In this final episode of Deal by Deal for 2021, Matt Heinz, Partner & Co-Practice Leader, Transaction Liability at Lockton Companies, joins the podcast to share the outlook on representations and warranties insurance.

As the fourth quarter of the year comes to a close, Matt has insights into how the robust M&A activity we’ve seen will impact the insurance market moving forward, as well as the challenges those in the industry are facing.

“We've arrived at a scenario where we have more demand than supply from the insurance market,” Matt says on this episode — referencing how demand combined with the increasing claim environment is leading to an increase in prices.

Also on this episode, a presentation excerpt from McGuireWoods Partners Greg Hawver and Jeff Brooker from the McGuireWoods Independent Sponsor Conference in October. The presentation titled, “What is Market with Respect to Independent Sponsor Deal Economics?” covers the independent sponsor survey. The excerpt in this episode covers the portion on closing and management fees.

Meet Your Hosts

Name: Gregory Hawver

Title: Partner at McGuireWoods

Specialty: Greg represents private equity and strategic clients in a wide variety of change-of-control transactions, minority equity investments, domestic and cross-border acquisitions, recapitalizations, joint ventures and corporate reorganizations, as well as advising clients on day-to-day corporate matters.

Connect: LinkedIn

Name: Rebecca Brophy 

Title: Partner at McGuireWoods

Specialty: Rebecca focuses her practice on advising private equity funds, other institutional investors, and strategic acquirers in connection with mergers and acquisitions and other complex business transactions. 

Connect: LinkedIn

Name: Jeff Brooker

Title: Partner at McGuireWoods 

Speciality: Jeff focuses his practice on advising private equity funds, venture capital funds and other institutional investors and strategic acquirers in connection with mergers and acquisitions, early- and late-stage investments, leveraged buyouts, recapitalizations, management buyouts and secondary transactions.

Connect: LinkedIn

Meet Your Guest

Name: Matthew Heinz

Title: Partner & Co-Practice Leader, Transaction Liability at Lockton Companies

Speciality: Matt’s name is synonymous with ​​transaction liability insurance for M&A professionals across the country. He has served as both an underwriter and broker during his time in the industry. Before joining Lockton, Matt served as a Senior Managing Director and Co-Practice Leader of Aon’s North American transaction liability team. 

Connect: LinkedIn

Acquired Knowledge

Top takeaways from this episode

★    An increase in demand and in claim activity has led to increased RWI prices. After more than 12 months of robust M&A activity, we’re seeing cases where insurance representation and warranties insurance market (RWI) carriers are not able to service all of the available deals in the market. Due to the increase in demand, carriers have to be more selective in the deals they want to underwrite. They are also charging more for their time.

★    While constraints due to deal caps are going away in Q1 2022, human capital constraints are not. As we move towards January 1st, those looking to structure a deal and secure RWI can look forward to any cap constraints being removed once we hit the new year. However, Matt explains that there will still be a constraint on the human capital available to underwrite and structure RWI meaning some of the current crunch we’re seeing in the market will continue into the new year.

★    Fees are unlikely to go down in 2022. The general sense is that while fees might stabilize in 2022 they are not going to go back down to the sub 3% fees seen previously in the industry. The prediction is that RWI fees will stabilize around the 3 to 4% range for the foreseeable future.

Episode Insights

[05:45] High demand: Matt shares how a hot insurance market and an increase in claims is pushing RWI prices up while insurance carriers also get to be more selective in the deals they underwrite.

[06:08]: The insurance market is getting more challenging: Today it is more difficult to get deals below 50-75 million in enterprise value, particularly if they are lacking audited financials. However, Matt notes that he believes reports of the M&A and RWI markets shutting down for Q4 are somewhat exaggerated.

[08:25] Carriers may be restricted by limit caps: Matt explains that insurance carriers may have a premium cap that when reached causes them to limit the new deals they take on as they manage their exposure in a particular market or industry. Not all larger carriers will have these same reinsurance restrictions.

