Reps & Warranties: M&A Insurance

Activity in the multi-unit space has been significant and growing for years now, with seemingly all industry participants eager to get deals done. Franchised concepts are a hot commodity, and there’s no shortage and buyers and sellers looking to engage. Yet despite all of this interest, we still see a number of challenges arise over the course of any deal.

While there are a variety of reasons both buyers and sellers alike will face difficulties when working to close a deal, purchase agreement negotiations typically turn out to be the most arduous part of the process. In recent years, one of the aspects that has required a lot of attention has concerned Reps & Warranties.

Reps & Warranties weren’t always such a point of contention. It wasn’t long ago that transactions had an air of “buyer beware” attached to the due diligence proceedings. True, sellers have always been legally required to disclose any and all information about their business that could have a future impact or economic effect post-close, but over the years these discussions have become increasingly more burdensome. Sellers no longer have the power to tell buyers to do their due diligence carefully and thoroughly, because after the deal closes, it’s done.

These days, Reps & Warranties have taken on a much larger and more onerous position within purchase agreement negotiations. Often, it’s no longer a straightforward discussion between the buying and selling parties, but instead a battle between the two parties’ legal teams. Having a trusted lawyer in place for purchase agreement negotiations is crucial to any transaction’s success. However, there are certain points of discussion, like those over Reps & Warranties, that can become unnecessarily long and drawn out in the process. Depending on the severity, this kind of occurrence regularly creates deal fatigue, ultimately having a negative impact on both parties and even interfering with a successful close.

Now we are seeing a trend in the industry, with one option in particular becoming more and more prevalent in today’s market: Rep & Warranty Insurance. With its ability to mitigate some of the otherwise laborious negotiations on the matter, and the inherent feeling of security that comes with being insured, Rep & Warranty Insurance is an important topic to examine.

To gain greater insight on the matter, I decided to reach out to one of the industry’s leading insurance companies providing Rep & Warranty Insurance in the M&A market today. Trisha Lee, the Senior Vice President of Lockton Companies, LLC, was gracious enough to contribute the following.

“Rep & Warranty Insurance (RWI) is at the forefront of merger and acquisition activity.  RWI is a tool sellers utilize to transfer their escrow requirement to an insurance policy, thereby freeing up sale proceeds at closing. This enables a cleaner exit and locks in returns.  From a buyer’s perspective, this insurance mitigates counter-party risk and strengthens the relationship with management rollovers by eliminating potential clawbacks. Claim examples could include a seller breaching the condition of assets representation; resulting in unexpected capital expense, or the financial statement representation such that the EBITDA determining the enterprise value was misrepresented. The insurance provides coverage over the general, fundamental, and tax representations with matching survival periods. Coverage can be structured for a specific representation or on a blanket basis. The process generally requires two weeks and insurers look to the quality of the buyer’s third party diligence work for their underwriting. It is most likely utilized on transaction sizes of $40 million and above.

Markets that write these policies are varied, and are written in US markets or foreign (UK/Lloyds) markets.  Claims are being paid, and this policy is designed to respond for financial loss arising from a breach of a rep or warranty from an unknown pre-closing issue.

From 2014 to 2016, premiums written increased from $46 Million to $400 million, and the number of policies in that timeframe rose from 95 to over 500.  Driving this growth is the product’s acceptance in the legal community as an effective M&A tool, along with improvements in the ease of placement and broader coverage language.”

RWI is certainly an effective tool to carry in your deal closing arsenal, as well as a wise and prudent choice for prospective buyers and sellers today. It’s especially worth considering when you take into account RWI’s ability to streamline the purchase agreement negotiation process, essentially eliminate unnecessary points of contention, and keep deal momentum up.  Because no deal is the same and each transaction requires its own unique strategy, I can’t say for certain that Rep & Warranty Insurance is right for everyone. What I can say is that I believe RWI is truly a beneficial mechanism, and it’s certainly worth exploring if you’re pursuing a transaction in the M&A space today.

