Saltire Capital Partners Insight Series: Managing risk in M&A transactions
Risk is part and parcel of a business changing hands. Some risks are obvious, like the impact of employee layoffs or a revised capital structure. Others are more challenging to detect or anticipate, such as market reactions to a merger, cultural clashes between teams, or the unexpected loss of a key person. Whether you’re a buyer or seller, due diligence is critical for success. As necessary as completing rigorous due diligence are taking steps to put the proper insurances in place.
The fifth edition of AIG’s M&A Claims Intelligence report shows a growing number of large claims with escalating losses. At the end of 2017, eight percent of claims were valued at $10m or above. By the end of 2019, claims had risen to 19 percent with an average claim size of $20m.
Gary O’Sullivan, former Principal of Blueleaf Consulting, a Gallagher company says,
“After working in the insurance business for 30 years, it’s clear many businesses prioritise protecting against physical risk. Not enough people give thought to protecting against the human capital risks that introduce vulnerability to a company’s equity, financial stability and impact on revenue.”
The value of insurance due diligence
Insurance due diligence is critical to help buyers understand the vendor’s insurable and uninsurable risks and make informed decisions about an acquisition or merger target. Typical insights from insurance due diligence cycles include a deep understanding of the business’s insurance strategy across total risk exposures and related costs, one-off insurance costs (occupational health and safety, retroactive cover, etc), comprehensive claims history, allocation of risk in the Sale and Purchase Agreement, opportunities to optimise insurance protection and reduce insurance-related risk, and recommendations for insurance post-completion.
For businesses readying to buy or sell, founders and owners should consider putting these four key insurances in place:
Key person insurance
A key person is anyone whose ongoing association with a company helps it realise economic gain and growth. Key people are often sales teams and include executive leaders whose specific expertise, ingenuity, or operational skills are critical to the company’s success. Examples of key people are the Managing Director, a Chief Financial Officer, Specialist Engineers, or silent partners who bring personal connections with financiers to help the business with its capital structure. Losing a key person can significantly impact the profitability or capital value of a business. Key person insurance helps replace lost profit or capital value to give the business continuity until a replacement person is onboarded.
Business succession planning insurance
To protect your business against unexpected events, it’s important to plan for a smooth transition of equity and/or control if one of the owners exits the business due to death, disablement, or a critical illness. In a privately held business, if a principal passes away or becomes disabled, there is generally an obligation on their family to divest their interest in the business. This can introduce significant challenges for ongoing funding requirements and the business’s management structure. A planned business succession program helps protect your business into the future, no matter what lies ahead.
Warranty and Indemnity insurance
Warranty and indemnity (W&I) insurance is a significant risk management instrument used to protect buyers and sellers in M&A transactions. There are two types of W&I insurances:
- Sell-side policy. This policy type insures sellers. The buyer claims any losses from the seller, and the seller may seek to recover costs from the insurer.
- Buy-side policy. The buyer is insured, and the buyer can recover losses directly from the insurer.
W&I insurance gives sellers the opportunity for a clean exit, or at least a means to reduce warranty claim risks. It lets buyers offer some peace of mind to financiers.
Modern business demands the gathering and storing of more personal information on customers, partners, suppliers, and employees than ever before. As businesses become more distributed, personally identifiable information is collected and stored using an increasingly complex mix of technologies in the cloud and on-premises. Managing and protecting data through a transaction is critical to mitigating legal, financial, and reputational risk. The speed at which cyber-threat is evolving means not all cyber risks will be covered. However, cyber-security and data protection due diligence is critical to understand technical risk, financial exposure, compliance status, and provide a transparent baseline to future investment needs.
The discovery of a data breach during the negotiation of Verizon’s purchase of Yahoo! for US$4.8 billion resulted in a US$350 million reduction in the purchase price paid by Verizon, and penalties of over US$35 million to Yahoo!
Ready to protect your next transaction?
Saltire Capital Partners believes in the power of partnering to bring the best industry experts together to give our clients outstanding outcomes. Navigating the complex risk landscape inherent in Australian M&A transactions requires specialist skill. We’re pleased to partner with market-leading firms, like Gallagher, to help our clients protect their businesses, transactions, people, and futures.
For over 90 years, Gallagher has helped Australian businesses face the future with confidence. If you’re buying or selling a company in the next 12 months, Gallagher is available to conduct a risk review and gap analysis to give you peace of mind that your business is appropriately protected.
Contact us for more information or to book a review.