[10:48] RWI premiums have increased: Looking at inclusive amounts for insurance including the premium, taxes, underwriting fees, and broker fees (if applicable), the rate has traditionally been 3-4% of the limit of liability assuming a policy equal to 10% of the enterprise value on a deal. Today this price has increased about a hundred basis points up to around 4 to 5%

[11:39] Underlying cyber insurance is crucial: Matt says RWI carriers do not want to take on all of the cyber exposure and carriers are now more careful about ensuring companies have existing cyber insurance in place at an adequate limit.

[15:28] Reps are no longer purely seller friendly provisions: Matt explains that claim activity for carriers around contract reps have caused them to re-look at how reps are written so they are no longer as seller-friendly as they were a year ago.

[17:44] Start early on challenging deals: Matt says that if you have a potentially challenging deal, including those in the $50-75 million range it’s important to line up RWI well in advance of your signing date and to make sure you have a well connected broker.

[20:39] Human capital constraints aren’t going away: While the capacity constraints Matt referenced earlier in the episode will be lifted in January 2022, the human capital issue and need for more experienced professionals working on these deals will continue to be a concern.

[24:24] Consult with an attorney on closing fees: Jeff notes that there are many different ways to structure closing fees and each comes with a different risk so you need to review what works best for you and your comfort level before making a decision.

[25:34] Closing cost calculus: Jeff says that the majority of closing fees are calculated based on the aggregate enterprise value of the deal, if the deal is valued at 50 million, then that is what the calculation is based on.

[27:17] Closing fees: Greg shares that according to their survey results, in the majority of deals, there are no fees paid to the equity capital partner. Sometimes, PE firms are an exception.

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

You are listening to Deal-by-Deal, a McGuireWoods independent sponsor podcast. Deal-by-Deal invites you to conversations with experienced independent sponsors and other private equity professionals. Join McGuireWoods partners Greg Hawver, Jeff Brooker and Rebecca Brophy, as they explore middle market private equity M&A, to provide you with timely insights and relevant takeaways.

Hi, this is Greg Hawver and welcome to what we expect to be the final episode of Deal-by-Deal for 2021. Glad that people could tune in. I know that everyone is very busy with the end of the year closing, and mad rush in general, so we will jump right into the content. Excited for this month's episode.

To start off, we have Matt Heinz of Lockton joining us, and he is in the transactional group there. He's going to chat with us about rep and warranty insurance. If you're looking at placing RWI during this final stretch of the year, he's got some words of wisdom on that front because it can be a challenge, and also has a look ahead of what 2022 and beyond may look like for rep and warranty insurance. So very interesting interview with one of the most active people in the space. Very excited.

After that, we're going to feature an excerpt from our independent sponsor conference in Dallas from late October. It was a huge success, the conference. We had around 900 attendees, capital providers, independent sponsors. One of the highlights I've heard from others was a presentation that Jeff Brooker and myself gave on "What is Market with Respect to Independent Sponsor Deal Economics?" During that presentation, we walked through all stages of the independent sponsor survey that we took. Lots of interesting data points. What we're going to post for this podcast episode is an excerpt where we focus on closing fees and management fees. So we thought this audience would find that interesting.

If you have more questions about that survey podcast... The audience obviously won't be able to see the survey presented, but if you have questions, contact myself or Jeff Brooker or any other McGuireWoods lawyer.

So with that, we'll jump right in and happy holidays and happy new year to everyone. Thanks.

For our next segment here, we're happy to have Matt Hines of Lockton on. Matt is the partner and the co practice leader of the transaction liability group at Lockton. Matt, welcome. Do you want to say a little bit about yourself and about your practice?

Yeah. So thanks for having me today. My name's Matt Heinz. I am a recovering M&A lawyer, practiced for about five years of Proskauer back in the early 2000s. Underwrote rep warranty insurance, tax insurance for a few years at AIG, and have been now broking rep warranty tax insurance for just about 12 years.

