Talking Insurance When Selling Your Business
Most entrepreneurs and business people hate talking about insurance. It seems like you never have enough, according to insurance people, and it always seems to cost more than you think it should. However, there are some important things to think about when it comes to insurance and selling your business.
The reason is that in many cases, just because you sell your business, that does not mean that your need for insurance in that area ends. There may be lingering needs, and you may not even be aware of some of them. While over insuring is often problematic, leaving yourself open can mean even more risk.
First, it is important to understand that when you buy insurance as your business, the contract is between that company and the insurer. When your company no longer exists, or you sell it, that contract may no longer be valid.
Second, the insurer based the policy on the conditions and in part on you, the business owner, and your risks. This is how they set rates and coverage. If that situation changes, so do the coverage and rate provisions.
Key Policy Provisions to Understand
Of course, insurers also know that businesses can be bought and sold, and they don’t want to lose that customer as a business. There are certain provisions in each policy because of this, and you need to be aware of them and each one means:
- Change in risk provisions: This basically means that any change in risk, including the company being purchased, can change the policy. The same goes if you are a company that is buying another business since that will also change your risk, and therefore your policy and premiums.
- Prior acts exclusion: If your company is being purchased by another company or even an individual, any act they did prior to buying your business will have to be covered by their old insurance company and will not be covered by yours even if the policy transfers smoothly otherwise. It’s important that your buyer understands this.
- Automatic Extended Reporting Period: When you sell, your policy ends on the date the other entity acquires your business, in other words when you go through closing. 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.
Your policy may have other exclusions or issues. You will need to talk to your insurance professional and your business broker to help determine what impact the business sale will have on your insurance policies and what you will need going forward.
Not all claims are made right away when the incident happens, and in some liability cases, it can be months or years before a letter from an attorney announces litigation. 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, so it is important to discuss a five- or six-year policy with your insurer.
Not every transaction needs this kind of insurance, but in many instances, either the buyer or the seller can insist on the coverage. Understand that under tail coverage, the incident still had to happen before the date of the business changing hands to be covered.
That’s great, and a good idea, but what about any new claims?
Transactional Risk Insurance
A big part of buying and selling a business is trust, which is why we stress honesty and disclosure here at Rogerson Business Services. A well-informed buyer is usually a happy one. However, what if a 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, or RWI comes in. This has some great benefits for both the buyer and the seller.
First, it can give the buyer peace of mind about their risk and can help close a deal faster, shortening due diligence and even escrow times. The buyer knows the representation and warranties of the seller are backed by insurance, giving them additional peace of mind.
Of course, as the seller, not only does this speed the sale of your business but if they are sued, the policy will provide money with which they can defend themselves. While these policies make the most sense for large deals like mergers and acquisitions, they can have a place in smaller transactions too.
The key is to check with your insurer and see if this kind of policy makes sense for you.
We don’t like to talk about insurance, but it is a necessary cost of doing business. When it’s time to sell your business, it’s also a good time for an insurance checkup. Are you ready to sell your business in California? Do you have questions or need a business valuation? Contact us at Rogerson Business Services today. We’re here to help.