known.
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And under the contract,
the buyer is going to come after you.
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Yeah.
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And we've seen it happen. Right.
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It can be something
as simple as an uncollected invoice
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and something as complicated as
you said.
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You had completed all the work
for what you invoiced, and they find out.
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Maybe you didn't.
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And now they're on the hook
for something that you got payment for.
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Or. And it's not intentional.
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Nobody's thinking it is,
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but it's better to have it covered
by an outside policy,
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then to have to hit an escrow
where you left your money,
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or in some cases,
take it out of your back pocket
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from where you just invested it with your
your purchase price.
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Right.
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So that's kind of the intention of this.
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Is the buyers protected
because they have this to lean on
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and the seller is protected
because it's, it's an extra
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an extra resource for the buyer
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to tap into that doesn't
involve your pocketbook.
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Absolutely.
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And I let me use an analogy here
because they're
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this is is new
and it's insurance is coming in.
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It's another expense and so forth.
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And so a lot of things to think about.
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But let's think about an alarm system
for your home.
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Okay.
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Some people will say, well,
I live in a really nice neighborhood.
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00:13:08,537 --> 00:13:11,499
We're not,
you know, we never have any crime here.
236
00:13:11,499 --> 00:13:14,543
Besides, my neighbors
have substantially more wealth.
237
00:13:14,543 --> 00:13:16,462
They got bigger houses,
they got nicer stuff.
238
00:13:16,462 --> 00:13:17,838
So nobody's going to target me.
239
00:13:17,838 --> 00:13:19,256
And by the way, you know what?
240
00:13:19,256 --> 00:13:22,009
We're just never leaving the house
because we don't go on trips or anything.
241
00:13:22,009 --> 00:13:22,551
We stay here.
242
00:13:22,551 --> 00:13:25,387
So we're, you know,
there's always somebody home, okay?
243
00:13:25,387 --> 00:13:27,431
And you think about that, it's like, oh,
I don't need it.
244
00:13:27,431 --> 00:13:30,017
And then you come along
and you get the reality.
245
00:13:30,017 --> 00:13:35,105
And, and this is the mathematics of,
of, of insurance here is that,
246
00:13:35,439 --> 00:13:39,777
you know, with an alarm system,
let's say the alarm system costs $700.
247
00:13:40,069 --> 00:13:42,571
And I just personally went through this
when we bought our house.
248
00:13:42,571 --> 00:13:45,741
But the alarm system was $700.
249
00:13:46,659 --> 00:13:49,620
By getting the alarm system, though,
my insurance cost
250
00:13:49,620 --> 00:13:52,623
for homeowners
insurance went down by $1,000.
251
00:13:53,374 --> 00:13:55,751
So it paid for itself.
252
00:13:55,751 --> 00:13:57,419
And on top of that, you know what?
253
00:13:57,419 --> 00:13:59,171
Now we can go on a trip and not worry.
254
00:13:59,171 --> 00:14:01,549
Okay. And and so it goes.
255
00:14:01,549 --> 00:14:05,845
The same mathematics, the same economics
happens with reps and warranties.
256
00:14:05,845 --> 00:14:08,764
And we can get into costs,
you know, in a moment.
257
00:14:08,764 --> 00:14:09,890
But the mindset
258
00:14:09,890 --> 00:14:14,812
is that what you're trying to do is you're
trying to remove as much financial risk,
259
00:14:14,812 --> 00:14:19,316
both sides because both sides benefit
and and move forward with that.
260
00:14:19,316 --> 00:14:22,820
And I will talk about
there are three major things that reps
261
00:14:22,820 --> 00:14:26,156
and warranties does okay
for all transactions.
262
00:14:26,156 --> 00:14:29,159
And this is why it has become
one of the fastest growing.
263
00:14:29,493 --> 00:14:32,997
Yeah, lies of insurance coverage
out there in the industry
264
00:14:32,997 --> 00:14:36,000
and why it's facilitated
so many M&A deals.
265
00:14:36,000 --> 00:14:37,334
It does three things.
266
00:14:37,334 --> 00:14:40,045
Number one
is that financial risk transfer.
267
00:14:40,045 --> 00:14:42,756
You transfer in the rest.
So there's no more escrow.
268
00:14:42,756 --> 00:14:45,301
And I can tell you in the middle market
nobody.
269
00:14:45,301 --> 00:14:48,304
This is why it's 95% utilization
in the middle market.
270
00:14:48,387 --> 00:14:52,516
Nobody's
going to have a 7 or 8 figure escrow okay.
271
00:14:52,850 --> 00:14:56,604
You know when they can get it for,
you know, 1%.