We have a practice group here at Lockton. Ultimately, what we're trying to do is help our clients allocate risk out of M&A transactions into the insurance market to achieve some efficiency, to achieve some overall yield benefit by using insurance in lieu of a traditional indemnity or escrow structure. We've got about 12 people, several, again, former M&A lawyers, are also recovering M&A lawyers, tax lawyers on staff. It's a thriving practice. Very, very proud of what we've accomplished. And we're very, very busy, as is everybody else in the M&A market right now.

That's fantastic, and I'll say that we've worked with the Lockton team on lots of deals, and you guys do a fantastic job.

So again, thanks for joining us. Wanted to have you on, Matt, because it's an interesting time right now in the M&A market. We're recording this in November 2021 and everyone is in the throes of the fourth quarter, kind of a deal frenzy right now, to get deals closed by the end of the year. And a question that we get a lot and we've been struggling with and working with clients a lot on is what is the RWI market doing at the end of the year? Is it possible to get insurance for a year-end deal closing and realizing that in mid-November the ship has probably sailed on many deals. But could you just sort of take us through, maybe at a high level, the changes that you're seeing from the typical RWI process and terms, call it over the last two years, versus what you're seeing for call it Q4, 2021 deals, and what are kind of the underlying dynamics in those?

Sure. So we're in a very interesting market here in Q4. We've now seen probably 12 to 14 months of the most robust M&A activity that most of us in the M&A world have seen in our careers, as well as a developing and maturing insurance market. When it comes to claims experience, knowledge of claims and how claims are ultimately adjusted in the rep warranty insurance market. So a combination of carriers claim experience, plus the volume that we're seeing and the volume is leading to bandwidth issues and human capital issues at our carriers. There's just a circumstance where they're just not able to service all of the deals that we're seeing.

We've kind of arrived at a scenario we've got more demand than there is supply from the insurance market. Again, coupled with this increasing claim environment that the carriers are seeing, and it's led to an increase in prices. I mean, when you put those two things together, what you wind up with is carriers being a little bit more selective in the deals that they want to underwrite, and also charging a little bit more ultimately for their time.

Certainly does not mean that the market is shut down. We're still getting deals done every day. We're getting deals done across the spectrum, all sectors. Some sectors are more challenging, some deal sizes are more challenging. I would say that deals below 75 or say 50 million in enterprise value lacking audited financials are particularly challenging to get done right now. Not impossible, but particularly challenging to get done right now. So we have seen reports about the M&A insurance market, the rep warranty insurance market, sort of shutting down for Q4, and I think those reports have been somewhat exaggerated. But it's certainly a more challenging market than it was 18 months ago. No doubt about that whatsoever.

Great. That's super interesting. And I want to come back to the deals in the sub-75 million range because I know that that our audience will have an interest in those deals. But just drilling down a little bit further. I had heard, and this may not be accurate, that the insurers taken as a whole market have a set level or a target level of insurance they want to write for each year, and that because of the M&A deal activity in 2021, they reached that target level in the aggregate earlier this year and so the supply has tightened up. But then in 2021, those sort of targets will reset, and we might see an opening up of the market. Speak to that because I'm sure I don't have the hundred percent under understanding of it.

I would say it's not exactly that. So it's not that carriers have a set amount of limit that they want to put out there or a set amount of premium that they want to bring in. There are, though, guidelines that the carriers work within based on reinsurance arrangements, based on access to the Lloyd's market. And so for several carriers, is there some combination of either a premium cap, when they hit a certain level of premium underwritten within a year they're backing reinsures or they're backing capacity, we'll say that's enough. For right now, we're trying to manage our book, we're trying to manage our exposure across many different lines and this is the amount of exposure we want to this particular market. And others have a limit caps where again, they say we don't want to do more or expose ourselves more than X limit.

So I think it's less that they want to do a certain number of deals or write a certain amount of business. I think they try to manage their book and manage their exposure in the context of their overall portfolio so they're not getting over exposed to any particular product line.

