Patrick Stroth is the Trusted Authority on Transaction Liability. He’s also the founder of Rubicon M&A Insurance Services, LLC. He is a pioneer in applying Rep and Warranty insurance to lower middle-market M&A transactions. He and his team are...
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Ronald Skelton 0:06
Hello and welcome to the how to exit podcast where we introduce you to a world of small to medium business acquisitions and mergers. We interview business owners, industry leaders, authors, mentors and other influencers with the sole intent to share with you what it looks like to buy or sell a business. Let's get rolling
Hello and welcome to the how to exit podcast today I'm here with Patrick Stroth. Patrick Stroth is a trusted authority on executive and transaction liability. His firm Rubicon mergers and acquisitions Insurance Services is a member of the Liberty company insurance brokers, a nationwide network of insurance brokers focused on middle and low middle market companies. Patrick is a pioneer in applying rep and warranties insurance to lower middle market m&a transaction. He and his team are committed to help middle lower middle market owners founders and investors achieve a clean exit. Patrick is the host of m&a Masters podcast where he speaks with leading experts in mergers and acquisitions. Thank you for being on the show. And I have you here today because you got this real cool, innovative product that exclusively set up to insure deals from 1 million to 20 million. Let's just jump right in, thank you for being here.
Patrick Stroth 1:32
Yeah. Hey, Ron, it's my pleasure. Thanks for having me today.
Ronald Skelton 1:35
All right. And for those know, for those you guys out in the live, you know, this is live cutting on raw, the, when you see the finished version of it, I'll have a cleaner version of his intro there. So we were just talking about this ahead of time, sometimes I make it through they're nice and smooth. And sometimes I tripped over my own tongue. But
Patrick Stroth 1:54
I have podcasts too. I do the exact same thing. It's rare when it gets out perfectly. But we're, we're off and running.
Ronald Skelton 2:00
Cool. I don't want to let everybody know but 100% clarity, I practice it three or four times before you came on camera. So that's even worse. So I got it better the first few times that I did just then. So let's just jump right in with you. What got you started in m&a, like mergers and acquisitions?
Patrick Stroth 2:17
Yeah, so I'm an insurance broker by trade, got out of college, went right into insurance and did everything from home and auto all the way through commercial insurance. I found a real passion for the complexity. And just the intellectual challenges with executive liability. This is directors and officers liability and plant practices think professional liability, things like that is a lot more interesting than home and auto. I got pulled into mergers and acquisitions, because one of my policyholders is a doctor. And then about five, six years ago, he had six companies, he was bundling them together, and he was selling them to healthcare conglomerate for about $50 million. And I had asked the doctors, we're putting the church together just to you know, have it run off, and so forth. I just said, so what are you going to do with money? Where are you going, Doc, and he said, I'm going to go country, which was Israel. So he was going to be after the merger, after he sold his company, he was going to leave the country and go go off to Israel. When the buyer found out that he was leaving the country, they changed the terms of the deal. And they said, Look, this isn't personal. We don't mean to be adversarial. But we got to hold back half the money, okay, for at least a year or two. Because you know what, if you leave the country, we have no way of climbing the funds back. So I'm afraid we have to set this up. So then we're going to hold back 25 of the $50 million in an escrow fund for I think it was probably more than two years. And so the doctor came to me said, Patrick, seriously, there's got to be a way we can insure this transaction. And I said, well, there is a way but it's prohibitively expensive. And he just said price is no object. And when a lot of clients and insurance tell you price is no object they sincere until they know the price. Big object and all of a sudden there's been no, well, this is late 2015, early 2016. And this product for ensuring mergers and acquisitions, it's called reps and warranties had just honored undergone a great reduction in rate. Okay, it went from a rate where this is probably going to be a million dollar plus policy to less than half of that I was shocked when I put up together the proposal for the doctor that for a couple 100 grand he was going to be able to exit and instead of leaving with only half his money, he left with 49 Out of the 50 million in his pocket. And when I saw the power of a product that can go ahead and enhance an entrepreneur to exit with almost all their money and not only exit with the money but get to keep it because if there was a post closing breach, the policy would respond to the buyer. The buyer did not have to come after the seller so he was free and clear and got out eventually he would get his his whole bag of that million dollars that was the deductible and moved on and when I saw that
happen in real time, I pivoted the practice of our firm to add in this, this product called reps and warranties, insurance. And essentially what it does. For those that may not know, it's probably the biggest thing in private equity today. But what it does is it steps in the shoes of the seller, and enables the seller who ordinarily they make a bunch of disclosures about their company to the buyer, and the buyer performs due diligence on the financials and the legal etc. Just to see how accurate those those disclosures or what we call reps and warranties are and and based on the buyers diligence, they're going to go ahead and say great, well, you know, we're going to move forward and purchase your company. However, we can't diligence, everything. So if something pops up that we didn't know about, or you forgot to tell us, we've got a provision in here called the indemnification provision that allows us to claw back some or all of the money from the purchase. Okay, if the discrepancy is big enough, and we want to be able to claw that back, well, what the insurance industry did, naturally, there's natural tension in here, because you got a seller that, you know, looking at the buyer saying, Hey, I told you everything that if you didn't find it, that's not my problem. The buyer is looking saying, wait a minute, you know, this is market, and I'm sorry, but we have to hedge our bets on this. And so this is what everybody does. And so you just have to take it. Well, the insurance industry came up years ago and said look, show us these disclosures. Okay, buyer, show us the the diligence that you performed to verify that the accuracy of these disclosures, if you did a good enough job on the diligence, I'll tell you what, for a couple bucks, you know, if there is a breach, we we the insurance companies, not the seller will pay the buyer, the buyers loss, seller gets gets out from under and usually not only do they get to exit with a very small hole back or escrow amount usually is 10% of the purchase price. Well, now it can be as low as 1%. Not only do they exit with more cash closing, but they have assurance that they can keep their money because like I said, if there is a breach the insurer, not the seller covers the buyer. And it's also helpful for the buyer for a number of reasons, because this is a way to get the deals moving forward. Now, you know, this is you know, rep and warranty just in a real thumbnail. The thing is, these are really good, and efficient $400 million deals because buyers at that level are going to do extensive diligence. They're gonna get legal diligence, they'll get quality earnings, audited financial, things like that. Okay, which is great. But that's not available for smaller deals. And so that's been the real gap out there is what do you do with a company that is maybe under $10 million in value? Okay, where's where's their protection?
