This product has a floor, and it is not set by insurers' appetite. Underwriting a policy costs a broadly fixed quantity of work: underwriter time, a review by lawyers, an investigation, and a minimum premium below which the transaction does not pay for its own handling. On an acquisition of a few million, that minimum premium and the associated fees approach the order of magnitude of the retention, so the buyer pays a significant fraction of the protection in order to obtain the right to hold it. The ratio stops being attractive long before anyone has mentioned risk.
A second constraint, more interesting, completes that floor. This product insures the quality of professional work, as we have seen, and a small deal cannot fund reports of the depth an underwriter requires. Even if the premium worked, exclusions drawn from a thin review would consume the cover. The floor is therefore set by the cost of the INPUTS and not by the insurer's willingness, which explains a disconcerting fact: a small buyer will not obtain wide cover by negotiating better, but by funding a review it cannot afford to fund.
One must then look at what actually occupies the ground below that floor, and it is simply what existed before insurance. A larger and longer holdback, which remains by far the most frequent solution. A seller's covenant backed by its own assets. Deferred consideration or an earn-out against which breaches are set off. And sometimes a personal guarantee. Each of those tools is smaller in size and better in certainty than a policy would be: it is exactly the exchange described in relation to the escrow, but scale tilts it the other way.
The market has produced intermediate offerings that must be known for what they are. Simplified policies exist for small deals: short fixed wordings, underwriting reduced to a single call, no reports capable of being relied on, and markedly wider exclusions. They are genuine cover and they are narrow, which is no fault as long as the buyer knows it. The danger is that they carry the same commercial name as full policies: a buyer who has read an article about warranty and indemnity insurance believes it is buying what it read about. The whole review of such a policy consists in spotting which of the structural families of exclusions has been widened.
An advisory failure is added and it is mechanical rather than moral. On a small deal, the fees for insurance advice are proportionally heavy, so advice is thin, so the buyer relies on its broker's summary note, and the broker is remunerated on placement. Nobody in that chain is dishonest and the result is constant: the small buyer is the least well advised precisely where the product is least standard and where reading the exclusions matters most. It is a fact of structure and better acknowledged than left to vigilance.
From all this follows a conclusion an adviser should be able to state without embarrassment: on many small deals, insurance is not the right tool, and saying so is the advice. An acquisition of a few million carrying an identifiable, bounded risk is better handled by a specific seller indemnity and a holdback than by a policy whose exclusions the buyer will not read. Declining an insurance transaction is part of the job, and an adviser who never does it tells you mostly about how it is paid.
There is nonetheless a case where a small deal perfectly justifies the product, and it has nothing to do with size. Where the seller needs a clean exit for a reason unrelated to price, a retirement, an estate to settle, a vehicle to wind up, the balance sheet effect described in relation to the escrow recovers all its force: the policy does not buy protection, it buys the possibility of the transaction. The right test is therefore not the size of the deal but whether the seller needs to be released. When it does, the cost is judged against a deal that would not otherwise happen; when it does not, it is judged against a holdback, and it almost always loses.
A buyer acquires an engineering consultancy for 7.5 million euros from its founder, who is retiring and settling his estate. The broker proposes a warranty and indemnity policy: 3 million limit, 75,000 euro retention, minimum premium and fees together 95,000 euros. The due diligence budget is 40,000 euros and covers legal and financial matters, with no tax specialist; the policy would therefore exclude tax. The founder refuses a twenty-four month holdback, which he considers incompatible with settling his estate. Is the policy the right tool?
The two reasons for buying this product must be separated, because here they give opposite answers. On the ground of risk transfer alone the deal is poor and the arithmetic is quick: 95,000 euros of certain cost, plus a 75,000 retention, that is 170,000 before a single euro is paid out, against a 3 million limit holed exactly where the risk sits. In a consultancy, the most likely source of breach is tax and social security, the status of contributors and the charges attaching to it, and that is precisely what the exclusion removes for want of a specialist within a 40,000 euro review budget. Here again is the floor set by the cost of the inputs: the buyer will not obtain better by negotiating, it would obtain it by funding a review it cannot afford. On the second ground the answer reverses. The founder needs a clean exit for a reason unrelated to price, and he refuses the holdback that would be the natural alternative. Without a policy, either the deal does not happen, or it rests on a personal covenant that an estate in the course of settlement would honor poorly. The policy then buys not protection but the possibility of the transaction, and on that basis 95,000 euros on 7.5 million is defensible. What an adviser should say therefore comes down to two sentences. If the deal can be done with a modest holdback, the holdback is better and that should be said. If the founder genuinely cannot accept one, the policy is justified as an instrument of feasibility rather than as protection, and the buyer must know that as it signs, devoting if possible part of the budget to the tax review that would close the hole rather than to widening a limit it will have no use for.
- 01The product's floor is set by the cost of the inputs, not by insurers' appetite: a small deal cannot fund the review that wide cover requires.
- 02Below the floor, what existed before insurance takes over again: a holdback, a seller covenant, deferred consideration.
- 03Simplified policies are genuine cover and they are narrow: the danger is that they carry the same commercial name as full policies.
- 04The small buyer is the least well advised where the product is least standard, and that is mechanical rather than moral.
- 05The right test is not deal size but whether the seller needs to be released: where it does not, the policy almost always loses to a holdback.