272
00:14:56,645 --> 00:14:59,023
It just doesn't happen
because it's built in.
273
00:14:59,023 --> 00:15:01,817
So we transfer the financial risk
away from the parties.
274
00:15:01,817 --> 00:15:03,152
That really helps.
275
00:15:03,152 --> 00:15:06,405
The second thing it does is it
276
00:15:06,780 --> 00:15:12,286
optimizes the negotiation process
and really shortens it.
277
00:15:12,286 --> 00:15:15,289
Because there are with having an insurance
policy,
278
00:15:15,331 --> 00:15:18,709
you bypass
the most contentious negotiation points.
279
00:15:18,709 --> 00:15:22,546
How much indemnity,
how long, how big of an escrow.
280
00:15:22,755 --> 00:15:23,964
All those are gone.
281
00:15:23,964 --> 00:15:27,217
Also the scope of the reps,
you know, if you want your your
282
00:15:27,760 --> 00:15:30,930
financial really broad and huge,
283
00:15:31,096 --> 00:15:34,099
you can get them narrowed down now
because the reps were insured.
284
00:15:34,099 --> 00:15:36,602
It makes things a lot easier. Tax,
things like that.
285
00:15:36,602 -->
00:15:38,687
All of those are taken care of.
286
00:15:38,687 --> 00:15:43,859
It will save the parties
tens, even hundreds of hours
287
00:15:43,859 --> 00:15:48,197
billable on both sides of the attorneys
by having this process in place.
288
00:15:48,489 --> 00:15:52,326
The third thing it does, it pays claims
what good is an insurance policy
289
00:15:52,326 --> 00:15:53,619
but doesn't pay claims.
290
00:15:53,619 --> 00:15:58,248
It is the most effective claims
paying mechanism
291
00:15:58,332 --> 00:16:01,001
throughout all of the insurance lines,
I can tell you.
292
00:16:01,001 --> 00:16:04,296
And if you think about it, particularly
if you're selling
293
00:16:04,672 --> 00:16:08,384
and let's say you've got $1
million held in escrow
294
00:16:08,550 --> 00:16:10,844
and the buyer goes in
and gives the announcement saying,
295
00:16:10,844 --> 00:16:13,055
I'm sorry, we're taking the
escrow, there was a breach.
296
00:16:14,056 --> 00:16:15,849
You're not going to take that sitting
down.
297
00:16:15,849 --> 00:16:19,353
You're going to get an attorney
to go and respond to that, okay?
298
00:16:19,436 --> 00:16:22,898
That attorney comes out of your pocket
to deal with this.
299
00:16:22,982 --> 00:16:25,651
If there's an insurance policy,
all of a sudden there's a third party
300
00:16:25,651 --> 00:16:30,155
mechanism and it all gets worked out
and it's in the expenses there.
301
00:16:30,155 --> 00:16:34,994
So it's done some really, really effective
things and it, you know, into the why.
302
00:16:34,994 --> 00:16:37,997
And if you think about it,
for a lot of owners and founders,
303
00:16:38,122 --> 00:16:42,209
you may not have a $300 million
manufacturing company,
304
00:16:42,418 --> 00:16:46,005
but you should see private equity
and a lot of these big,
305
00:16:46,630 --> 00:16:50,134
strategic acquirers
who are cutting $300 million checks.
306
00:16:50,217 --> 00:16:52,428
They don't even think about the ripple
warranty.
307
00:16:52,428 --> 00:16:54,179
Okay? It's just built in.
308
00:16:54,179 --> 00:16:57,224
And when you think about smaller
deals, well, we're too small.
309
00:16:57,266 --> 00:17:00,686
Hey, your margin for error is a lot
310
00:17:00,728 --> 00:17:03,731
smaller than a $300 billion deal.
311
00:17:03,731 --> 00:17:07,901
And so and the cost again,
we will get in the cost later.
312
00:17:07,985 --> 00:17:11,447
The cost is commensurate
with the smaller risk and so forth.
313
00:17:12,239 --> 00:17:14,783
Well,
and one of the very first transactions
314
00:17:14,783 --> 00:17:20,748
that I did, we ended up with
a, with an escrow post close issue.
315
00:17:21,290 --> 00:17:26,378
And the, you know, the seller
had an attorney and an accountant
316
00:17:26,462 --> 00:17:30,049
and all all the all the people back me
317
00:17:30,257 --> 00:17:33,260
all back into the process again.
318
00:17:33,260 --> 00:17:36,930
To kind of re renegotiate, re haggle.
319
00:17:37,222 --> 00:17:39,266
It becomes contentious.
