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Optimizing M&A Transactions Through Specialty Insurance

Aug 14, 2019 blog featured image

With deal volume continuing to outpace prior years, and a disproportionate amount of the growth coming from core and lower-middle market deals, M&A teams are under fire to close transactions, while stretching to maximize stakeholder value. Hylant is helping drive greater value in middle-market mergers and acquisitions by using insurance as a substitute to capital.

As deal interest continues to move down-market, uncertainty of deal quality and hopeful exit valuations are driving the search for alternative ways to lay off deal risk and increase return on equity.

Buyers who are enjoying successful mergers and acquisitions are:

  • Consistently evaluating how to use insurance as another form of capital in the structure of the deal;
  • Using insurance as recourse to derisk the satisfaction of financial remedy in the event of a breach within the transaction agreement; and
  • Leveraging the value of efficiency and certainty of having a creditworthy insurer as the counterparty to a compensable breach.

Insurance Risk Capital as Capital

When correctly structured, capital provided by an insurance company, delivered in the form of a loss payment, is another form of capital available to a business. Additionally, it is another source of capital available in the capital markets.

Insurance risk capital is unique in that it has structural and economic advantages:

  • It is option like. A small option premium can generate a large capital payment.
  • It conserves cash. A small premium payment with a strike value does the work of otherwise dollar-for dollar liability matching.
  • It creates financial leverage. A small premium creates a substantially greater capital pool.
  • It is non-recourse lending and the premium may be deducted as a business expense.

Derisking Satisfaction of Financial Remedy in the Event of a Breach

In the event of an alleged breach, a financial remedy from a seller post-closing requires investigation, assertion and pursuit of seller. This is potentially more complex when the seller maintains an equity position or operating role within NewCo.

An appropriately structured representation and warranty insurance policy allows the buyer to tender a first-party claim directly to their insurance company, bypassing the need to seek and pursue the seller. Moreover, third-party claims made pursuant to the transaction can be satisfied directly by the insurance company on behalf of the buyer.

Leveraging the Value of Efficiency and Certainty that Insurance Provides

Claims made by a buyer or third parties pursuant to a transaction may take time to form and be presented. In the case of general representations, there is value to the certainty and efficiency of being able to tender a claim up to three years post-closing by presenting the fact case to trigger capital payment. Likewise, relative to tax and other fundamental representations, there is value and efficiency in being able to tender a claim up to six years post-closing, with the sole burden of presenting the fact case to insurers to trigger a capital payment.

There’s inherent risk in every transaction, but risk can be effectively managed and transferred to an insurance company, through a custom-designed insurance structure based in specialty property and casualty products. Moreover, insurance risk capital can help close a difficult deal.

The alternative risk niche within commercial property and casualty insurance can be highly creative to resolving a wide range of sticky issues.

Some recent examples of insurance as a substitute to capital in a transaction include:

  • Seller-side arrangements to cover unexpired representations and warranties
  • A buyer-side bridge between escrow and cap, plus an additional extended survival period
  • ERISA-liability buyout, aligned with uninsured stock-drop fiduciary liability litigation
  • Volatile exposure for discontinued products still used by consumers
  • Buyer-side protection for the triggering of a reverse termination fee should a merger fail

Effectively resolving tough issues demands an effective insurance professional with years of M&A experience, one that can readily analyze contractual and financial information.

Each deal has its own set of circumstances and unique price structure. To maximize pricing, value, terms and conditions, an alternative risk property and casualty specialist should be a key member of any deal team. A thorough review of insurance placements and contractual requirements often uncovers substantial cost-takeout opportunities.

By Kip Irle, Senior VP, Strategic Risk Advisor, Hylant Alternative Risk and Captives Practice Leader