I would like to extend my sincerest appreciation to Ms. Lee for her contribution to this article. If you have any further questions regarding Rep & Warranty Insurance, you can reach Trisha by email at


The Benefits of Simple & Straightforward Negotiations

“Life is really simple, but we insist on making it complicated.” – Confucius
Overcomplicating things is part of the human condition; whether it’s something basic like picking out an outfit for a job interview, or something as monumental as selling the company you poured your heart and soul into, people tend to overthink both their choices and their actions. True, it’s not hard to understand why someone might overdo it when selling their company, but the bottom line is that most transactions are complex enough already, so making the effort to curb any overthinking will deliver the best chance of reaching a successful close.
Interestingly, although perhaps not surprisingly, I have noticed a sort of “Jekyll and Hyde” dichotomy depending on the type of transaction a client is pursuing. Typically speaking, clients looking to recapitalize their business are more like Dr. Jekyll, remaining more rational and reserved during the process. On the other hand, we find our buyers and sellers presenting themselves in a Hyde-like manner. Sure, theirs are inherently more aggressive transaction circumstances, but that doesn’t account for the massive attitude shift that occurs in many people.
While there are multiple factors that induce this change in behavior, I’d argue that they all come back to one central theme: objectivity vs. subjectivity. Each deal I have worked on in my 25+ years of experience has had its own unique characteristics, but there has also been an unmistakable trend. Although not always the case, I have often found that clients seeking some form of capitalization or financing engage in the process with an objective mindset. Alternatively, those pursuing an acquisition or divestiture go about things in a more subjective manner. Think about it this way… The Jekylls operate in a straightforward fashion, where their efforts are intended to accomplish a specific purpose, based solely on the facts of the situation. On the flip side, our Hydes are more likely to emphasize their moods, attitudes, and opinions, basing their actions on their own perceptions, as opposed to evaluating a deal opportunity in an unbiased fashion and by its merits alone.
It should be no shock that dealing in a subjective manner undoubtedly makes any process more complicated than it needs to be. When people get wrapped up in their own emotional response, it becomes exceedingly difficult to understand the true motivation and reasons for your actions. Take a step back and look at the big picture. Why did you decide to pursue this course in the first place? How is it that you can best achieve this original goal? If you instead choose to focus on the granular details that hardly matter in the long run, you’re letting the deal process dictate the outcome, when it’s actually the deal opportunity that should drive your decisions.
To be a legitimate player in the industry today, you should only engage in an acquisition or divestiture once you have a clear plan of action and a specific, resolute goal in mind. Know what you want to accomplish and have the confidence to stand by your business decision. If you want to sell your business, be prepared to sell – if your intentions are wavering regarding any aspect of the deal, you are automatically hurting your chances of reaching a successful close, not to mention the significant effect this could have on your reputation. If you’re known as someone who is difficult to work with, you’re severely hindering your chances of being taken seriously in the future.
There’s a portion of the deal process that stands out as one which would arguably benefit most from taking this logic into consideration: Due Diligence. Above all else, buyers and sellers need to remember to be reasonable, on top of being objective. Sellers – don’t withhold pertinent information. Excluding excessive requests, the buyer has every right to view your updated financials and any additional metrics that are necessary in order to substantiate a valuation. Buyers – don’t submit a 30-page Due Diligence request list. Diligence is meant to assist you in understanding and subsequently confirming your bid; it’s certainly not the time to enlist an army of accountants and lawyers to take a fine-tooth comb to everything, with the hope that their reports will tell you what decision to make. Quite frankly, most of these items should have been addressed prior to this point anyway. Additionally, keep in mind that you are purchasing a business, not a guaranty – if you want a guaranty, buy an annuity.
At the end of the day, you need to be able to rely on your own business judgement, because this is what should ultimately produce your decision. Think back to your original goal: looking at this transaction objectively, does it accomplish your core purpose? Don’t let your answer get muddled by a process that was unnecessarily complicated due to an emotional and irrational human brain.