320
00:17:39,266 --> 00:17:40,934
And then do you agree?
321
00:17:40,934 --> 00:17:43,896
Do you agree? Do we need a third party?
322
00:17:43,896 --> 00:17:46,857
You know, that's the accounting,
323
00:17:46,857 --> 00:17:49,860
an additional accounting firm to come in,
324
00:17:50,194 --> 00:17:52,529
you know, then do you go to mitigation?
325
00:17:52,529 --> 00:17:54,073
Do you do you fight it?
326
00:17:54,073 --> 00:17:55,407
Do you agree to it?
327
00:17:55,407 --> 00:18:01,038
Like, it's just not, not a fun process.
328
00:18:01,163 --> 00:18:04,166
Had there been reps
and warranty insurance?
329
00:18:04,708 --> 00:18:09,421
And and a paid for attorney, I think
my seller would have been a lot happier.
330
00:18:09,755 --> 00:18:11,215
Of course, this was.
331
00:18:11,215 --> 00:18:14,885
This was before it was in our territory.
332
00:18:15,052 --> 00:18:19,014
But,
it's one of the reasons that I look at it
333
00:18:19,014 --> 00:18:23,352
and go, that would have been
a different ball game, because our buyer
334
00:18:23,352 --> 00:18:26,355
has an attorney on a retainer,
335
00:18:26,605 --> 00:18:29,566
has an in-house accounting firm.
336
00:18:29,608 --> 00:18:33,821
The only person paying for these services
out of pocket is the seller.
337
00:18:34,696 --> 00:18:38,033
Because
and now you don't even necessarily
338
00:18:38,033 --> 00:18:41,495
have access to the employees
that you would have relied on
339
00:18:41,495 --> 00:18:45,707
to help with this process
because the buyer owns them now.
340
00:18:47,084 --> 00:18:48,836
Yeah. So
341
00:18:48,836 --> 00:18:52,756
having having that backup built in is,
342
00:18:53,674 --> 00:18:57,719
is a nicer feeling that should help
you sleep better at night.
343
00:18:58,011 --> 00:19:00,597
Yeah,
I would, I would think for peace of mind.
344
00:19:00,597 --> 00:19:02,057
It's a wonderful tool.
345
00:19:02,057 --> 00:19:04,476
And there are two scenarios out there.
346
00:19:04,476 --> 00:19:07,646
You've got the owners and founders
that want to get a clean exit.
347
00:19:07,646 --> 00:19:09,022
They don't want to think about anything.
348
00:19:09,022 --> 00:19:11,275
They just want to write off
into the sunset.
349
00:19:11,275 --> 00:19:14,611
They've got some other new venture
they want to get get involved with,
350
00:19:14,695 --> 00:19:16,947
and they will have
as much of their money out there.
351
00:19:16,947 --> 00:19:18,240
That's one thing.
352
00:19:18,240 --> 00:19:20,993
You do have another set of owners there
353
00:19:20,993 --> 00:19:24,997
that they want to,
you know, upgrade and level up.
354
00:19:24,997 --> 00:19:29,251
And so they are, you know, rolling equity
355
00:19:29,418 --> 00:19:32,379
to the new to the buyer
and moving forward.
356
00:19:32,379 --> 00:19:36,091
And I can tell you
and I'm in Silicon Valley, that gets very,
357
00:19:36,091 --> 00:19:40,637
very awkward
when you are rolling a lot of equity over.
358
00:19:40,679 --> 00:19:44,683
And, and the buyer goes in
and says six months into it, you know,
359
00:19:44,725 --> 00:19:46,059
there's been a problem,
360
00:19:46,059 --> 00:19:49,479
and if there's no insurance that's
going to come out of somebody's pocket.
361
00:19:49,479 --> 00:19:53,275
There is a dilemma in Silicon Valley,
depending on the size of the deal,
362
00:19:53,275 --> 00:19:57,237
where some buyers are so afraid
that they're going to demoralize
363
00:19:57,237 --> 00:20:01,992
or lose these rock star programmers
and coders, they just quired
364
00:20:02,451 --> 00:20:04,494
they're all going to disappear on them,
that they're just like,
365
00:20:04,494 --> 00:20:06,663
you know,
we're going to have to eat the loss.
366
00:20:06,663 --> 00:20:07,080
Okay.
367
00:20:07,080 --> 00:20:08,749
Now, you know,
368
00:20:08,749 --> 00:20:12,836
now that's taken away from the two sides
and it works out very, very nicely.
369
00:20:13,837 --> 00:20:14,421
Great.
