The past few years of economic uncertainty have undoubtedly affected attitudes to risk, especially in the context of M&A.
One industry that has benefitted from this heightened awareness in the need to manage risk on M&A transactions is the insurance sector. Nervousness on both the buy-and sell-side has led to a significant increase in demand for insurance cover as part of a transaction. This insurance can mitigate known but unquantifiable risks, such as potential tax liabilities that may emerge during the due diligence disclosure process, and also risks which are unknown or unidentified at completion and which may only come to light after the deal is done.
Buyers and sellers are affected by different uncertainties and use insurance in different ways to cover these. Buyers are frequently worried about having to chase their sellers for cash if there’s a breach of a warranty or indemnity; insurance may reduce concerns about the need to chase a former owner who may have spent it all already.
From a seller’s perspective, the attraction is to achieve the cleanest exit possible and certainty about the proceeds they will receive. With cash tighter than it was, they may prefer to take out insurance to protect their final value, rather than leaving cash in a retention account to cover any future issues.
Insurance companies have embraced this desire for more certainty and are capitalising on the trend. While in the past warranty insurance policies both lengthened the deal process and introduced yet another layer of complexity, insurance companies like Willis and Marsh have made it much quicker and easier to take out this added level of protection to cover transactional risk. They can also tailor products for specific risks which arise in the deal process, addressing individual warranty and indemnity requirements and tax liabilities.
At Livingstone, we see insurance policies becoming common components of the deal process, but it is always important to look at each deal separately and consider insurance on a case by case basis. If the target is well-managed and due diligence has been thorough, then taking out insurance may be unnecessary and could introduce an element of mistrust into what is already a sensitive process. If there are specific risks, or general nervousness, insurance might be the ideal way – and sometimes the only way – to bridge a gap between the parties. The relative appetite for risk of the individuals involved in the deal will also determine their appetite for utilising insurance.
By deciding when and how to implement an insurance policy, and positioning this carefully to all parties concerned, insurance can and should be seen as a way of reducing risk for a fixed and manageable upfront cash sum, aligning incentives and helping to cement relationships. And, realistically, with the lessons that have been learnt during the financial crisis – it’s here to stay.