The Right Operator - A Crucial Yet Scarce Commodity

Franchised concepts have attracted both consumers and investors alike for decades now, who often feel compelled by one simple notion: they know what they are going to get. Whether it’s a familiar menu or a stable cash flow, recognizable brands simply put people at ease. This common mindset has played a huge role in creating such a successful climate for multi-unit concepts over the years, with more and more people looking to buy into franchised systems.

In the restaurant space for example, the interest is so great that there’s ample opportunity to acquire restaurants in scale and all segments of the industry. However, the ability to invest does not necessarily translate into the ability to operate, which rings true in regard to any franchised business, regardless of its industry. Herein lies the problem: the ratio of skilled operators to prospective purchasers/investors is skewed heavily towards the latter group.

The fact is, there is more capital available for transactions presently than there are talented operators. Equity is available from a variety of sources, be it embedded equity in franchised stores from Franchisees of the same brand, embedded equity from investments in other brands, Family Offices, or Private Equity, there is no shortage of capital. Debt markets are also functioning well, with an adequate debt-level available, attractive advance rates, and terms/conditions for major brands being already well established.

What we have found is that quite often the missing piece of this puzzle is a proven operator or operating partner who runs the business on a day to day basis. Talented operators are truly a scarce commodity and finding the right person for the job can be one of the greatest challenges facing investors today.

As already mentioned, it is not difficult to find parties seeking investments in franchised concepts – investors are usually comfortable with the segment and the risks involved, and already understand how to own and operate a business in general. Financial returns and engineering are largely applied across any industry, also adding to the investors’ basic operational knowledge. The primary issue stems from the investors’ lack of skill or experience in operating a specific brand.

Franchisors will typically embrace or consider different types of equity capital ownership, but they are consistently seeking out franchise groups that have operators experienced in their brand or similar concepts, especially when it comes to deals that are larger in scale. All companies and their respective systems were not created equal, and having the proper knowledge and insight into how a specific brand functions can be of paramount importance in achieving operational success.

Franchisors are well aware of this truth, and thus approve and select prospective purchasers fitting this description at a significantly greater rate than those who do not have the same brand or segment specific operating experience. Too often, new equity investors fail to address this critical need early enough, often chasing the deal before solving the operator question. As a result, they often get passed over in a competitive process, regardless of their financial strength. Additionally, Franchisors undertaking refranchising initiatives can make their brand more attractive to prospective purchasers by assisting in the placement of operators.

Therefore, operators proving to be the “right fit” find themselves in the unique position where they can and should demand attractive opportunities in exchange for partnering with an investor. Furthermore, in certain situations deals may be contingent upon keeping the current operators with the business, providing them with an even more critical ongoing role. That being said, operators would be wise to augment their skillset to be viewed as capable of running the business as opposed to simply managing restaurant operations.

Essentially, the two main takeaways here are as follows… If you are an investor looking to purchase stores in a new brand or industry, it would greatly behoove you to seek out the right operator as one of your first steps. This will substantially increase your chance of being selected as the winning bidder, while also boosting your capacity to achieve subsequent financial success. On the flipside, if you are an experienced operator, it is imperative to remember that you have a highly marketable skillset. There are numerous investors out there today searching for you, so make a point of becoming visible to those groups and you will likely find an exciting opportunity in the future.

Refranchising Gains: Selling Corporate Stores Benefits All Players

The modern franchise business model was created by Isaac Singer, a highly successful entrepreneur whose automated machine revolutionized sewing in the 1800’s.  Prior to Singer’s invention, most sewing was done by hand, a slow and labor intensive process.  Singer’s machine could produce 900 stitches per minute - a huge advancement for professional and amateur sewers alike. Mr. Singer knew that his product had the potential to change the industry, so he formulated a plan to get his sewing machines into the hands of as many consumers as possible. Initially, he came up with the first ever installment payment plan as a way to make his machines more affordable to the masses.  While important, this only solved part of Singer’s problem; he still needed a way to distribute his machines across the country and eventually the world.  The impact of Singer’s sewing machine was obvious, so he could easily attract business people across the country that paid him an up-front, licensing fee for the right to sell his sewing machines in a specific geographic territory. Mr. Singer’s franchised business plan proved to be incredibly successful, with many other companies in various industries ultimately recognizing the benefits of his model and adapting it to fit their respective businesses. 