Ronald Skelton 7:53
So this original product was for, like larger deals. You were saying $100 million deals? You know, it's very common in that space.
Patrick Stroth 8:02
Yeah. Yeah, it went, it was reserved initially just for 100 million dollar plus enterprise value deals. It has over the years, come down to 75 and 50 million and 30 million. And so I mean, they're writing policies now for $25 million enterprise value deals. The challenge, though, is, you know, if you're a private equity firm, are you going to spend, you know, several 100,000 to a million dollars to diligence a deal, that's probably, you know, 25 million, it's a lot easier. The bigger buyers have the leverage, so they can essentially tell the tell the and I've had clients come to me say, sellers come to me saying, Patrick, we've heard of this rep and warranty, we'd love to, we'll pay for tell the buyer, we'll pay for it, just can we get it. And the buyer is just going to sit there and say, Look, I'm sorry, it's cost prohibitive for us, we just, we just can't do it. And so that's where there's been that gap until now. And this is why I'm so happy to be with you today is because there's a very innovative insurance firm called CFC. They're a London based insurance firm, very good reputation in the reps and warranties space for the traditional deals. And they looked out across the pond and they said, look, there are 1000 times as many small micro deals as there are these regular deals. These are, these are smaller Mainstreet companies that have very little risk. They're pretty straightforward. And you know what, we're not seeing a lot of big claims on the big deals. So why don't we make a volume play a make a simple, you know, broad product that is inexpensive, so we can go ahead and start getting these, you know, scores and hundreds of deals that happen every single month. And so they've come up with a product it's called TLPE, transaction liability, private enterprise. And it's designed for companies with enterprise value of not more than 20 million. They can write an insurance policy that can cover up to $10 million of the enterprise value, and we've gotten several cases now, where sub $10 million deals, we just insure him for whatever the purchase price is. And we move forward with that. And it's is the newest innovation out there, that is beginning to gain momentum. But as with a lot of things in insurance, you know, getting the word out is a challenge. That's why I'm happy to be here with you to talk about it today.
Ronald Skelton 10:26
So in the bigger policy, you guys have audited financials, you got legal due diligence, you got a whole team, it's been in 10s of 1000s, if not hundreds of 1000s or more verify in that transaction. And then the insurance company reviews that right? And this case, what is the application process? Or what what is needed? Is there still audited financials and stuff? Or is it what's the subset that a business owner would need to present?
Patrick Stroth 10:52
That's a that's a great, great question. I'll say we're going to break it up between the TLP and the traditional, okay, traditional rep Home Warranty, there's no application, essentially, what the underwriters do is they want to get a draft copy of the purchase and sale agreement where there's a list of what the reps are, we then ask for the reports that the buyer had, what diligence reports, do you you know, did you do quality of earnings? Report? Did you do a tax report, human resources, legal diligence, all operational doses, all those types of, you know, areas of focus that were performed? Okay. And then based on that, the underwriters will look at that and put out a proposal that says, Okay, well, if we were to dive into this and really go through this, we figure a policy of X amount of coverage is going to cost Y amount of premium. And before we get into this, we're going to need to hire an outside counsel to, you know, look over the due diligence and actually vet it, okay. That's called an underwriting fee. That underwriting fee is routinely between 35 and $60,000. So out the door on a traditional policy, you're going to be paying 30 to $60,000, just for the underwriters to go through their whole process, that process can take about a week to two weeks i There are some people that say they can do days, it takes a week to two weeks, and then you know that that process moves forward. Now let's contrast that with TLPE. TLPE is a straightforward application process where again, this is a simpler thing. And what underwriters are going to do is they're going to go through, they're going to ask instead of underwriting the buyers diligence, they're going to look what the seller can tell him because nobody knows a company better than the seller, the owner, the founder knows the company best. And so what the insurance underwriters are gonna do, they're gonna rely on the seller, being honest, which is, you know, typical for every insurance policy, fill out this application as best you can. And based on your your industry class code and the size of the deal, they'll go ahead and evaluate what the what the risk is, and then put out a price. And the great thing about this is there's no underwriting fee that's necessary, and so forth. And I could step back a little bit on TLP and how it's different from from the traditional rep and warranty in this way. And not to get too into the weeds with coverage but, a traditional rep and warranty policy, the policyholder is the buyer, the intent of this rep and warranty is so the seller gets a clean exit if the buyer suffers a loss buyer goes to the insurance company to collect okay. So it is on a format called a biocide policy. Under TLP is what we call a sell side policy. It is not dependent on the buyers diligence at all, it is just dependent on the quality of the policyholder the quality of the seller and their business. They they review an application they represent a review the current financial statements of the seller, they would look look at the letter of intent just to see just format on the structure of the deal. And then they will put out their their terms and the terms this process because it's finite, it's not going to cover every type of deal. The process takes is on an accelerated platform because the intent is underwriters want to write hundreds of these a month. And if you have a cumbersome, cumbersome, multistage process for quoting and evaluating it's not going to work and so they wanted to streamline process and they put together processes you know, essentially that from beginning to end can take literally two days to to get these things done. So it works out very, very nicely.