370
00:20:14,421 --> 00:20:18,258
So let's talk about by side
versus sell side.
371
00:20:18,300 --> 00:20:21,345
Sure. Okay. There are two flavors.
372
00:20:21,595 --> 00:20:24,598
You know for your analogy
there of reps and warranties.
373
00:20:24,598 --> 00:20:28,060
And it just depends on
who the policyholders who the insured is.
374
00:20:28,268 --> 00:20:31,271
The traditional policy is a buy side
policy okay.
375
00:20:31,313 --> 00:20:33,440
It is in the name of the buyer.
376
00:20:33,440 --> 00:20:36,443
It requires the buyer to perform
377
00:20:36,443 --> 00:20:40,656
extensive due diligence, share
that diligence with with underwriters.
378
00:20:40,864 --> 00:20:41,490
Okay.
379
00:20:41,490 --> 00:20:45,827
And if in the event there's a breach
and that the buyer suffers financially
380
00:20:45,827 --> 00:20:48,830
because of a breach,
then suddenly the buyer just goes,
381
00:20:49,164 --> 00:20:50,374
we don't even talk to the seller.
382
00:20:50,374 --> 00:20:54,253
The buyer just goes right to the insurance
company says, here's my breach.
383
00:20:54,461 --> 00:20:55,545
Here's the math.
384
00:20:55,545 --> 00:20:59,675
How I calculate a $1.5 million
loss of value in the company
385
00:20:59,675 --> 00:21:03,428
because of this breach,
and they'll sit down and work it out.
386
00:21:04,054 --> 00:21:08,892
It is the traditional form of reps
and warranties policy.
387
00:21:08,892 --> 00:21:13,105
The formats, you know, the vast
majority of policies are biased policies.
388
00:21:13,480 --> 00:21:15,983
The challenge is the cost.
389
00:21:15,983 --> 00:21:20,112
There is a $40,000 underwriting fee
at the start
390
00:21:20,153 --> 00:21:21,363
that underwriter is going to charge.
391
00:21:21,363 --> 00:21:23,865
When I say they have to look
at the diligence reports and so forth,
392
00:21:23,865 --> 00:21:28,245
their underwriters are going to require
a legal diligence report.
393
00:21:28,245 --> 00:21:31,248
They require, in most cases, audited
financial.
394
00:21:31,290 --> 00:21:35,419
Some cases they will allow a Q of report
rather than that.
395
00:21:35,460 --> 00:21:38,839
And then a lot of other third parties
have to come in here.
396
00:21:38,964 --> 00:21:42,217
Consultants,
operational consultants, environmental.
397
00:21:42,259 --> 00:21:44,886
They're not just going to take
the buyers. Word for that.
398
00:21:44,886 --> 00:21:47,014
Well we looked at everything looks great.
399
00:21:47,014 --> 00:21:48,223
They're going to require that.
400
00:21:48,223 --> 00:21:49,599
So there's an additional expense.
401
00:21:49,599 --> 00:21:54,021
But again that that's consistent
with $100 billion transaction.
402
00:21:54,021 --> 00:21:57,691
You're going to spend $1 million
in diligence to get that right okay.
403
00:21:57,733 --> 00:21:59,192
And it moves forward.
404
00:21:59,192 --> 00:22:03,613
It is very broad even in the event,
because the underwriting process
405
00:22:03,613 --> 00:22:07,117
doesn't even consider
or touch base with the seller.
406
00:22:07,242 --> 00:22:12,122
So even in the event of seller fraud,
where the buyer just didn't catch it
407
00:22:12,122 --> 00:22:16,501
and the seller lied or misrepresented
things, the policy is going to pay
408
00:22:16,501 --> 00:22:18,754
the buyer provided
the buyer didn't know about it.
409
00:22:18,754 --> 00:22:19,629
And again.
410
00:22:19,629 --> 00:22:23,467
Starting costs on
these policies is going to be about
411
00:22:23,467 --> 00:22:26,470
130,000 $140,000.
412
00:22:26,636 --> 00:22:28,930
Add the $40,000 underwriting fee.
413
00:22:28,930 --> 00:22:32,309
And so, underwriters
provided the diligence
414
00:22:32,309 --> 00:22:35,896
as their underwriters are open
to ensuring transactions.
415
00:22:35,896 --> 00:22:41,860
As I've written a bias policy
for a $9 million enterprise value deal.
416
00:22:41,943 --> 00:22:43,737
And so it is available
417
00:22:43,737 --> 00:22:47,074
if you're willing to deal with the cost
and you and you can qualify
418
00:22:47,115 --> 00:22:50,410
for the underwriting,
that's fine if you don't have the reports.
