Both the creative and technology sectors have always seen large volumes of mergers and acquisitions (M&As). Recently, however, we’ve noticed a significant rise in such purchases lacking M&A insurance during the due diligence stages.
As the acquiring company, why would you risk the potential exposure of litigation for past uninsured activities? What if the purchased business has big gaps in their Professional Indemnity policy that didn’t cover the services they were delivering?
Failure to cross-examine your merger or acquisition could result in a significant loss for your company. That’s why we’re sharing the importance of insurance during the due diligence process here.
Understanding your acquisition
First things first, you need to ascertain the actual value of the business you’re acquiring or merging with. For example, what if the insurance they have in place doesn’t comply with the contracts of their largest clients? That could be limits provided, jurisdiction, or failing to note specific rights, which allows them to just walk away.
The business’ current or legacy client contracts might require a specific type of insurance to be in place for a certain amount of time. A purchasing business needs to be aware of these responsibilities, because if the necessary cover isn’t in place, you could lose the highest value clients of the purchased company.
It’s not unusual for the purchased business to have better protection than the purchaser. This means the purchaser would need to either extend their own policy to comply with contracts for their new acquisition or find other solutions such as run-off cover.
Without insurance during due diligence, the cost to increase the cover for the purchaser or implement run-off solutions is unlikely to be properly factored in. This can leave an unpleasant bill at the end, or worse, potential exposure to the ongoing concern.
Breaking down M&As
To further explain why M&As should involve a more comprehensive review of insurance policies (whether you’re a small business or a large one), we’ve broken down the terms you’re likely to run into at the acquisition stage:
Due diligence is an investigation, audit or review of a company’s financial records to mitigate risk during a business or investment decision. It can be a long-winded process, and involves considering a variety of factors like client retention rates, finances, tax, employees, and contractual obligations.
Several expert partners from tax, accountancy and law firms will navigate this stage and ensure the deal is suitable and viable for you. The value of a good insurance broker, however, is often overlooked…
Insurance within your own business is a risk transfer strategy typically dictated by three things:
The final point is crucial, as without legal or contractual obligations, insurance can be at the board’s discretion. They may believe their risk is relatively low and therefore purchase limited cover.
So, it’s important to remember that while you can control your own business’ insurance programme, when purchasing another, you need to consider their board’s initial oversight and potential exposures.
Insurance due diligence
In this context, insurance due diligence refers to the review of financial and legal documents in a merger or acquisition. It can take on a number of forms, from a full broker review or legally qualified reports to some simple observations.
This process can help you understand the liabilities, exposures and potential cost implications of merging with or acquiring another business. It may also provide valuable feedback to validate your decision to purchase the company.
Having a suitably qualified expert review is vital, as they can factor in all the relevant information and present an accurate overview of the business’ risk exposure.
What insurance brokers review
When an insurance broker conducts due diligence of your merger or acquisition, they factor in a number of areas, including:
A broker will assess how much the purchased business currently pays for their insurance premiums. They’ll ask if there are any realistic savings to be had through merging policies, and enquire about any foreseeable changes in insurance cost – factoring in current market conditions as they go.
Here, a broker asks what the business currently insures, and what the key exposures are. They also determine whether the purchased company is adequately covered, if they have low limits, or are even perhaps underinsured.
This is to establish if their policies are accurate and held with established, financially secure providers with suitably comprehensive wordings.
Next, they assess whether the business has certain contractual obligations requiring specific limits or types of insurance. We’ve seen agreements require cover to remain in place for six years from the contract’s termination or completion. You need to know the cost implications to meet these demands.
Brokers will also check whether the business has made a large number of claims and, if so, what for. Any previous claims could impact your insurance, and might indicate that there are underlying problems regarding risk management.
From there, a broker determines if the acquisition will affect the insurance. For example, do the target business’ current policies require alteration? Or will they be triggered into run-off or cancellation by the acquisition?
This is particularly relevant to Directors’ & Officers’ Liability (D&O) cover, which naturally focuses on business acquisitions within the UK. Overseas entities generally have different exposures and legal requirements to consider.
Why D&O cover is important
D&O insurance protects the personal liability of directors and senior management from wrongful acts, such as misrepresentations during a sales process. It’s a common request from investors or buyers to have this in place.
Cover is on a ‘claims made’ basis, so it only applies from the retroactive date. If the policy isn’t live, any representations prior to this date aren’t covered. That means it must be set up before entering the merger or acquisition process.
Once a sale is agreed and completed, the transaction clause is likely to be triggered (usually when something in the region of 50%+ share capital is transferred). The policy is then often in automatic run-off. As such, we normally recommend that the seller take out run-off cover for six years to match the statute of limitations. This can be paid for by the buyer, but it has to be instructed by the seller.
Without a D&O policy, or warranties and indemnities cover, you leave yourself exposed. So, if the seller makes a misrepresentation about the business’ performance during the acquisition stages, you won’t be able to respond.
The post-transaction process
When due diligence has taken place, an action plan can then be established – with clear steps on how to proceed post-completion.
This might include optimising the insurance programme through merging policies, potentially saving money and reducing risk.
How RiskBox can help
We understand that insurance is probably the last thing on your mind when going through a merger or acquisition and carrying out due diligence. That’s why we want to make things simpler, and ensure you’re protected from any fallout.
The benefits are clear, and they also prevent your business from incurring an incredible cost at a time when you’re financially vulnerable. Help protect your interests by speaking to a member of our team today.