Now, not all carriers have that sort of limitation. I mean, we deal with several carriers. Some larger carriers who don't have those sort of reinsurance restrictions. Some of the MGUs, or managing general underwriters, with whom we work don't have those restrictions from their backing carriers. So it's a little bit of a mix, but there is certainly a subset of the market that is constrained like that. And so what that results in is reduced competition, right? Reduced supply on the carrier side, and that does have an impact on the overall marketplace.

I would say that the one area or the one sector where these restrictions have been most is healthcare. You know, our ability to get deals done with filling in coding regulatory reps and warranties on them is definitely constrained right now. There's always a subset of carriers, smaller subset of carriers, that can handle that kind of business and underwrite that kind of business? In this current market, several of those carriers who are capable of underwriting that business have hit those kind of caps, right? And so you've already got a smaller pool, and that pool has been somewhat diminished by these reinsurance guidelines.

Very interesting and really good to hear it straight from an expert as opposed to a telephone game among lawyers to hear the exact dynamics of what's causing a tightening here. Super interesting.

Even within healthcare it's not as though that market is completely dead. It's just far more challenging, and that's where you see lack of supply leading to really noticeable rate inflation, the kind of market where you have to call somebody up and say, "At this particular deal, do you think you can handle it? How much capacity you have left this year?" That kind of thing whereas normally, again, we get four to five quotes on a particular deal, now we may be lucky to scratch out one quote and it takes quite a bit of scratching, calling to get that done.

So when you're thinking about the deal terms that are becoming tougher, is it primarily the amount of the premium? And can you talk about what were the average premiums before versus what are they in Q4? And then what are the other tough deal terms, exclusions and any other pressure points?

Yeah. We generally advise clients on total costs when it comes to warranty placements so inclusive of all amounts. So premium, taxes, underwriting fees, if there's broker fee involved, bake that in there. That amount's the all in cost. It was sitting somewhere between three to 4% rate online, meaning three to 4% of the limit of liability that was being purchased assuming we were buying a limit or an insurance policy equal to 10% of the enterprise value on a given deal. So for a long time, we were sitting in that three to 4% rate online range. Nowadays we're easily a hundred basis points higher than that, if not 150 basis points higher than that? We're typically advising clients assume four to 5%, if not 4.5 To 5%, on the total cost basis with those same metrics. So assuming we're covering 10% of enterprise value on your average mid-market M&A transaction.

In terms of other responses from the insurance marketplace, I would say as a general rule carriers in the rep warranty world are sort of paying more deference to underlying insurance, business insurance that that should be in place. The most noticeable is certainly cyber insurance. The insurance industry writ large has had I think a checkered performance when it comes to cyber insurance, meaning that the insurers I think paid out quite a bit of money on claims in the cyber space, and I think rep warranty carriers are cautious not to become de facto primary cyber carriers based on a very, very broad cyber or IPIT type of rep in a merger agreement or in a stock purchase agreement. So what they're saying is, we'll cover the cyber exposure, but only excess of underlying cyber insurance that should be in place, and it should be in place at an adequate limit.

Interesting, interesting. And are you seeing anything specific as far as pushback on exclusions, and I've recently seen a more aggressive pushback on synthetic changes to a purchase agreement that are baked into the policy. Any changes or developments on that front?

Sure. I think that's an interesting one, right? Because for a long time we would get quotes that simply had no modifications to the rep warranty package whatsoever. I actually have some sympathy for the carriers on this one, because I think that sellers' indemnity obligations have been diminished over time as rep warranty insurance has become more ubiquitous. I think sellers have, again, in general become far more amenable to a broader set of reps than they were when they were standing behind a 10% of enterprise value indemnity cap with an escrow tied to that. So I think the general rule rep packages have gotten quite a bit broader than they were five or six years ago on non-insured deals.