However, it was the McDonald’s model under Ray Kroc’s leadership that forever changed the way in which multi-unit concepts do business.  Kroc saw so much potential for a franchised business model at McDonald’s that he acquired the brand from the McDonald brothers, took it public in 1965 with 500 stores, and grew it to the global franchised brand that is McDonald’s today. 

Franchising has proven to be a successful business model across a wide spectrum of industries utilizing multi-unit retail distribution.  At its heart, franchising allows everyone to focus on what they do best – manage, support, and grow the brand in the case of the Franchisor with Franchisees focused on delivering a high quality, consistent product or service to the ultimate customer.   Refranchising – the sale of franchisor owned units to new or existing franchisees – allows franchisors to address both financial and strategic goals in their business by optimizing the mix of company and franchised ownership.  Refranchising has been a hot topic in the restaurant industry in particular with a number of national chains executing large scale refranchising initiatives over the past 5 years.  The Cypress Group led most of these large scale refranchising programs and sees this activity continuing for the foreseeable future, and likely spreading to multi-unit segments outside of the restaurant industry. 

Historically, most franchised restaurant concepts have operated under an ownership structure that had the franchisors owning and directly operating a “material” percentage of their overall system. While this ownership percentage has varied from brand-to-brand, it was historically significant – generally in the 25% to 50% range. The thinking was this level of ownership meant franchisors would lead by example, essentially showing their franchisees how to operate the business.  Additionally, this direct ownership was seen as the best way to align the interests of the Brand and its operators.
As it has matured, the chain restaurant business has become much more complex.  Increased competition, governmental regulation, changes in the workforce, and consumer preferences make the business more challenging today than ever.  Many chains have concluded that new thinking is needed to address today’s environment, with Refranchising initiatives becoming an important Brand strategy.    Although Franchisors have historically fine-tuned their ownership of units, today’s refranchising initiatives tend to be larger in scale with more strategic implications. Franchisors in recent restaurant initiatives have seen franchisors go as far as zero company-owned restaurants. The trend towards larger and more sophisticated restaurant franchisees has helped operators deal with the more complicated business we see today, as well as create demand for large scale refranchising initiatives in national systems including Wendy’s, Burger King, Applebee’s, and TGI Fridays.

            So can refranchising be a “win/win” for franchisors and franchisees? In our experience the answer is “Yes” if designed and executed correctly.  Benefits can include:


  • Comp Sales growth driven by renewed focus on menu, marketing, technology, reimage initiatives, etc.
  • New unit growth with expanded franchisee footprint ideally in combination with new prototype, and corporate initiatives including enhanced RE & Construction resources, incentives, etc.
  • Entrepreneurial / Growth Opportunities for Brand Employees
Improved Financial Metrics:
  • Reduced volatility in Revenue, Earnings, and Free Cash Flow
  • Capital re-deployment to System growth initiatives
  • Ability to optimize capital structure

  • In core brand – from both acquired units and franchisor’s broad brand initiatives
  • As a supplemental brand
  • For People – enhanced career paths
Improved Financial Metrics:
  • Frequent ability to improve unit level profits
  • Leverage existing overhead
Stronger Overall System
  • Encourages partnership with strong players – both new and existing franchisees
  • Growth creates opportunities for all
Ultimately, we believe refranchising is here to stay. These initiatives have the ability to revitalize and improve the operational strategy of major franchised organizations. Franchisors undergoing the process are finding they have a renewed sense of purpose, focusing on new innovations and brand management without having to worry about daily restaurant operations. Franchisees are granted the opportunity to grow their store portfolios large enough that they become capable of streamlining operations, leading to greater efficiencies, sophistication, and success. While restaurant refranchising initiatives remain a hot topic, we expect to see the discussion quickly expand into non-restaurant, multi-unit retail systems that can benefit from the same sort of dynamics experienced in restaurants.    