Ronald Skelton 14:43
Now, if you guys already worked with, like the Small Business Administration loans and the typical ways people fund the LBOs?
Patrick Stroth 14:50
No, we haven't we haven't been in that. Usually it the size that we're looking at right now. We've got buyers that are funding, you know either with a loan and not necessarily SBA loan or anything like that we're and we don't get too involved in the financing process of the transaction itself. Well, we're going to look at as we were looking to protect the seller. And in in this vein, when you protect the seller, you're also protecting the buyer, because there will be a source of remedy for the buyer should there be something that blows up.
Ronald Skelton 15:22
Yeah, I guess you're right. Because in case there's unless there's real estate involved, they're not gonna go above that, into that range, they're gonna stay below the $10 million range.
Patrick Stroth 15:30
Usually, yes, and we're, and honestly, we're we like to see this is, this doesn't have to be limited to just individuals or families buying and selling companies, this is going to be very big, we believe, for private equity, where private equity has strategies now where they're looking to get a platform, portfolio company, and then add on to that, and just, you know, rather than get organic growth, growth through, you know, doing add ons, and bolt ons, and those add ons, and bolt ons are the ideal, you know, type of risk that our underwriters are looking for is that, you know, the the sub $10 million to $15 million SaaS company that gets bolted on to a larger platform. That's where that's where we like to be.
Ronald Skelton 16:16
So a lot of times these earnouts are tied to not just risk base, which I can see the insurance policy tying, but the new acquirer wanting to keep the, you know, the particular member or members of the team around kinda like it's an additional golden handcuffs. So I can see this policy kind of keeping people truly honest in the transaction, right. Like, it's,
Patrick Stroth 16:40
I'm sorry to interrupt and jumping in on you. But I think that's just a real key issue here, and we see this in Silicon Valley a lot is that one of the great benefits of rep and warranty, particularly on the TLP, because you've got a much smaller, you know, seller there that's intimately, you know, involved with the company and could be transitioning over. And they don't have a lot of bandwidth to lose money. And so it gets very uncomfortable. If let's say post closing, there is a loss, and you have a real uncomfortable situation where the seller is a key member of the new team coming over and is waiting for their whole back of their escrow, to mature and collect. And then the buyers got the unenviable task of going out and breaking the news that it was outside of everybody's control. But this happened in that million dollars, you are waiting for it. Yeah, I'm sorry, we had to use it here. We've actually seen situations in Silicon Valley, where you bring on some Rockstar programmers, and there's a real dilemma there for the buyer. Do we, you know, alienate these people who are just great contributors? Or do we just eat the last? And what's real convenient and elegant about reps and warranties insurance is that you know, what, if you've got a third party that has very deep pockets, bring them the claim, they're going to pay the loss. And and it just makes it very simple across the board for everybody.
Ronald Skelton 18:10
I can see where that would be a real problem, right? You're working, you're working there, you committed to being there for the next, whatever, I guess I'm hearing three, between three and five years on earnouts these days. And then something goes right. And they're either going to try to claw back money from you while you're sitting in the chair, or like, you know, not delivered to you what you're expecting. So I can see this actually, you know, helping with one of the key reasons why a lot of these acquisitions fell. And that's integration, right? Something happens throughout the integration process policy and you can't keep people engaged and active and, and make things mesh together. This I can see reducing some of that friction that causes that failure to integrate.