As a result, carriers are looking at those rep packages and saying, and again, most of the, the underwriters are former M&A lawyers themselves. They're saying we're still happy to cover a buyer-friendly set of reps, which is what we've always done, but we're going to cut back on some of the more forward-looking stuff, we're going to cut back on some of the more really broad language around facts and circumstances, and that may or may not have occurred that kind of thing, and try to limit reps to something more precise that a seller probably would negotiate if they were actually standing behind them [inaudible 00:14:04].

I hear you. And for our audience's reference, the dynamic here is you have a purchase agreement that's negotiated between the buyer and the seller, and to Matt's point, at times it can be somewhat seller friendly if RWI is in play. And then so the insurer will, in the policy, say not withstanding what's in this purchase agreement you need to add an XYZ word to this rep and this rep. Based on my experience, that used to be a year or two ago, those synthetic edits were really for almost misses by the parties or really seller-friendly overreaches and kind of forward-looking statements that were in the reps. And now recently I'm seeing they're almost kind of jump ball provisions that arms' length buyers and sellers may have come out one way or another, but again, kind of jump balls. And the insurers are saying, no, we want that to be on the buyer friendly side of that jump ball.

Yeah. I think we're seeing that pendulum swinging in real time. I think six months ago, we probably saw a more aggressive set of comments from those carriers than we're seeing right now, even though we're still in the midst of a hard market as we call it, again, and where carriers are trying to reset on some of the stuff that they've given in the past. As a general rule I think you're right. We really shouldn't be sort of falling out where on the jump ball provision, the carriers are modifying the reps so that it's a very, very seller friendly sort of rep at the end of the day? But some of this is also informed by claim activity, right? I mean, so the carriers have seen a lot of claims around material contract reps in particular, and some material contract either being canceled or terminated, or modified and not scheduled and not notified to the buyer pre-closing, and all of a sudden you've got either a recurring expense that's been increased or a recurring line of revenue that's been decreased.

As a result of that, folks are making claims on a [diminution 00:16:06] in value basis and saying that this impacts the EBITDA upon which I base my pricing multiple as such, and this is not just a direct loss of X dollars. It's those dollars that we can actually calculate, times the multiple that I paid for this business, and so they've seen some very, very chunky claims on those in particular.

So this all leads to a material contract rep seeing modifications where written notice is the standard that they want to see for a change to a contract, as opposed to just a notice standard or some sort of limitation on notice, that kind of thing.

That's a fair point, and I have some sympathy there. Even though on this podcast, whether our listeners or buyers or sellers, we simply don't have sympathy for the insurers, but I hear you on that point. So to wrap things up, I want to cover a couple final points though. So you mentioned as we're sitting here in November in a white hot market, deals that are under 75 million to 50 million are particularly challenging to bind RWI coverage. What would be some tips for people that are transacting in deal size space as they try to look to RWI?

I would say to get out early on those, and this is a very, very self-serving statement, but make sure you've got a broker that's got some pull in the, in the insurance market if you do need to get that done, and who's got some ability to talk to a carrier and make a phone call and say, "I really need help on the deal. It's a very good client, and I think this is a good one for you." Ultimately, that sort of thing actually is important because of the volume that we've seen.

I think there are some carriers that are limiting their responses to some of the distribution channels, namely brokers that are producing quite a bit more business for them. And again, it's a supply and demand thing. It's not to disparage anybody or anybody's practice, but they only have so many hours in the day to respond and so they're limiting their responses to the folks that you ultimately bring them the most business. So I would say, get out of it well in advance of your signing date, make sure you've got somebody on the scene who does this every day, who actually does rep warranty insurance for a living.

If it is a deal that does not feature audited financials, again, going to be much more challenging. You're just going to have a [inaudible 00:18:22]. You're probably not going to get away with some sort of internal diligence on a non-audited financial target. Those are really, I think, the key points. Again, it's not a dead market by any stretch of the imagination, but it's taking a little bit more time and it's taking a little bit more effort to get some deals done, particularly in that size range.

