By: Taylor Hargrave, Marsh & McLennan Agency - Dallas Producer
Mergers and acquisitions happen across every industry, from marketing to manufacturing, as buyers and sellers negotiate the details of a business transfer that work to everyone’s benefit. Large corporations frequently have an in-house team of risk management professionals, who can work in concert with executive management and legal counsel to ensure a sale or acquisition aligns with the firm’s business strategy and identify potential red flags. Historically, however, midsize firms have been at a disadvantage in this arena.
Because the business transfer of a midsize business often happens directly between the buyer and seller, without involving private equity, both parties are left to navigate the complexities of due diligence, negotiations, and insurance coverages on their own. Even when a private equity firm is engaged in the purchase, the owners and managers of midsize companies generally are unfamiliar with the delicate dance of a buyout. As a result, the seller can overlook critical details during the process, leaving money on the table, while buyers may unknowingly assume present or future liabilities. Involving risk professionals to assist with the transaction can provide protections for both parties, and ensure that the right coverages are in place to minimize risk during and after the business transfer.
Many of the factors that determine the success of an acquisition happen well before the actual sale. Sellers must first prepare for the due diligence process, which includes drawing up confidentiality agreements and a selling memorandum that educates potential buyers about the business operations, assets and financial track record. Working with an insurance professional who understands the sensitivities around the transaction from a risk management standpoint demonstrates a level of sophistication to buyers and can help protect the seller’s interests through proper vetting.
Likewise, buyers need to have a clear idea of the type of acquisition they are looking for, and how it aligns with their business strategy. For example, some companies may want to purchase a smaller business in the same industry to grow their market share, increase production capabilities or expand geographically. Others may be looking for a venture in an unrelated industry, so the organization can move in a different direction. Whatever the reason for the purchase, having a clear framework for the financial and risk implications and a vision for how the company will move forward after the acquisition is vital to a successful transaction.
Identifying Red Flags
The due diligence process gives sellers the opportunity to determine whether a prospective purchaser can pay the asking price, and whether the acquiring company’s vision dovetails with their own desires for how the business will continue in their absence. At the same time, buyers have an opportunity to identify potential sticking points that could delay or even torpedo an acquisition. For the purchaser, possible red flags include:
Loss Run Reports – Reviewing historical claims filed against the seller’s insurance companies can bring to light areas of the business operations that may present a greater exposure or require a more in-depth analysis.
Legal Action – Major lawsuits or lawsuits filed for recurring regulatory violations can indicate a need for significant changes to the seller’s operations or corporate culture. Uncovering these issues during due diligence also lets the buyer put in place appropriate protections against future legal claims.
Future Risk – Depending on the nature of the target company’s business, the probability of future risk to the new entity may increase with the acquisition. The seller’s risk management strategy also may differ significantly from that of the acquiring company, and leadership will need to come into alignment as the deal moves forward.
Other areas of concern can include compliance issues, operations, and letters of credit, all of which merit scrutiny as part of the due diligence process. To this end, a virtual data room lets representatives from the purchaser and the selling company exchange relevant documentation between parties in a secure online environment, and limit access to those individuals directly involved with the deal to safeguard confidentiality. Both parties would be wise to include risk professionals among those granted access to the data room, so they can develop a risk management report that identifies potential exposures, as well as cost-savings that can be achieved by consolidating insurance programs.
Covering All the Bases
Regardless of the industry or business size, a business transfer will have implications related to the insurance coverage of each entity. For example, events that occurred before the date of acquisition could give rise to a future claim, depending on the insurance reporting period. Similarly, policies often are triggered by and around the business transfer. For example, the seller’s general liability policy may go into runoff or be cancelled automatically with a change of control in the firm. Understanding the nuances of how coverages work and the end goal for both the buyer and seller are critical to the risk management process. Insurance programs should be structured to address known and future risks to protect the buyer from financial or legal liability after the sale, and include “tail” coverage or extended reporting periods where needed.
As a further safeguard, it is not uncommon for the purchaser to require the company being acquired to put up a large escrow—which often represents the seller’s profits—to meet the indemnity obligations of the purchase and sale agreement. In this case, both sides are highly incentivized to make sure they have explored all the options, and that insurance policies purchased pre-sale will indemnify the appropriate party if something is discovered that was not disclosed.
Experts in Risk Management
Pre-acquisition due diligence is not just for private equity companies or large enterprise. It’s for anybody who is in the market to purchase or sell a business of any size. Marsh & McLennan Agency offers specialized consulting services for organizations needing additional risk management expertise to guide the acquisition process, whether as a buyer or a seller, and ensure an equitable transaction.
Because every deal is different, we carefully review documentation in the data room to identify potential exposures and cost-saving opportunities, and meet one-on-one with the management team to explore and develop comprehensive strategies for risk management and loss control around the sale. Likewise, we customize the process to meet stated timelines, while navigating the heightened emotions of everyone involved. Our ability to get out ahead of issues that could slow down or even kill a deal—such as meeting rigorous insurance requirements mandated by institutional lenders—benefits both the buyer and the seller.
If you are considering the acquisition or sale of a company, regardless of whether a deal is already in the works or you are simply exploring the possibilities, we invite you to contact our office to learn how we can help you achieve your business goals.