Unknown Speaker 18:51
Oh, I think I think that let's step back a little bit. Just look at m&a in general and and situations here. Because this is this is really where overall reps and warranties is coming in really contributed to the parties and how I would say probably about 90% of private equity deals now involve some form of reps and warranties. And here's what happens in mergers and acquisitions. You've got two parties, you got one party that's very experienced, that's the buyer and then the seller is usually inexperienced in the whole process, okay. And it's not anybody's fault. It's just that they're, you know, if you're in the business of operating a company, you're operating the company, okay, when your private equity or other buyers, your you know, your business is buying. So you're used to this. And so, there will go through these processes where you know, the buyer is going to ask for all this information before they make a decision, the seller, I mean, it can it can be, in their opinion, a very invasive process going through this whole diligence process, okay. And the buyer keeps coming up with more things to ask and more things to look at and so forth. And the seller is going through this whole process thinking you know what, I've opened up my soul to you, I mean, this, there's nothing more I can tell you, and the buyer and the buyer is just sitting there saying, Look, I understand, you've told me everything, you've been very helpful, but you know, I'm being asked to make a, you know, millions, or 10s of millions of dollars bet on you that your memory is perfect. So I'm sorry, we have to go through this. And then the seller finds out, you know, when they because they're not used to this process is once they go through that old thing, their attorney system down and talks to him about indemnification. That's that whole clawback issue. And the sellers reaction is, wait a minute. So I've told you everything. And even if you miss something, I'm still on the hook. Wait a minute. And so there's this distrust that happens, and it's just a dynamic that goes through. And unfortunately, you know, if circumstances are the way they are, you've got sellers cornered, and they're going to reluctantly move forward, and they're gonna lose a lot of sleep. And hopefully the deal goes through and nothing happens. And, you know, they they move forward. Well, you got reps and warranties comes in. And that's just taken away from the two parties. And I can tell you, I mean, this is what's been great about having this TLP for smaller deals. The very first policy that CFC wrote is one that we were very proud that we reached out to, but yet a SaaS company $5 billion enterprise value, okay. The buyer was a portfolio company, a very, very sizable bank, and the bank wanted had within the provisions, they said, look, it's a SaaS company. If there's any intellectual property breaches, we want to retain full control, we're going to use our attorneys to fight anything like that. Now, this bank had very expensive attorneys and the sellers were looking at that and saying, wait a minute, you can expand up to the full purchase price on your attorneys that are going to be very expensive, and we're on the hook for it, we can lose the whole $5 million. Absolutely not deal died right there. Right right there at that point, because the bank wasn't going to back down. And the sellers were, quite frankly, like, we're not writing a blank check for you guys. Okay, within a day, they had heard about us with the TLP reached out said is this possible, we were able within a couple of days, to ensure the full $5 million value of the SAS, we put in a provision that it was simple, the bank had full authority to use whatever attorney they want, they could incur whatever legal costs up to the policy limit, which was $5 million. And they were set all of a sudden seller, the worst, they were going to lose this $50,000 That was the deductible that was okay, move forward on the deal and got it taken care. And those are the types of cases that we really like because we want to come in where a seller is very vulnerable, and they've got nothing to hide, but they need to get this and the buyer has a legit concern, and they want to hedge their risk. And so how can we bring that product for both of them. And that's what TLPE does.
Ronald Skelton 23:04
I've actually had a personal case where we made an offer and one of the things we'd like to put in our offers when there's when the due diligence was okay. But there's still like there's some unknown things is we give a 45 day walk back clause where we can walk back the whole process and hand your company back in 45 days. And I've had some huge pushback from companies where we were looking at it, we sat down, we made them the offer. And you know, this one of them was kind of a turnaround deal. We it was a very low offer, we just pretty much offered to take over the huge debt they had. And nothing huge, and it was 4 million bucks. So they were close to $4 million in debt, we were going to take that over and take a company that was there trying to shut down and bring it back to life. And the thing that they bought them more was wasn't the kind of dollar down deal, or we're taking $1 down, take your business and pay your debt off over the next three years. That didn't worry them as much as what do you mean, you can give it back to me in the next 45 days? Right? Yeah, it was with and I know this wouldn't apply to that just because of the like I said, everything wasn't cleaned as well, we had to make that offer. But there's a lot of cases out there where, you know, the buyer has some gut feeling that there needs to be that clawback that needs to be some type of and I can't even say the word that I didn't the fee. Yeah,
Patrick Stroth 24:21
It's part of our daily lexicon.
Ronald Skelton 24:26
So there's there, you know, there's gonna be times where that's just like, there's natural, natural pushback, I can see a huge wind for this. And when we were talking on the phone before the show, I had heard of the R NW or the risk, you know, rep and warranty, rep and warranties that for the big deals, and I just never heard that there was anything for the smaller deals. Like do you have examples of other like other examples you mentioned earlier, like the SAAS company, what are some other deals where that's actually it helped the deal get done?
Patrick Stroth 25:01
Yeah, I think I mean, we we have one right now where we had a situation where it was another technology company, but yeah, to have husband and wife or divorce. And so they want to be able to split the proceeds from the sale of the business and then move on with their lives. And so, again, this is another one of those situations where it was unique. It was under $10 million. And then went forward, we just just this week, a wholesale performance glove company, they they distribute high performance gloves for the outdoors. There, they got purchased by sporting goods. Sporting Goods apparel company, okay. $1.4 million. I mean, small deal. Okay. We were able and the concern, there was just, you know, there's going to be a whole back of 10%. So it's $140,000. Is there anything we can do on a deal that that's not that size, and so we came in, we looked at it, we could ensure the full purchase price, $1.4 million, cost $20,000. That was the premium. Okay, we can talk about pricing later. But for 20 grand, that pullback went from 140,000 to 14,000. That was the deductible policy attaches right over that. And the buyer just said, Look, you know, I'd love to work with you seller, and it's not that we're afraid of it just the way we do things. We have to have this whole back. Okay, well, once that whole whole back got covered with the insurance, they were fine. I can another you know, consumer electronics company is on on the table this week, $6 million purchase price, and they they don't want the whole back of 600,000. Okay, bring in a policy, that's maybe a little over 65 $70,000. But their whole bag goes from, you know, they go from collecting 5.4 million and closing to 5.9 million at closing. I mean, it's pretty good. And so those are the types of things that are out there. Okay. And I guess if you were to ask, okay, well, what kinds of companies are eligible for this? Okay.