That makes sense. And I'll echo your sentiment so it's not, quote, self-serving. I think that for our listeners who are doing deal by deal economics, being able to leverage a broker that is a major player in the space, such as Lockton, and there are a couple others. But there's a handful of major players in the RWI space and there's a lot of other players. So totally agree with you there.

As a final question, as you look to Q1, I know that a lot of us deal lawyers, as we're around the clock, have been really looking to Q1 as our light at the tunnel where things might slow up a little bit, given maybe some pressures from a tax perspective may lessen. They may not, but in any event the flip side of the coin is that may not change all that much in Q1, as far as M&A activity. I mean, there's a lot of deals that are already slipping and other than some tax pressures, we don't see a ton of other reasons that this white hot market is just going to slam the brakes on. So with that intro, what do you see ahead for Q1 and 2022 as far as RWI goes?

Yeah, I think... I was actually talking to some folks about this the other day. I tend to think personally, and this is more based on gut instinct than anything else. I mean, everything is cyclical and I do think that we're at the zenith of, as you said, a white hot market right now and I do think things will slow at some point. How slow things get and whether this is close to the new normal and what we should expect in terms of M&A activity going forward I think is the real question. I do think there was some tax concern baked into the activity that we've seen. I think some of that concern has now settled out and there's a little bit more clarity around the ongoing tax legislation that may be forthcoming.

The one thing in our market that's certainly of note is... We talked before about some premium and limit caps that folks had, or capital constraints. Those should go away January one, so we should have... The human capital issue that I mentioned earlier is not going to go away, right? There needs to be an influx of talent into the rep and warranty insurance underwriting space I think, in order for us to service our clients' needs going forward, so that issue will still be there. But in terms of capacity constraints or anything like that, that will go away as of January one for most carriers. I fully expect us to be able to service all the deals that, that come down the pike in Q1, whether we stay at this rate of activity, or actually I don't think it's a matter of weather. I think it's how long will we stay at this rate of activity into 2022 that remains to be seen. But we'll be here ready, willing, and able to service that market.

Great. And so specifically you think some of the pricing pressure and exclusion pressure is going to come off healthcare deals and also the sub 75 million deals. You think the dynamic of having to kind of call a friend on the smaller deals may go away a bit in 2022?

From a pricing perspective, I do expect there to be a bit of a leveling off and a decrease over time. I don't' think it's going to be drastic though. I mean, I think rate increase, as with most hard markets, it increases very, very quickly and then it's sort of a slow bleed. The air is slowly let out of the balloon over the course of a cycle where rates decline a little bit.

I don't know that we will get back to an extended period of rates that we saw three or four years ago, where we were at sub-3% on most deals, 2.5% or two and 2.75%. I think there's enough claim activity now where carriers are looking at that band of rate as being challenging for them, ultimately. I think longer term settling in somewhere in the three to 4% range is probably where the market settles out in terms of client appetite and client willingness to take on that expense, as well as carrier needs from a profitability perspective. But it's not going to be overnight. It's certainly not... We're not going to flip a switch on January one and all of a sudden see 3% rates again.

Got it. That makes sense. Matt really appreciate your time. This has all been super interesting and I could talk to you for another half hour about this, but I think we've all got to get back to this white hot market that we've been talking about. So again, thanks so much for joining. I really appreciate it.

Thank you. And always happy to do it and good luck to everybody out there doing deals.

So now we will, as promised, transition to an excerpt from a presentation on "What's Market," from our McGuireWoods independent sponsor conference held in Dallas this past October 19th and 20th. Again, this presentation was from Jeff Brooker and myself. Thanks.

Okay. So next up, one of the other pillars here is the closing fee, and we're going to use the nomenclature here, closing fee. It's kind of loaded from a regulatory perspective because of broker dealer regulations, and most independent sponsors are not affiliated with the broker dealer. So I think this is one that is really important from the early stages when you are thinking about your LOI and what kind of language goes into it, that you are consulting an attorney and making sure that you're kind of putting the best face forward, as well as structuring things in a way, or at least understanding the risks that you're taking. So I wanted to reiterate that, and then maybe I take a step back.

