Over the last years I have developed a side line niche practice in acting for management teams of PE owned companies in their roll-over to a subsequent sponsor. This is a dynamic and complex process, with many issues to deal with. One of these is the concept of management warranties. I notice a development whereby the selling sponsors do not offer any warranties or indemnities (other than title to shares) but demand from the management that they give the full set of business warranties and the tax indemnity as well, be it that these are all covered by a W&I insurance.
That in itself is not so unusual, but what is new is that management is expected to pick up the entire check of the retention (eigen risico) under this insurance policy. Considering that the retention amount typically ranges between 1-5% of the enterprise value, this creates an unbalanced situation between the selling sponsor and its management, especially in the more sizeable transactions.
My view is that bidders do not want to first claim from their future managers before they can bring a claim under a W&I policy, especially not if the managers' financial exposure is high. The bidders would rather see them co-invest that amount in the new venture. My feeling is also that the selling sponsors don't always realise that re-investment and warranty obligations add up to what management is willing and able to put on the table at exit. Finally, I believe it is only the insurers (and not any of the other parties involved) who have an interest in a high retention. This concept is wrong and I therefore urge parties and their advisors in similar positions to push back on this. First in terms of sharing the retention amount between all selling shareholders on a pro rata basis. Second in bringing down this retention to what is truly skin in the game, because that is what is relevant.