Criteria for TLP enterprise value has to be under $20 million. Okay, originally was under 10 million, we, you know, modified it a bit, but it's got to be under 20 million, just because the underwriters figured the complexity level accelerates exponentially above that threshold. So, under $20 million. We're looking for mainstream types of businesses, these are light manufacturers, light technology, retail, hospitality, restaurants, franchise, you know, all those types of businesses, you see business services that are, you know, on Main Street, those are the types of companies that are being sought. There are other companies that insurance agencies can be purchased. And covered under this light. We mentioned light manufacturing, having a manufacturing just the environmental is too big, pretty much the only things that TLP can't accept are highly regulated businesses and larger deals. Okay, so anything in the energy sector healthcare sector, where you got a lot of regulatory banking, those unfortunately, are not available that leaves the field is wide open out there. Okay. And, you know, the two most common questions I get, number one, how much does it cost? Okay. TLP and rep and warranty premiums are priced based on not the size of the deal, but they're priced based on how much insurance do you get? Okay, usually, the minimum limit on traditional rep and warranty is a $5 million limit policy carry, you know, parties are usually looking for anywhere from 10 to 20% of the enterprise value for buying insurance there on TLP. They can go all the way up to $10 million in limits to match whatever the enterprise value. Okay, so, unfortunately, you can't insure a $5 million company for 10 million, but you can't get the 5 million or if you know the party, you say look, we got a million dollar hold back, okay, we just write the the million dollar limit, do it that way, okay. The premiums are running between now 10 to $20,000 per million in coverage, okay. So, you can have a policy now, the absolute bottom rate is $15,000. So, the minimum premium is 15,000. But then it goes from there to 10 to 20,000 per mil in limits that that are needed, the deductible is 1% of the enterprise value, so you'll have that deductible in there and there is no underwriting fee. So I mean, the expenses of this are very, very low. The second most common question I get is okay, well then who pays? And as all things are emerged as an acquisition shins, whoever has leveraged in the deal pays, okay? With TLP, it is a sell side policy, the seller is the policy holder. So very often the seller will be funding this thing, the buyer just says, Look, you're either gonna go with a traditional 10% Hold back or you get the policy, okay at your expense. We are seeing many, many cases where buyers are very cooperative with with their counterparties. And they have agreed in the last two deals, I've had the two parties split the cost evenly. So whoever whoever pays does not matter, it gets paid at closing, and and goes goes through that process. But again, when you get into reps and warranties on the traditional side, you're looking at minimum premiums of 250 $300,000 plus underwriting fee plus taxes, plus, plus plus. This is a great again, elegant, ideal alternative that's now available in the law. I call now the micromarket.
Ronald Skelton 31:01
So inside of these policies, what's covered and what's not covered? I mean, what exactly is insured in this structure?
Patrick Stroth 31:08
That's actually a basic question, everybody, you know, wonders on that, okay? The, the TLP policy, we're just going to say a TLP, or DLP policies are triggered when the seller receives a demand from the buyer saying, there is a breach we have suffered financially, it doesn't even have to be a breach of the reps, it can just, you misrepresented to me that x, y, z, it was accurate, okay, we suffered a loss we are now looking to you to collect. Okay, so the scope of the policy is usually just within those reps and warranties, and the policy gets brought. So those are fundamental reps on ownership, and financial reps, tax reps, operational reps, if you you know, we've had cases where the, the seller forgot to disclose to the buyer that a bunch of their equipment was leased. Okay. And so, you know, the question just didn't come up. And that can happen a lot. He's fast moving deals, and the buyer brought an action because they lost $50,000 of value because of those lease agreements, policy paid. So there are those things that we're looking for as these are demands from the buyer against the seller, that's what's covered. What's a little bit easier, and gives gives us a little bit more credibility, on insurance policies, what's not covered? Okay, first of all, if there's anything known, that the seller knows about is not going to be covered, the seller is aware that they're about to get audited, not covered, if the seller is aware that well, we've got some problems and, you know, this little corner, you know, if you know about if it's been disclosed, it's not covered. Okay. And that's going to be true of every insurance policy out there. With TLP, which is unique, unique from other things, is that financial reps, if, and most companies in the TLP range are not audited, okay. If however, they represent to the buyer that their financials are GAAP, they're in accordance with GAAP standards, okay? If they're not audited, that's not a legit rep, because you are not a GAAP standards if you're not audited, okay. So, any kind of representation to GAAP standards is not going to be covered. Okay? If there are the TPP, loan issues things, those areas, underwriters are not liking those condition of assets is another big limitation on the coverage. Okay? This policy is not here to be the warranty policy. So if you're selling your equipment and the equipment or the inventory isn't up to whatever you represent it in the value is actually less, it's not going to cover that. Okay. And then finally, exposures that are better insured elsewhere, okay. Specifically, we're going to look at things like cyber liability if there was a cyber breach or whatever, okay, that is insurable through a cyber policy is separate, okay, if there's an environmental issue, or some other kind of exposure that is covered by a regular commercial policy, those aren't going to be covered by TLP. TLP will then take take on any of these unknowns that'll pop up,
Ronald Skelton 34:30
post closing. So it sounds like you'd pair this with some type of general liability policy.