Casual Dining's Upside

I frequently receive questions from clients and prospective buyers asking, “What’s the hottest new opportunity in the marketplace”? While it’s true that discovering the new McDonald’s or sexiest “Brand du Jour” seems most exciting, often times the greatest opportunities are far less glamorous. Do new and flashy concepts seem instinctively more appealing? Perhaps, but glamour is inherently fleeting, and as we operate in the multi-unit franchise industry and not the fashion industry, this subjective allure will forever be eclipsed by stability and the potential for operational upside.

This might come as a shock to some, but I believe that Casual Dining might just be that opportunity in 2017. So, what about the widely-publicized fact that the Casual Dining subdivision has suffered greatly over the past few years? It turns out that the explanations for this are legitimate, but also manageable, and by no means going to cause the downfall of the entire segment. For example, some of the primary reasons for Casual Dining’s downtrend include more competition, consumers’ shifting preference towards take-out and delivery, changing tastes, demand for high quality offerings, and demand for speedy service. Considering these aspects, it’s not farfetched to see Casual Dining as behind the times, but it is also important to note that all of the aforementioned elements affecting this segment are not solely problems for Casual Dining, or even restaurant concepts at large, but instead factors that affect all businesses operating in the market today.

Yet despite these issues, Casual Dining concepts will almost certainly bounce back in the future. There is one particular phenomenon I have witnessed time and again during my 35+ years working in the restaurant industry that is particularly relevant in this case: brands don’t die. Some brands will inevitably dissolve, but most find a way to survive and even thrive. Some relevant examples of this happening can be found by examining the Burger King, Arby’s, and Denny’s systems. All of these brands found a way to weather some serious hardships, and are now arguably operating better than ever before. Thus, it is reasonable to expect that Casual Dining can and will experience a similar rebound.  

Furthermore, the Casual Dining segment is certainly not sitting idly by, waiting for the market to bring about this rebound; the big, savvy brands are making some crucial adjustments to address the issues they are faced with. Due to their established nature, these organizations have the ability to leverage their large-scale infrastructure to put the necessary resources behind these initiatives in order to win back their customer base. With a renewed focus on higher food quality, improving menus, and refining mobile apps and online ordering, these restaurants are ready to fight for the consumers’ attention. Casual Dining is also in a unique position, as it is perfectly situated to capitalize on the growing take-out and delivery trends that are making a huge impact on the restaurant industry today.

Interestingly enough, it is this current conflict in the Casual Dining segment that consequently presents prospective buyers with the most substantial opportunity. The underperformance of the segment as a whole has significantly brought valuations down to the lowest multiples seen in years. On the flipside, valuation multiples for the top performing QSR brands, such as Taco Bell, have reached record highs, making the Casual Dining financials look far more attractive to a prospective purchaser. We must also consider the fact that it wasn’t so long ago that the QSR segment was experiencing a nearly identical struggle, further demonstrating the ebb and flow of concept and segment success that is fundamental to the industry. Granted, Casual Dining restaurants will experience their own distinct complications – such as more limited financing options and a larger capital requirement – but nonetheless these strong, broadly recognized concepts possess the brand equity to maintain consumer interest and subsequently adapt to better address the demands of the marketplace.

Everyone who is active in the field plays with their own strategy, and there is no basis upon which any one specific approach can be touted as best, but before determining which method best suits you, ask yourself this: As a buyer, what do I find more compelling right now – a hot QSR brand at 8.0x EBITDA or a national Casual Dining brand sitting at 5.0x EBITDA? We think some buyers will make the move towards Casual Dining and ultimately be happy that they did.