Major deal point trends appeared to reverse in the final months of 2020 — not due to a secular change in direction, but due to the deluge of deals that closed in the fourth quarter — according to GF Data’s just-released Spring 2021 Key Deal Terms report.
“The extended seller’s market of the past decade was characterized by two trends that extended into the early pre-COVID months of last year,” said Andrew Greenberg, CEO of GF Data. “Increasing utilization of reps and warranty insurance and declining caps on general indemnification for breaches of reps and warranties.”
“After four years of steadily increasing utilization rates, deals featuring reps and warranty insurance declined from 55.2% of completed volume in the first half of 2020 to 52.2% in the second,” added Mr. Greenberg.
“At the same time, average indemnification was all over the map. Average cap in the second quarter was an abnormally low 6.7% — as we said at the time, a sign of the unusual hardiness of the deals that found the finish line last spring,” said B. Graeme Frazier, IV, GF Data’s co- founder and principal. “Then the average for the third quarter spiked the other way — to 27.9%. These two periods perhaps make more sense as a blended average, but the upward trend continued in the fourth quarter, with an average cap of 17.2%.”
GF Data’s 230 active private equity contributors completed 117 transactions in the fourth quarter that met the data tracking firm’s parameters — Total Enterprise Value (TEV) of $10 million to $250 million and TEV/Trailing Twelve Months (TTM) Adjusted EBITDA of 3x to 15x. This volume substantially exceeded completed transaction activity in the second and third quarters combined.
“We regard the shifts in reps and warranty insurance usage and average cap as reflecting a larger pool, rather than changes in direction,” said Mr. Greenberg. “Insurance carriers were able to choose the business that they wished to underwrite in the busy fourth quarter, leaving a greater swath of deals to proceed with no insurance and/or with less favorable terms.”
Mark Witt, a shareholder at Milwaukee-based law firm Godfrey & Kahn, added this perspective — “In a hot seller’s market like we are seeing so far in 2021, sellers will receive favorable indemnification limitations with or without reps and warranty insurance and its costs.”
“Given enhanced insurer concerns about claims exposure and the increased underwriting and exclusions that may result, a key question for buyers is whether reps and warranty insurance will allow them to move faster and meet sellers’ increasingly tight timing expectations while still transferring the material unknown pre-closing risks of the target to the insurer,” added Mr. Witt.