Patrick Stroth 34:36
What you would look at that I think that that happens if you are a professional service, for example. They have types of policies that are called claims made policies. You would buy a tail that would extend the policy reporting period for a claim for years post closing, that's routine, this policy would go parallel with that and go that way and then other trips and falls if If something happened pre closing, that's gonna be on the on one policy that happens post closing, that gets picked up on TLP.
Ronald Skelton 35:08
And then we've talked quite a bit about, like, you know, these policies are equated on the value of the company, is that the valuation like what we're paying for it? Sometimes that's three times the sellers discretionary earnings? Or is that like, what, what number are you working off of when you say the value of a company,
Patrick Stroth 35:26
So we're gonna work on whatever the cash purchase price is at closing. So we're not multiples or anything. I mean, if there's a multiple, but the number comes out at like, for example, the the consumer electronics deal $6 million deal. They also have a number of earn outs and other post closing bonuses out there for up to another 6 million. That's not insurable. We're just looking at the six. Okay, it's the cash is that's being paid at closing, however that's valued. There will be as you get into other types of rep and warranty policies, they do look at, okay, well, what what's your multiple if the market multiple is, you know, 10 times EBITDA? And you're paying 40 times EBITDA? Okay, what's going on here? Okay, those are those conversations on the TLPE side, it's straightforward.
Ronald Skelton 36:15
Okay. Let's talk about uh, you know, we've, we've reached out to you, we're thinking about, you know, buying a business or something like that. How, what's the what's that?
Patrick Stroth 36:30
Is it the process you're asking about?
Ronald Skelton 36:32
Yeah, like, what's, what's the process here? Like, if I, if I'm reaching out to a business, and I see like, you know, what, I just kind of want something there to ensure that this is right. Can the seller you know, or the sorry, the buyer, is to get that conversation with you guys and get the seller involved or that normally, the seller coming to you guys,
Patrick Stroth 36:50
ideally, the seller is going to come to us, however, the buyer can come and say, Look, we have this target, and we're aware of it, as a seller may not be aware of we're aware of this, you know, can you help, we have a straightforward application. That the seller, we need the seller to fill out, the buyer could try filling out but I mean, like I said, the seller is going to know this stuff. So and there are, you know, disclosures in the application, do you know of any past lawsuits or anything like that best out the seller do that. So we would get the application, we get a copy of the letter of intent, if we can't, if you get the purchase and sale agreement, that's great. But letter of intent, it's helpful, we need the current financial statements balance sheet and income statement. From there, that's essentially all underwriters need, when we when we can establish what NAICS class code industry code is for the business, we can then go ahead and rate it up takes, like I said, a day, maybe to put out a proposal, if you want, you got a $5 million company or, you know, here's, here's what a $5 million payment policy costs. That's pretty much it, you get the proposal setup. And then we wait till closing, we will have a draft of the policy prepared. And all the seller has to do is they have to sign the warranty statement within the draft policy that we give at the closing, when the you know, all the documents are there, we give you from the document package a draft copy of the policy, they just have to sign that as of closing there, you know, everything on the application is accurate, there are no changes. And they don't know of any claim, they sign on that we get we get paid at at the closing right there and move forward. The underwriters will get a copy of the policy, we'd like an index of the data room, if they've got a data room just we don't need to copy the data, we just want their index of the data room, and then a copy of the sign person sell agreement, you know, you know, post closing, when we get those items, policies in force goes forward, the question comes out, well, how long is the policy? Do we have to keep doing this? We renew it or anything, no policy. The length of the policy matches whatever the survival rate of the agreement has. So if you've got fundamental reps that are six years in survivability policy matches that if you've got specific general reps, you know, for intellectual property or things like that, that are maybe 18 months or three years, policy matches those as well. There's no difference in price is just the policy is designed to match the agreement terms and so we get it set up that way. And so it's a one time deal. And as I said with the with his glove manufacturer, we did that deal in literally two business days. The the original SAS company I did for $5 million. We turned to turn that around two days. It actually took the bank longer to redraw all the documents to have that ready. And then we just go ahead and just we do ask that when the documents get signed, they get signed to closing, don't sign the documents pre closing because then if anything is delayed, the policy is triggered at closing. And it happens all the time that something gets delayed. A couple of days we actually had a deal that was delayed just because the seller will the buyers. They did not want to be purchasing something on April Fool's Day. And so they said, I noticed Friday, no, no, we're gonna move it up. I don't care. I just don't want to be on record that we bought this on April 1. People can be superstitious that happens.
Ronald Skelton 40:33
And they'll say no, it's bad luck to be superstitious. Yeah. Yeah. So, you know, I'm a big fan of the marketing. And I've got a marketing MBA and commercials in general, there's a famous, fairly common insurance commercial authors, as we know, a few things, we've seen a few things. What kind of claims have you seen inside of this? Are there any click? Like, okay, we paid that, you know, just kind of interesting, standout type of claims that were paid, just because that, you know, it fell within this policy.