Everyone, I think understands what a closing fee is. It's a fee paid at closing and it can be paid in cash, or it can be paid in equity and there's various strategies that we can take around tax to try to minimize the tax that's paid in the year that the closing fee is paid.

You want to consult with an attorney up front, I think, to help them. There's a few different answers that you can come up with. They've got different economic results, but also different risk tolerances. You definitely need to understand, some folks might advise on some approaches that have significant risk, and I think you want to, you really want to think about that and what is the right answer for you before you really structure your fee.

I would reiterate that and I would say that we at McGuireWoods are aware of all the structures out there and can talk you through them and talk through the potential risks involved with the side, the structure.

Right. Greg and I were talking before this and they said, "Oh, do you know what... X firm is out there, how they structure." Yes, we are aware of all the different ways to do this and can counsel you through them. If something sounds too good to be true, it often is, and there's usually risk to that. The IRS wants their piece and there are permissible ways that we can try to avoid paying them their piece in the first year, but there are limits and being mindful of those is important.

So how's the closing fee percentage calculated? The vast majority of deals here are they're calculated based on enterprise value. So aggregate enterprise value of the deal. So if the target's enterprise, if the value is 50 million, then the right base value to calculate is 50 million.

It's a pretty small number of deals that do other things. 7% based on all capital rates and then 10% based on the equity capital rates. So I think definitively, an enterprise value basis for the fee is market.

So the next slide, size of the closing fee, I'll let everyone just kind of look at and digest the results, but you'll see the most common band here is between 1.5 up to 2.49, as far as a percentage of the enterprise value for a closing fee. If you were to further dive into the data, the 2% results for deals from 10 million to 50 million, 2% of enterprise value is the most common result that we saw which is consistent with what we see in our practice as well.

One item to note, I mean, as, as alluded to is the decision of there is this closing fee that's going to be paid, the decision of whether to roll all or a portion of that into the equity of the go forward company. Looking at the data we about 40% of independent sponsors rolled the entire closing fee into the deal, and with the remainder rolling a portion or none.

The next slide is the flip side, in a sense, of are there closing fees that are going to be paid to the equity capital provider as well. The data shows that in a majority of deals, there are no closing fees paid to the equity capital provider. This is another one where if you dive into the data and look at our private equity firms more likely to take the closing fee versus family offices, I think consistent with our practice you would probably see that it skews to be more common that a PE firm would take some fees. But again, the majority of capital writers are not taking fees at the closing.

Great. So moving along to management fees. For those of you unfamiliar, this is an annual, or more commonly, a quarterly fee paid by the portfolio company post-closing to the independent sponsor and potentially to the equity provider for ongoing private equity consulting expertise. It forms, as many know, sort of the base case economics that the independent sponsor will receive in all, but sort of dire scenarios where perhaps the credit agreement goes into default and then we'll talk about what happens with respect to the management fee being shut off the promote being the upside economic piece.

So diving into the data, you'll see that the EBITDA-based model is by far the most common. So the two ways to measure this are the parties can agree to a straight dollar fee, call it 200,000, and pay that annually, or more commonly you look at the operating EBITDA of the business and measure that as a percentage. There was a small number of data points where instead of EBITDA-based, it was a revenue-based fee, but I think there were only three or four responses of that nature so we're really just talking about EBITDA versus straight dollar amount. There was a very small percentage where there was no management fee at all. And this is talking about the management fees paid to independent sponsors here, to be clear.

So the next slide, this talks about in the EBITDA-based model, what are the management fees that we're seeing. Pretty resounding data set at 5% being market. So really there are parts of the survey that are less clear. We'll talk about the carried interest. There's not a clear cut market response, but we do see 5% EBITDA-based management fee being pretty clear. And Jeff, I may have stepped on your slide a little bit, but...

No, it's all right.