419
00:22:50,410 --> 00:22:51,078
Here's the problem.
420
00:22:51,078 --> 00:22:55,665
If you don't review something because
you don't want to pay for it, that's fine.
421
00:22:55,665 --> 00:22:58,126
It's in the report warranty.
422
00:22:58,126 --> 00:22:59,795
So it is a challenge there.
423
00:22:59,795 --> 00:23:05,175
Now, as broad and robust as that policy
is, it's not necessarily
424
00:23:05,175 --> 00:23:09,638
a fit for deals that are priced
between 1 million and 30 million.
425
00:23:09,763 --> 00:23:12,724
A lot of these are going to be add
ons to other platforms
426
00:23:12,724 --> 00:23:17,104
or just independent sponsors, small,
you know, search funders,
427
00:23:17,229 --> 00:23:20,148
other organizations
or small strategic
organizations
428
00:23:20,148 --> 00:23:23,151
that don't have a full corp
dev department.
429
00:23:23,151 --> 00:23:27,864
But they want to go ahead and acquire,
you know, another, another commercial
430
00:23:27,906 --> 00:23:32,327
business in, in, in a new research
or whatever, you know, those
431
00:23:33,370 --> 00:23:34,704
sub $30 million
432
00:23:34,704 --> 00:23:38,875
deals have been kind of stuck where
if the buyer doesn't
433
00:23:38,875 --> 00:23:43,547
like to spend the cost on rep of warranty,
they go forward without insurance.
434
00:23:43,880 --> 00:23:46,800
There is now product for.
435
00:23:46,800 --> 00:23:49,845
Before we get to the next product,
let's let's just
436
00:23:49,845 --> 00:23:53,140
poke on the the buy side policy
for just a minute.
437
00:23:53,348 --> 00:23:57,477
As a company owner
looking to sell your business,
438
00:23:57,936 --> 00:24:02,274
it is unlikely that you get much say
439
00:24:02,732 --> 00:24:05,485
in having a buy side policy.
440
00:24:05,485 --> 00:24:08,572
Generally the people in that,
441
00:24:08,655 --> 00:24:14,161
you know, sub $30 million transaction,
it's the buyer coming in saying,
442
00:24:14,244 --> 00:24:19,416
we've used this before, we want to do this
because we like it as a seller,
443
00:24:19,666 --> 00:24:22,669
you'll find that,
444
00:24:22,794 --> 00:24:26,173
you don't get a lot of say
and putting in a buy side policy.
445
00:24:27,674 --> 00:24:30,677
So let's talk process for a second.
446
00:24:30,802 --> 00:24:35,891
Where do we learn what the
what the buyer wants for reps and warranty
447
00:24:35,891 --> 00:24:40,145
and where do we
where can we motivate somebody?
448
00:24:40,520 --> 00:24:45,484
And we see it in the negotiation
of the letter of intent.
449
00:24:46,193 --> 00:24:51,281
That's the first place where you want
to hear them talk about indemnification
450
00:24:51,281 --> 00:24:55,410
reps and warranty and whether or not
they're considering an insurance policy.
451
00:24:56,328 --> 00:25:00,499
So but by side you're the seller.
452
00:25:00,665 --> 00:25:03,668
So you have very, very little control.
453
00:25:03,960 --> 00:25:07,005
That does not mean
they will not ask you to pay for it.
454
00:25:07,756 --> 00:25:09,466
That does not mean
455
00:25:09,466 --> 00:25:13,845
that they won't take down
the purchase price to accommodate for it.
456
00:25:13,845 --> 00:25:17,849
So these are kind of the T's
and sees that, you know,
457
00:25:17,891 --> 00:25:21,770
when we work through an alloy,
we want to keep our, our ears up
458
00:25:21,853 --> 00:25:25,565
to make sure that,
that we have an understanding of that.
459
00:25:25,607 --> 00:25:28,818
So if your buyer is unwilling to do it
460
00:25:28,818 --> 00:25:34,199
because of cost, expense, time,
and you still want to do something
461
00:25:34,199 --> 00:25:36,326
because you're the kind of person
462
00:25:36,326 --> 00:25:40,288
that wants to either
reinvest all your money or move,
463
00:25:40,497 --> 00:25:45,835
you know, sleep better at night, whatever,
whatever your own proclivities are.
464
00:25:47,337 --> 00:25:49,089
There's another way to do it.
465
00:25:49,089 --> 00:25:51,716
And that's
that's the second option, right?
466
00:25:51,716 --> 00:25:52,759
It's the cell cycle.