Patrick Stroth 41:02
Yeah, well, fortunately, TLPE has only been out it just launched on July 1 2021. So it hasn't been, it hasn't been around long enough to have a string of claims we do, we actually do have a couple of losses that have been paid. And you had one was a chain of Mexican restaurants. And it was an issue on the equipment lease. And so the seller failed to disclose to the buyer that there was an equipment lease out there. And so the buyer incurred additional expenses above and beyond policy, investigated that and and paid the paid the claim, here's a great benefit. There was another with the same deal had a second claim, actually. But here's the issue with a seller policy is that the policy is written where the underwriters are providing not just the money to settle a claim with the buyer. But you don't just go and respond to the buyer who's probably bringing their attorney over to bring an action against you. You don't go against an attorney with a non attorney. So what the underwriters do in this program is they provide legal defense to respond to the buyer, they're not going to sit there and just write a blank check. They're going to sit there with the buyer and work out a settlement and try to get it as low as possible in in favor of in favor of the seller so that they don't incur too much of a risk. And again, you may have a small deductible, but if the policy can be the deal can be settled below the deductible. Wouldn't that be nice. And so in addition to the the least equipment issue, there was an employment violation that the restaurant chain had been allegedly using underage employees and working them longer hours and then was allowed by the state. This is a this is a chain based in the state of Texas. And so the Texas workers Bureau brought what was it a violation notice, which total about $450,000 in fines. The policy provided the legal defense to respond to that regulatory board because it was actually the buyer would be on the hook for this. And so buyer notify the seller, seller goes and gets the insurance to come in and the attorneys for CFC under the policy went negotiated with a workers, the workers bureau in Texas, they reduced the penalties, negotiated settlement and then paid the settlement. Okay, wasn't disclosed. But I mean, it was the original demand is $450,000. So they have been there and stepped up and-
Ronald Skelton 43:45
You said something really important in there and it's split second I want my audience to get. The buyer would have been liable for those violations. A lot of people think that they do asset purchase like an invoice purchase and stuff like that is severs all and a new LLC and severs all liability. And I think yeah, unless you're dealing with government agencies, state agencies federal like EPA, because they're going to hold the new buyer accountable no matter what you did, right. So yeah,
Patrick Stroth 44:13
yeah. Let's step back a little bit just on claims reps and warranties in general because here's it's a great point on why these products is so successful. Okay. The buyers of rep and warranty policies are repeat buyers, okay? You know, private equity and you know, other other serial acquirers are strategic and they're buying many, many companies. Okay. So what the underwriters did through the whole process is they're going through vetting particularly in a traditional rep and warranty. They're going through looking at all the diligence reports, they are having an underwriting call with the buyers to say did you look at this, did you look at that and they check off the boxes and everything. So essentially underwriters and the reco and the deal parties are in the same virtual room together as they negotiate. And so unlike other insurance policies, there's really no gray area on what's covered what's not covered. Okay? It's a little different with TLP. But it's still there's this rigor that's out there that the underwriters are really looking at these deals very closely. So as difficult for the insurance industry is sit there. And when a claim comes in, just say, You know what, I don't think that I don't think that qualifies as a loss. I think we're going to we're not going to cover that. Okay. Any insurance carrier in the rep and warranty market that denies and or is at least reluctant to pay a claim? They're toast, I mean, the marketplace will turn their back immediately. So policyholders have tremendous leverage over over the insurance industry, in reps and warranties. And quite frankly, the underwriters in reps and warranties, and I've spoken to many of them, they really want to get these things, right. They appreciate all the business they're getting, these are very profitable programs. And if they get the information from their policyholder on a claim, and if it makes sense, they're going to pay it, they you know, because it is not just the right thing to do, but it's just great business for them. And then you know, you've got to you've got a client for life on other things. So, CFC, I mentioned that the paper behind the underwriting facility behind TLP has been a traditional rep and warranty, insurance market for years, they've paid loss of losses, they know the value of the relationship with the policyholder, and it's never more important than at the time of the loss. And so, you know, they will keep promises made. And I'm very in the insurance industry. I'm very, very proud about that.
Ronald Skelton 46:42
Awesome. Let's take a step back. And let's look at what type of deals you know, this isn't necessarily for, you know, your your mom and pop operator by another pop and pop operator, this is for which I guess it could be in some cases, what? What type of deals are is our NW insurance? Or you know, in this case, the what do you call it it? To me? Yeah, DLP? T TLP. Insurance? What is it? When should a buyer or seller approach it? What kind of deals is this best for? Is there's, there's,
Patrick Stroth 47:16
yeah, I honestly, I hate to say, well, we're open for everything. But I would say, you know, if there's a question I reach out to us, but again, are we are looking at purchases of Main Street business that are valued at 20 million and less. There are financial statements. And again, if there's a challenge, if it's a if it's a, you know, adverse sale where, you know, companies on the verge of bankruptcy or something like that, there could be some some limitations there, you know, in that element, but if you've got a solid company, I mean, we're looking at HVAC contractors, we're looking at companies are rolling up landscaping companies that are for a million dollars. Okay. All the way up through tech. Like I said, you other than the regulatory businesses, I think if you're targeting a company, and we're seeing this now where I mean, I, you know, funeral homes, bars, restaurants, other types of hospitality, you know, the retail, clothing, retail, other consumer goods, all those types of companies, if it's under 20 million in enterprise value, and they need insurance up to $10 million. Absolutely. Give us give us a look. And you know, we put together an application and it moves very quickly.
Ronald Skelton 48:38
Awesome. We're about 15 minutes and I want to make sure people know how to reach them. I'll put this up on the screen. And make sure to take a quick look at that. Actually, I probably I see I got a double thing. Let me fix something real quick.
