The majority of entrepreneurs and most people in general dread talking about insurance. They are unclear on if they have enough or how much coverage they need, and it always seems to cost more than what you were anticipating. However, there are some important things that you should keep in mind when it comes to insurance and selling your business.
An important factor to keep in mind is that just because you sell your business it does not mean that your insurance needs will immediately end. There could be a continuing need that you may not be aware of, leaving yourself vulnerable to unanticipated risk exposure.
It is important to understand that when you buy insurance, the contract is between the business and the insurer. When the business no longer exists, or you sell it, the contract may no longer be valid. This is because the insurer based the policy conditions in part on you, the business owner, by determining coverage and rates based on your history and risk profile. If that situation were to change, so might the coverages and the rates available.
Key Policy Provisions to Understand
Insurance companies know that businesses can be bought and sold. To protect the insurer from potentially losing a business customer, there are key provisions that might be included in the policy you need to be aware of and understand:
- Change in risk provisions: This basically means that any change in risk, including your company being acquired, can change or cancel the policy.
- Prior acts exclusion: If your company is being purchased by another company, private equity group or even an individual, any act (product sale, service, incident, etc.) prior to the transaction date would likely be covered by the original insurance and will not be covered by the new policy. It’s important that both the business buyer and seller understand this.
- Automatic Extended Reporting Period: When you sell your business, your policy ends on the date the other entity closes on the acquisition of your business. However, your policy will usually have a period from 30 to 90 days where you can report a claim, as long as the reason for the claim happened before the acquisition date.
The provisions listed above are a brief examples. Your business policy could have other exclusions or issues as well. It’s important to talk to your insurance professional to determine what impact the business sale will have on your insurance policies, risk exposure, and what type of coverage you will need going forward. Here are a few coverage examples to keep in mind after the sale of your business:
A proportion of insurance claims aren’t made immediately when an incident occurs, and in some liability cases, it can be months or years before litigation is announced. This is where “tail coverage”, or an optional extended reporting period, is added for an additional premium. Since the statute of limitations of such torts is usually six years, it is important to discuss the need for an extended policy with your insurer.
Not every transaction needs this kind of insurance, but in many cases, either the buyer or the seller may insist on tail coverage. Understand that under tail coverage, the incident still had to happen before the acquisition date to be covered.
Transactional Risk Insurance
A big part of buying and selling a business is trust, which is why we stress honesty and disclosure here at Edison Avenue. A well-informed buyer is usually a happy buyer. However, what if a seller representation was false or misstated, and that fact costs the buyer money down the line, even a few years later? Who’s responsible?
Essentially this is where transactional risk insurance, also known as Representation and Warranty Insurance (RWI), comes in. This type of policy has some great benefits for both the buyer and the seller.
It can give the buyer peace of mind about their risk which can help close a deal faster, shortening due diligence and even escrow times. The buyer knows the representations and warranties of the seller are backed by insurance, giving them additional peace of mind.
For the seller, not only can this type of insurance help speed up the sale of your business, but it will also provide coverage in case of a legal suit. While these policies make the most sense for mid-size and larger mergers and acquisitions, they can have a place in smaller transactions as well. The key is to check with your insurer and determine if this kind of policy makes sense for you.
As we do not provide insurance advice our only intention is to help you begin to think about this area of risk. We can refer you to a top-notch insurance professional. Are you ready to sell your business? Do you have questions about the process, timing or need a business valuation? Call Edison Avenue the #1 trusted M&A Advisor for a confidential consultation at 800-975-2114 or email firstname.lastname@example.org
Edward Valaitis Managing Director of Edison Avenue has earned his Certified Business Intermediary (CBI), Certified Merger & Acquisition Professional (CMAP), Certified Value Builder (CVB). He has more than 25 years of experience building, managing, and selling companies with expertise in business transactions, business valuations and growing businesses. Business Broker serving the United States based in Tampa and Destin, Florida.