When undergoing an M&A process, having representations & warranties cover in place is crucial to insure against the unforeseen costs associated with any breach of the seller’s representations made under the Purchase Agreement in an M&A transaction.
“When a seller is selling their business, they’re going to make a number of representations about the condition of their company,” said Robert Jevens (pictured), managing director of Heffernan Insurance Brokers’ private equity and M&A practice.
This can include tax and financial records, intellectual property rights, customer contracts, employment agreements or pending litigation, among others.
However, “with the aid of a fulsome and robust pre-acquisition due diligence effort by the buyer, the broker can work to uncover and address these risks resulting in more thorough reps & warranties insurance coverage and often an improved deal outcome for both buyer and seller,” Jevens said.
“Rather than having to set up an escrow account to provide funds to cover the loss resulting from the breach of a seller’s rep that may occur in the aftermath of a transaction, we now have this insurance product that will insure that risk by transferring the risk to a third-party insurer.”
This is good for the seller too, because once this coverage is purchased, the seller can effectively walk away from the deal with “nearly all of their chips off the table.”
In an interview with Insurance Business, Jevens spoke about some risk mitigation procedures to follow in the lead up to an M&A transaction and the types of insurance products that are necessary after acquiring a business.
When asked about some risk management decisions or advice to protect a transaction and make it less vulnerable to claims down the road, Jevens noted how private equity firms are making the process a lot easier.
“Once a private equity firm acquires a company, they’ll pull the various levers that they need to pull to make the company more profitable, and then they’ll turn around and they’ll trade that company again with a higher valuation,” he said.
“Many of the companies that we see are professionally operated and if the company is large enough, they will have an in-house risk manager.”
However, not every company that is in the midst of an M&A transaction will have the resources of a private equity firm to ensure the company is both sellable and following strict guidelines.
In that case, a broker can help their client procure the best rate for all insurance coverages while also making them a better risk to take on via a thorough insurance due diligence screening process.
“The buyer will want to know if a company has regular safety training and equipment to avoid any injury, sexual harassment training, cyber security training, among other risk mitigation strategies, and if they have protocols that uphold those standards,” Jevens said.
For first-time buyers who have little experience with conducting due diligence, “the underwriting process for reps & warranties coverage can help provide newbie buyers with a sort of road map toward a more fulsome and robust due diligence effort,” he said.
“Often, the longer that buyers have operated in the M&A trenches, the more onerous they become with the general pre-acquisition due diligence portion of the process, especially buyers who routinely utilize reps & warranties insurance.”
While reps & warranties insurance and the due diligence process can result in a successful and claim-free transaction, there are also coverages that companies should purchase after the deal has closed to stay adequately protected.
“The primary coverage that buyers are most often concerned about post-close is directors & officers insurance,” Jevens said.
“This product is paramount in the eyes of the buyer, to make sure that they’ve got protection against the decisions they make while operating the company post acquisition to thwart a shareholders’ suit.”
Depending on how the business is structured, there may have been D&O coverage that was in place on the target company before it was acquired, and that policy would be “tailed off” so that there’s coverage in place that will protect the existing directors and officer from future claims made against them post-acquisition.
Then, there’s the new D&O policy that’s put in place that will protect the operators post-acquisition.
“The other insurance coverages that are routinely emphasized, especially from a reps & warranties insurance perspective, are cyber and environmental liability insurance,” Jevens concluded.