Patrick Stroth 48:53
Yeah, and my name is pronounced Stroth like growth. But if you look me up in it is Patrick Stroth. I'm not I'm on LinkedIn, which is great. You also can get my on my on my email, which is my first initial last name at Rubicon, I-N-S short for insurance of Rubicon, ins.com. drop me an email we can meet like, our team can come out there send you the application and just a checklist. We've got an I have a lot of buyers will come to us and just in we have a target. Do you have any material or any information we can share? We've got a brochure we have a case study where we talked about that SaaS company as a matter of fact, we're going to be adding more case studies coming up. But we will provide that over to you and and you know, I'm always available to get on a call with with parties and just talk them through the process and just what it is what's covered what's what's not. And I like I said, this is a new experience for a lot of people. And so we understand that. The other thing that's important though, is you know, my why in being involved in mergers and acquisitions is that I have tremendous respect for entrepreneurs, people that, you know, created tremendous value where nothing before existed, and to do anything to help them out as a transition to their next chapter, you know, who wouldn't want to be a contributor in that way? And this is the way that we can do this. And some of these are, you know, life changing events. And how can we ensure that this life changing event gets through successfully, without all the wear and tear emotionally, that's going to happen, because these are big, stressful times. And you know, we want to be that voice a common helping you move that risk away.
Ronald Skelton 50:42
So just to make sure we just know this in, if if somebody were to take, let's say, two topics, two items from the show today, and they listened to all thing and all they really grasped was two things, what would you want them to walk away with? What did you want the the audience to say, if you don't remember anything else, remember these two things,
Patrick Stroth 51:01
I would say that if, if you're looking at it, if you're looking at a target, and as under $20 million, bring up the idea of insurance insuring that deal as as an alternative to a 10%, hold back, okay? I guarantee you, if you're the buyer, if you bring that idea to the seller, okay? They will happily pay the cost, no matter what. I mean, this is an absolute, if you're a buyer, this is at zero cost to you. Okay, if you're a seller, if you know, if you're concerned about the risk, okay? This is a great product, it is not required that the buyer accept the insurance, okay, this is to protect you, the seller. And so if you need that peace of mind, and and the buyer isn't going to cooperate, you're not relying on the buyer, this is something for you. And you know what, it doesn't hurt to ask and to take a look. I mean, we price these things out instantly. So I mean, the worst that can happen is it's just not a fit, you just won't buy it.
Ronald Skelton 52:07
That's a great concept. You just said there, like you could be the seller of a business concern that the new guy just isn't gonna do what he said he's gonna do or handle it, and they're gonna come back to you for something, right? And then the insurance policy like this can actually help alleviate that fear that if they come back for something, you disclose everything you could, like you said, this guy asked you, you know, I'm on the on the buying, and I'm this guy, this guy me asked you a million questions to start with. But if they miss something, and you fail to disclose it, this, this covers that I can see where that would be a peace of mind, for a seller, right? I think that when I said earlier in the show, when people push back that I can hand it back to you, if I find skeletons in your closet, you didn't disclose? This would be a huge win for them. Because like, look, you know, I've got this insurance policy, you don't have to bring back anything. If it's something I didn't disclose that I fell to, then, you know, they'll cover it.
Patrick Stroth 53:01
Yeah. Yeah, the two things that, you know, the parties want, first of all, they want the deal to close, okay. And deals that are insured, okay, are nine times more likely to close successfully than deals that are not insured? That comes from investment bankers, that's not from us. Okay. So everybody wants to close. And then for the sellers, quite frankly, they just, you know, what, I just want an exit, okay, I, you know, I've gone through this process I want out and, and I don't want to get pulled back. And I think the day you know, would be terrible for somebody, they go and they sell them animals and 45 days later, they get the company back. And it's like, oh, great, because that's never going to come back work more. So you want to be able to walk away. And if the both parties, there's always some risk, there's always a leap of faith on both sides. However, we can make that leap a little bit, you know, shorter. That's what we're trying to do.
Ronald Skelton 53:55
Awesome. Well, I appreciate having you here we are at the getting close to the end of the hour here. For everybody that you know, was listening, please reach out to Patrick on either LinkedIn, or I put up his website there. Also on the site, those links will be on the show notes. So take a look there. appreciate having you here. Hang out for a few seconds when we're done. And we'll wrap the show up.
Patrick Stroth 54:21
Hey Ron, thanks so much. It's great to be here. And I really appreciate the opportunity. Thank you so much.
Ronald Skelton 54:26
Awesome. Well, that's the show. Hey, it's your host, Ronald Skelton. I want to thank you personally for watching the show today and invite you to call our new hotline 918-641-4150 That's 918-641-4150 Call us and tell us about our show, ask questions, suggested guests or even tell me about a business you have for sale and we'll reach back out to you again that number is 918-641-4150 call our hotline leave us some information. Thank you see investors and entrepreneurs professional mastermind. The investors and entrepreneurs professional mastermind combines that additional peer to peer mastermind entities first in Napoleon Hill's famous book Thinking Grow Rich, with accountability partnering, where your peers help you ensure that you set goals take action and get results. If you want to scale blow past roadblocks and achieve success faster than you might think is possible. I suggest you take a visit over to tiepm.com That's T i e. P m.com. And check out the investors and entrepreneurs professional mastermind