Yeah, no, this is definitely one of the most interesting slides I think in the presentation, because it's one of the core pieces of what is market. 5% really resoundingly came across as the market and everything else is kind of widely dispersed.

One thing that's not reflected on the slide is caps and floors. Our data does dig into that. The survey dug into it, and we have a lot of responses that. We'll elaborate on that in a fuller published piece. But typically even if there's a 5% management fee, it's very common to have a floor. So that way the independent sponsor knows if they're at least going to get something, even if the company is puttering along and maybe not hitting an amount that's necessary for them to keep the lights on. And then usually a cap as well, so correspondingly, if the company is going gangbusters, there's some upper limit to how much money is going toward the management fee.

And so, as I said, the published paper will have a little bit more detail on that, but wanted a flag that it doesn't mean 5% no matter how big the company gets.

Yeah. I mean, it's interesting because as you think about the three different pillars of the economic model, they're also interlinked and dependent upon one another. That we have found with the caps and floors, it didn't really make sense to say this percent of deals had caps or has this percent had floors because you got to think, was there a cap and a floor? Was there just a cap? And so I think we'll have more to come on that topic.

Yeah, that's right. The data was a little bit... Sometimes when the data got a little bit difficult to present in this type of format, we're just punting to the larger presentation.

This is a straight dollar management fee when it's not EBITDA-based. As we discussed before, EBITDA-based is the most common model. You need to recall the deal sizes that we're predominantly working with here. I think it was two-thirds in the 10 to 50 million, and then 75 or 80% under 75 million. And so when you in your mind kind of overlay that with this to help rationalize what that is, what these dollar amounts are, relative to the deal size? What you'll see, basically 100 to 300 was by far the most common. Two-thirds of the deals in that space.

The next data point relates... We just talked about the management fees, the independent sponsor, and then the next question is, well, is the equity capital provider also taking similar management fees? And the data showed that the vast majority, there were no ongoing management fees paid to the equity capital providers. And we think this is reflective of the value add that independent sponsors are bringing to the portfolios, that they are the ones that are recognized with the ongoing management fee for their services.

This is one where, if you were to dive into the data further, you would probably see some differences between whether private equity firms are going to want to take a management fee versus family offices. But in broad strokes, this was the result, and again, we thought it spoke to the value of the independent sponsors.

We alluded to the concept of this management fee is an important part of the investment, and really only material items and events are going to cause the management fee to stop being paid to the independent sponsor. One common interplay is with respect to the credit agreement and what occurs if the company is no longer able to perform under the credit agreement. As you'll see, the most common result here is one that is beneficial to the independent sponsor where the payments pause. So it's not the most beneficial outcome for the independent sponsor. That would be if the fees are not blocked, even if default, so we only saw that in 6% of the results. But the most common one is that the fees are blocked while there's event of default but during that time period they accrue. And there is not a cap on that accrual. It is the second most common results is that the fees are blocked and they accrue, but then there is a cap that is agreed while that occurs.

Yeah. And then the logic behind that one is if the company's scuffling along and it can't pay the management fee, that there should be some upper limit on how much can accrue. That is effectively diluting the rest of the equity before we say enough is enough. The dilution is enough and we're going to apply a cap. That's interesting data for sure.

Yeah. And the other interesting point is that in only 2% of the deals did the management agreement completely terminate upon an event of default under the credit agreement. So again, it's a very important part of the economic model for independent sponsors. It should pause, and there should be negotiations about what happens with respect to that. But the termination result is not market, as you can see.

Well, great. I hope you found the excerpt of the independent sponsor conference to be helpful, and I also hope that everyone found the discussion around rep and warranty insurance from the Lockton team to be similarly helpful. Again, good luck to everyone as we finish out the year strong, and happy holidays and happy new year.

Thank you for joining us on this episode of deal, by deal a McGuireWoods independent sponsor podcast. To learn more about today's discussion and our commitment to the independent sponsor community. Please visit our website at mcguirewoods.com. We look forward to hearing from you.

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