What is the Role of M&A Insurance in Today’s Marketplace?

What is the Role of M&A Insurance in Today’s Marketplace?

Matt Gilbert

January 23, 2023

Transactional Risk Policies, also known as M&A Insurance, are becoming increasingly popular in today’s M&A world. Their purpose is to subtract risk from the equation for both buyers and sellers of lower middle and middle market businesses.

A properly-leveraged insurance policy can strategically assist a business buyer in offering better terms to a seller. By allowing the seller to make a clean exit rather than having to extend the sale consideration over future warranty periods, the sale can often proceed more smoothly. In addition for the buyer, the inherent risk of a nauseating post-deal surprise is mitigated to only a concern about the policy’s deductible.

Another positive for adding M&A insurance to a deal process is that it increases the level of diligence required, thereby reducing the likelihood of a claim. The insurance providers will run their own diligence processes to assess and price their risk.

One of the largest underwriters of M&A policies in the USA reports, “One in seven M&A deals end in dispute, resulting in an insurance claim.” Claims between buyer and seller can be found in areas such as accounting and revenue recognition, trademark ownership, and of course litigation.

Transactional Risk Insurance is generally broken up into three areas of policy focus:

Warranty & Indemnity – This type of policy protects either a buyer (in a buy-side policy) or a seller (in a sell-side policy) from financial losses that may arise if there is a breach of representations, warranties, and/or indemnities given by the seller in the purchase and sale agreement for the transaction.

Tax Liability – This type of policy can reimburse an insured for taxes, interest, insurable penalties, and the costs of contesting or defending one or more covered tax positions. Not paying attention to the tax treatments that apply to acquisitions could cost a buyer significantly and perhaps negate any advantage they had in the deal.

Contingent Legal Risk – This type of policy provides the insured party with coverage against the adverse financial impact of an identified actual or potential legal exposure. The coverage offers protection from a broad range of contingent risks for which neither party is willing to stand behind. The insurance transfers a known or uncertain contingent liability from a company’s balance sheet to the insurance company.

Predictably, the major purchasers of M&A insurance are parties that have a limited ability to determine their risk exposure. Purchasers also include professional buyers and private equity firms that face many challenges as they mobilize down-market and buy increasingly smaller businesses within the lower middle and middle markets.

Situations as simple as sellers having limited data pose an enormous risk for a buyer because they have limited verifiable information on which they can rely. A buyer also has risk when they lack specific industry knowledge in a space where they are acquiring a platform and launching a new investment thesis. In addition, parties that need a clean departure from a specific legal jurisdiction use M&A insurance policies to remove tail liabilities associated with exiting the jurisdiction post acquisition.

M&A insurance is a tool used in our practice to get a deal over the finish line when there is a gap between the buyer and seller in pricing. Buyers can sweeten the deal when they offer to pay the cost of M&A insurance because the policies can carry a hefty price tag. However, most of the time simply splitting the cost often brings the parties into alignment.

Private equity buyers remain the biggest fans of risk transfer mechanisms and are more likely to take out the policies; however, it’s sellers who are more likely to put in a claim, according to general industry data.

In the end, these policies are tools to help a buyer and seller come to terms of agreement. But nothing beats a great pre-sale diligence and disclosure process as part of the scope of services managed by your transaction advisor. For a potential seller, simply aligning with a great transaction advisor who knows these waters intimately is the best mechanism to avoid conflict in an M&A transaction.

If any of this resonates with you, we encourage you to take our M&A Discovery Questionnaire and talk with us to see if your business makes the cut as one who can still command a great exit in this M&A environment. We will be in touch quickly to discuss the results. Click here to take the assessment.

Gilbert & Pardue Transaction Advisors (GaP) is a Houston-based business advisory firm serving lower middle market and middle market business owners from coast to coast through representation for Mergers & Acquisitions (M&A).

Matt Gilbert and Bret Pardue established GaP to provide owners of lower middle market and middle market businesses – those businesses generally enjoying annual revenue of $10-$80 million – with the quality of M&A representation and value-enhancement services previously only available to upper middle and large businesses. GaP brings highly experienced executives, sophisticated financial and marketing products, proven-effective processes, and fully-integrated expertise to every engagement. No other M&A firm serving the lower middle and middle markets provides the quality of representation and transactional expertise that we do.

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