467
00:25:52,759 --> 00:25:57,389
Well, you mentioned a couple things that's
really highlight on this is the time
468
00:25:57,389 --> 00:26:00,809
to discuss the concept of whether or not
there's going to be insurance.
469
00:26:00,934 --> 00:26:01,476
Okay.
470
00:26:01,476 --> 00:26:06,231
The low time is ideal for that
and for sell side advisors out there.
471
00:26:06,231 --> 00:26:09,568
And also for sellers,
this gives you a chance for some leverage.
472
00:26:09,693 --> 00:26:13,446
And you're not getting pushed around
to, you know, extensively by the buyer.
473
00:26:13,446 --> 00:26:17,534
But you know question one
is there going to be insurance yes or no.
474
00:26:17,534 --> 00:26:21,204
And if there is insurance,
there should not be a big escrow,
475
00:26:21,204 --> 00:26:24,833
because the purpose of the insurance
is to replace the X for escrow
476
00:26:25,166 --> 00:26:26,710
as much as possible.
477
00:26:26,710 --> 00:26:31,131
There are some buyers that just out
of principle, they want skin in the game.
478
00:26:31,131 --> 00:26:32,882
They're going to require something.
479
00:26:32,882 --> 00:26:36,094
And so you debate you can debate that.
480
00:26:36,094 --> 00:26:39,055
But then it will be
the concept of repertoire T-shirts.
481
00:26:39,055 --> 00:26:42,934
If the buyer insists
that it's going to be a buy side policy,
482
00:26:42,934 --> 00:26:46,271
they have made a decision because
they have to do all the underwriting.
483
00:26:46,271 --> 00:26:48,607
They have to do all the involvement
with the underwriters.
484
00:26:48,607 --> 00:26:52,444
If they're open to doing that,
it really is their call.
485
00:26:52,485 --> 00:26:57,782
Okay, because as much as a seller
may want a buy side policy out there,
486
00:26:57,866 --> 00:27:00,785
if the buyer doesn't agree
that it's not going to happen.
487
00:27:00,785 --> 00:27:03,622
But first, you get the idea that there's
going to be insurance in there.
488
00:27:03,622 --> 00:27:08,293
Then if the buyer says by a side,
you move forward, that that's wonderful.
489
00:27:08,543 --> 00:27:12,464
Now a lot of times the, you know,
you do have the case with the buyers,
490
00:27:12,464 --> 00:27:15,467
like we're going to get a buy side policy
and you're going to
491
00:27:15,550 --> 00:27:18,428
we're going to split the cost 5050,
which is now common.
492
00:27:18,428 --> 00:27:19,679
Okay.
493
00:27:19,679 --> 00:27:22,891
If you're the seller, you could the
we have posited this
494
00:27:22,891 --> 00:27:25,435
on a couple of occasions
where the seller says, well, look,
495
00:27:25,435 --> 00:27:29,606
if if I'm paying half the cost,
I should have some say into
496
00:27:29,606 --> 00:27:32,567
which insurance policy,
you know, is going to get,
497
00:27:32,567 --> 00:27:35,111
you know, particularly
if you get a couple of bias policies
498
00:27:35,111 --> 00:27:39,908
and one is 250,000
and the other one is 230,000.
499
00:27:40,283 --> 00:27:41,242
Yeah.
500
00:27:41,242 --> 00:27:44,329
I'd like some input if I'm paying
half of that, which is reasonable
501
00:27:44,954 --> 00:27:47,540
now for transactions that are under
502
00:27:47,540 --> 00:27:50,543
$30 million where this makes sense.
503
00:27:50,752 --> 00:27:54,089
There's an alternative to this by side
with a $40,000
504
00:27:54,130 --> 00:27:57,092
underwriting fee
and $130,000 minimum premium.
505
00:27:57,092 --> 00:28:01,554
Okay, there's now a what
we call a sell side policy.
506
00:28:01,680 --> 00:28:03,848
The Brits branded seller protect.
507
00:28:03,848 --> 00:28:08,561
It was designed for a lot of these smaller
deals, between 1 million and 30 million
508
00:28:08,603 --> 00:28:11,815
that were getting no insurance
because the buyer just wasn't going to get
509
00:28:11,815 --> 00:28:14,818
because cost
something is better than nothing.
510
00:28:14,859 --> 00:28:18,405
And so what happened was Lloyd's of London
developed this product
511
00:28:18,405 --> 00:28:21,950
where what we do is we ensure the seller
rather than the buyer.
512
00:28:22,325 --> 00:28:25,787
The by doing this,
we underwrite the seller
513
00:28:26,079 --> 00:28:27,872
rather
than getting the third party diligence.
