If you are thinking about selling in the next year or so, you will want to read this post. Understanding this concept and acting on it now can save you time, stress, and dollars when it comes time to sell.
But first, let me set the stage…
For most owners, selling your company is a major liquidity event. Overnight, you become a deep-pocketed individual, and the press release announcing the sale lets the world know you are flush with cash.
So (surprise, surprise), people start coming out of the woodwork who are suddenly motivated to pursue some sort of legal action against you. Maybe it’s an upset customer or an employee who was recently terminated.
In one case, a customer decided to sue a recent seller over a hire made a year ago because they now knew there is money to be had. In another instance, a press release unleashed a cyber-attack via the activation of a bot that had sat on the seller’s servers for two years.
The point here is that you need to protect yourself against these situations. That’s why insurance post-sale is key. You need a policy that will protect you from acts that happened while you still owned the company but didn’t make themselves known until after the sale. That policy is called “tail insurance.”
What Is Tail Insurance?
Tail insurance, also known as “extended reporting period coverage,” is an optional add-on to a claims-made insurance policy. It provides continued liability protection after the policy expires, allowing you to report claims for incidents that occurred during the policy period, even after it’s ended.
Tail insurance is usually required on every transaction, but not for every policy. Most buyers require tail on D&O (Directors and Officers), E&O (Errors and Omissions), and, if a technology firm, cyber insurance. Tail periods can vary from three to six years. Six years is the statute of limitations, so it is the tail period most often requested by buyers. However, this is negotiable, so know that you can request a lower tail period coverage. I would recommend getting quotes on both 3- and 6-year coverage; you might see that the additional three years is not that much more, as the coverage price goes down each year.
I have found it difficult for most sellers to get 6 years of tail coverage for cyber insurance, so if you are shopping for a new policy, make sure they can provide that for you once you sell. I had one occasion where the broker would not insure more than one year tail on any policy, so now is the time to call your insurance broker to see what you can purchase when the time comes to sell.
You may have other policies like commercial insurance, and EPLI (Employment Practices Liability Insurance). Even if a buyer does not require you to provide tail for something like EPLI, I recommend that my clients purchase it anyway so they know they are protected post-sale.
In order to decide if you need tail insurance, you need to look at your policy to see if it is a “claims- made” or an “occurrence-based” policy. A claims-made policy only covers incidents that happen and are reported within the policy’s timeframe (unless a “tail” is purchased). An occurrence policy has lifetime coverage for the incidents that occur during a policy period, regardless of when the claim is reported. If you have an occurrence policy, you may not need tail, but that will depend on the type of transaction you are contemplating. Regardless, check with your insurance broker.*
What Is Representations and Warranties (R&W) Insurance?
R&W insurance (often called “reps and warranties” or “RWI”) is a type of insurance policy that provides coverage for financial losses caused by breaches of the seller’s representations and warranties made in a purchase agreement during an M&A transaction. In every transaction, both the buyer and the seller will make certain representations and warranties.
For example:
Each of the parties represents and warrants to the other party that:
(a) such party has all requisite company power and authority to execute and deliver this Purchase Agreement and to perform such party’s obligations hereunder,
(b) this Purchase Agreement has been duly authorized, executed, and delivered by such party, and is a valid and binding obligation, enforceable against such party in accordance with its terms,
(c) this Purchase Agreement will not result in a violation of any terms or conditions of any agreements to which such party is a party or by which such party may otherwise be bound or of any law, rule, license, regulation, judgment, order, or decree governing or affecting such party, and
(d) such party’s entry into this Purchase Agreement does not require approval by any owners or holders of any equity or other interest in such party (except as has already been obtained), etc.
There are then more specific representations that a seller needs to make to the buyer about customers, contracts, employees, and such. A RWI policy can be either “buy-side” or “sell-side.”
Buyer-side policies: Protect the buyer from financial losses resulting from breaches of the seller’s representations and warranties, allowing them to avoid suing the acquired management team and potentially offer lower escrows or more competitive terms.
Seller-side policies: Provide a cleaner exit for the seller by reducing or eliminating the need for an escrow, allowing for quicker distribution of proceeds, and potentially streamlining negotiations.
In the U.S. market, buy-side RWI is more prevalent than sell-side RWI.
All this said, how often do you see R&W insurance in the lower-mid-market transactions?
Almost never, partially due to cost and the need for additional due diligence. But if it is a cross-border transaction or a larger transaction (say, over $50M), the more complex and the stronger the likelihood a buyer might request R&W insurance.
The Difference Between R&W and Tail Insurance
Here’s a summary of the key differences between representations and warranties (R&W) insurance and tail insurance (D&O Runoff Coverage).
Representations & Warranties (R&W) Insurance:
- Protects against financial losses arising from inaccurate or misleading representations and warranties made by the seller in a merger or acquisition (M&A) deal.
- Can be purchased by either the buyer or seller (though more commonly by the seller).
- Covers breaches of contractual assurances about the company’s financials, liabilities, compliance, and other material conditions.
- Helps mitigate risk in cases where the seller provides limited indemnification.
- Policy period typically lasts a few years post-transaction (e.g., three to six years).
D&O Tail (Runoff) Insurance:
- Protects individual directors and officers against lawsuits filed after the sale/merger for wrongful acts they committed before the transaction.
- Necessary because standard D&O insurance may terminate or limit coverage after a change in control.
- Provides extended coverage (typically six years) for claims arising from past actions.
- Critical if the acquiring company refuses to indemnify former executives or the company goes bankrupt.
- Covers legal defense costs, settlements, and judgments related to mismanagement, breaches of fiduciary duty, or shareholder lawsuits.
Key Differences
| Feature | R&W Insurance | D&O Tail Insurance |
| Who it protects | Buyer (sometimes seller) | Directors & officers of the selling company |
| What it covers | Misrepresentations & breaches of warranties in the M&A agreement | Legal claims against past executives for pre-transaction conduct |
| Triggering event | Inaccurate disclosures in the sale process | Lawsuits filed post-acquisition for past wrongful acts |
| Duration | Typically 3-6 years | Typically 3-6 years |
| Focus | Protects deal value & financial exposure | Protects individuals from personal liability |
Why Both Are Important in M&A
- R&W insurance safeguards deal value and reduces disputes over indemnification.
- D&O tail insurance ensures executives aren’t left exposed to post-closing lawsuits.
In my next article, I will be giving you tips on what to do if you don’t currently have D&O insurance and you are ready to sign an LOI.
*Remember, I am not an insurance broker nor am I giving insurance advice. I am just letting you know what you need to look out for if you are contemplating a transaction, so be sure to check with your broker.
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