Our M&A attorney suggests requiring Representation and Warranty Insurance to shrink our seller indemnity escrow from ten percent to one percent, but the diligence costs and policy premiums are high. When does an RWI policy make financial sense for a lower middle market seller?

Question

Tyler Smith · Accepted Answer

Representation and Warranty Insurance, known as RWI, shifts the financial liability for breaches of seller representations and warranties from your balance sheet to a third-party underwriter. In a traditional lower middle market transaction, buyers demand that eight to twelve percent of the purchase price be locked in an escrow account for twelve to twenty-four months to cover potential indemnity claims. With an RWI policy, that seller indemnity escrow routinely drops to one-half of one percent of enterprise value, freeing up significant cash at close.

However, RWI is not free. Between underwriting fees, broker commissions, and policy premiums, placing an RWI policy typically costs between one hundred fifty thousand and two hundred fifty thousand dollars, along with requiring audited financial statements and institutional-grade legal diligence.

As an operational rule of thumb, RWI rarely makes economic sense for transactions below fifteen to twenty million dollars in enterprise value. On a ten-million-dollar deal, spending two hundred thousand dollars to release a one-million-dollar escrow is inefficient capital allocation, especially when your company operates with clean financials and a verified customer base. Above twenty-five million dollars, however, RWI becomes an exceptional tool. It eliminates the risk of post-closing litigation, releases millions in cash immediately, and simplifies purchase agreement negotiations.

If you use RWI, negotiate in the Letter of Intent for a fifty-fifty split of the premium and diligence costs with the buyer. Strategic acquirers and private equity sponsors frequently accept this split because the insurance provides them with a direct, uncontested claims process backed by an A-rated carrier.