514
00:28:27,872 --> 00:28:30,083
So there's no underwriting fee.
515
00:28:30,083 --> 00:28:33,586
We limit the scope of the types
of industries are eligible.
516
00:28:33,586 --> 00:28:37,924
It's usually business services, light
manufacturing, technology, simple things.
517
00:28:37,924 --> 00:28:40,176
We just stay out of things
like healthcare,
518
00:28:40,176 --> 00:28:43,179
banking, heavily regulated industries.
519
00:28:43,179 --> 00:28:45,223
But we do the smaller ones,
they're smaller,
520
00:28:45,223 --> 00:28:46,975
they're less risky
and they're less complicated.
521
00:28:46,975 --> 00:28:48,518
So why charge a higher rate?
522
00:28:48,518 --> 00:28:53,481
And so with an application process,
no audited financial is required,
523
00:28:53,481 --> 00:28:57,485
no queue of okay financial information
and a simple application.
524
00:28:58,111 --> 00:29:00,905
We can provide terms where the pricing,
525
00:29:00,905 --> 00:29:04,701
the rate goes between 15 and $20,000
526
00:29:04,743 --> 00:29:09,414
per million in limits,
a fraction of the cost of a biased policy.
527
00:29:09,664 --> 00:29:10,832
Is it as broad?
528
00:29:10,832 --> 00:29:15,336
Well, it's not going to cover the fraud
entirely as it does on the other side.
529
00:29:15,336 --> 00:29:16,171
That's one.
530
00:29:16,171 --> 00:29:22,093
Number two, if you have a, a company
with very heavy asset values,
531
00:29:22,093 --> 00:29:26,598
we're a multimillion dollar equipment,
multi-million dollar inventories.
532
00:29:26,806 --> 00:29:30,560
It may not be a fit because it's not going
to cover a condition of assets reps.
533
00:29:30,727 --> 00:29:34,647
Outside of that, though,
for most businesses it is a viable option
534
00:29:34,647 --> 00:29:38,568
that can come in there
and you figure you figure the cost.
535
00:29:38,610 --> 00:29:41,821
Again if a buyer and this is one argument
536
00:29:41,821 --> 00:29:45,700
that we are having now
with a lot of construction companies, HVAC
537
00:29:45,825 --> 00:29:50,872
organizations, those types of businesses
were $20 million enterprise value.
538
00:29:51,915 --> 00:29:52,874
I just give you the math.
539
00:29:52,874 --> 00:29:56,336
On a $20 million deal
outside of insurance, there's $2 million
540
00:29:56,336 --> 00:29:57,295
that's put aside.
541
00:29:57,295 --> 00:30:00,423
Sellers
got to wait a year for $2 million over.
542
00:30:00,548 --> 00:30:03,051
Two months. For 18 months. Yes.
543
00:30:03,051 --> 00:30:05,762
Outside of that,
if we were to go to a by side policy,
544
00:30:05,762 --> 00:30:09,557
you're looking at
a, you know, a 2 or $3 million limit
545
00:30:09,557 --> 00:30:12,852
policy is 175 to $200,000 in expense.
546
00:30:12,936 --> 00:30:18,274
You split that, you go seller
protect a $5 million
547
00:30:18,274 --> 00:30:23,196
limit policy is less than 100,000,
maybe $90,000.
548
00:30:23,571 --> 00:30:26,324
Okay, 5 million
549
00:30:26,324 --> 00:30:30,036
in protection,
a deductible now of 50,000, let's say.
550
00:30:30,453 --> 00:30:34,874
And you have now if you split this 45,000.
551
00:30:34,999 --> 00:30:37,710
And so what
the seller can say to the buyer
552
00:30:37,710 --> 00:30:40,713
is, well, I know you want to buy a side
and it's going to cost,
553
00:30:40,713 --> 00:30:42,173
you know, $200,000.
554
00:30:42,173 --> 00:30:43,925
Well, I've got this thing as 90.
555
00:30:43,925 --> 00:30:45,343
What do you want to do.
556
00:30:45,343 --> 00:30:48,388
And so there is there are options.
557
00:30:48,429 --> 00:30:51,933
I would say this
we can get into a longer explanation.
558
00:30:51,933 --> 00:30:54,269
I would just invite people to,
to speak with me
559
00:30:54,269 --> 00:30:58,273
about this, to get in the granular
on the differences between the two.
560
00:30:58,439 --> 00:31:01,734
But what we look at
is that by side is the broadest, most
561
00:31:02,735 --> 00:31:03,736
product out there.
562
00:31:03,736 --> 00:31:06,155
Sell side where it fits.
563
00:31:06,155 --> 00:31:08,283
It makes great sense, particularly
if you do,
564
00:31:08,283 --> 00:31:10,535
you know, you do cost benefit analysis.
565
00:31:10,535 --> 00:31:14,038
Either
one is better than no protection at all.
566
00:31:14,038 --> 00:31:17,792
And I think that's where we want to do
I mean, you know,
sellers shouldn't
567
00:31:17,792 --> 00:31:21,462
have to struggle with seven figure escrow
and with rebel warranty.
568
00:31:21,462 --> 00:31:22,547
They don't have to.
569
00:31:22,547 --> 00:31:25,508
It's just their options available.
570
00:31:25,508 --> 00:31:25,967
Great.
571
00:31:25,967 --> 00:31:28,636
Well, Patrick,
thank you for joining us today.
572
00:31:28,636 --> 00:31:30,555
We appreciate the time
you've put on this.
573
00:31:30,555 --> 00:31:32,432
You hit the nail on the head.
574
00:31:32,432 --> 00:31:37,896
If somebody wants more information
we would encourage them to contact you,
575
00:31:37,937 --> 00:31:42,108
your socials and your bio
and all of your page links are going to be
576
00:31:42,108 --> 00:31:48,114
on the the bottom of the touchstone page
and be on our LinkedIn socials as well.
577
00:31:49,282 --> 00:31:50,992
So I have one parting
578
00:31:50,992 --> 00:31:54,704
question
that I ask all of my all of my attendees.
579
00:31:54,913 --> 00:31:57,916
If you are not working in the insurance
realm,
580
00:31:58,041 --> 00:32:00,668
okay, this this job is off the table.
581
00:32:00,668 --> 00:32:03,671
What other career path
would you have gone into?
582
00:32:04,881 --> 00:32:07,884
Boy that's tough.
583
00:32:08,134 --> 00:32:10,470
It's a little different now because,
584
00:32:10,470 --> 00:32:14,140
I'm Gen X, and so we're brought up.
585
00:32:14,140 --> 00:32:17,352
We were thinking, you know,
going into white collar jobs and so forth.
586
00:32:17,393 --> 00:32:21,105
I'll tell you, with the things
that swing now, I wouldn't mind being,
587
00:32:21,105 --> 00:32:25,526
in construction,
you know, a contractor building things.
588
00:32:25,610 --> 00:32:29,405
I, I, I love the grit and the thing
of being able to have something tangible.
589
00:32:29,489 --> 00:32:34,118
So I probably would be a builder that,
that or that or I would teach history
590
00:32:34,118 --> 00:32:34,661
one of the two.
591
00:32:34,661 --> 00:32:36,579
Because then I can go
and do a lot of talking.
592
00:32:36,579 --> 00:32:40,333
So two, two offices, things
I, I would not have given you that,
593
00:32:40,333 --> 00:32:42,335
that any answer 5 or 6 years ago.
594
00:32:42,335 --> 00:32:44,671
But I'll tell you
again, I'm in Silicon Valley.
595
00:32:45,964 --> 00:32:48,925
You do not have a,
596
00:32:49,008 --> 00:32:50,176
in construction.
597
00:32:50,176 --> 00:32:54,305
You don't have a poor plumber,
electrician or contractor.
598
00:32:54,347 --> 00:32:54,806
Okay?
599
00:32:54,806 --> 00:32:59,811
They actually have nicer vacation homes
than most of us in Silicon Valley.
600
00:32:59,811 --> 00:33:02,230
So that's probably the place
I would have gone.
601
00:33:02,230 --> 00:33:06,526
We see the same thing in New England,
so that's not special for California.
602
00:33:06,567 --> 00:33:10,446
I think that that our
our hands on construction plumbers
603
00:33:10,780 --> 00:33:16,160
and mill workers and,
and they're all doing really well here
604
00:33:16,369 --> 00:33:19,664
and they're not going
to be taken out by AI. No.
605
00:33:19,872 --> 00:33:21,708
Nobody can AI build a.
606
00:33:21,708 --> 00:33:23,876
It is a proof or a building.
607
00:33:23,876 --> 00:33:25,920
Yes, absolutely.
608
00:33:25,920 --> 00:33:27,922
Well, thank you, Patrick, for joining us.
609
00:33:27,922 --> 00:33:31,968
And if you are just seeing Touchstone
Talks for the first time, please
610
00:33:31,968 --> 00:33:36,931
make sure you like, subscribe and follow
on all of your favorite podcast platforms.
611
00:33:48,693 --> 00:33:50,153
Means we.