A dried-up debt market, increased inflation and interest rates, and the macropolitical environment have all contributed to a significant deal flow slowdown over the last few quarters. According to The Middle Market’s Mergers & Acquisitions, “The world’s dealmakers are enduring their worst start to a year in two decades, as economic and financing headwinds continue to prevent a bounce back in mergers and acquisitions.”
At Woodruff Sawyer, we believe firms will find a way to get deals done this year, but their processes need a higher acceptable diligence threshold to close.
Having worked in the private equity and M&A community for over 25 years, we recommend performing insurance due diligence on every transaction to identify, quantify, mitigate, diminish, or otherwise transfer the potential risks that could negatively affect EBITDA for the portfolio company. Due diligence means scrutinizing financials, tax, legal, operations, cyber, market outlook, and insurance and risk management.
|Including an expert insurance advisor on the due diligence bench will enhance a deal team’s understanding of the target acquisition pre-close—ensuring that no surprises come up post-close.|
Our 2023 Guide to Transactional Risk: Insurance Due Diligence for Private Equity & M&A explains how we help our private equity, growth equity, special purpose acquisition company (SPAC)/de-SPAC, and strategic acquirer clients through their transactions. Here are highlights of our new guide.
Why Does Insurance Due Diligence Matter?
It’s critical for organizations to understand the importance of due diligence. Our Guide identifies and explains the following factors:
- EBITDA: A primary goal of due diligence is to uncover potential land mines that can negatively affect EBITDA for an acquisition in both the short and long term.
- Risk management: Due diligence helps teams understand the foundation of insurance, general risk management strategy, and approach to employee benefit offerings that help protect the business and employees prior to investment.
- De-SPAC transactions: Due diligence helps prepare organizations for the critical transition from a private company to a publicly traded company.
- Total cost of risk: Diligence helps uncover opportunities for cost structure improvement post-close.
- Representations and warranties insurance (RWI): Diligence is essential to avoiding exclusions or other issues with RWI.
- Historical losses: Management will be able to better understand historical losses and how to make changes to prevent them.
- Run-off policies: Due diligence helps teams understand the potential risks of run-off or tail policies.
- Evidence-based benchmarking: Prepared teams know how much commercial insurance the target should purchase and how the benefits program compares to peer companies.
- New programs: New Property, Casualty, Management Liability, or Employee Benefits programs may need to be implemented at close depending on the transaction structure and agreement language.
- Lender requests: Like RWI insurance underwriters, lenders require a base review of the insurance program. Due diligence helps you be prepared.
|What is the diligence team looking to find during their analysis?|
|Acceptably insured exposures|
|Deficiently insured exposures|
|Underinsured / over-insured exposures|
|Underfunded / unfunded liability exposures|
|Cost and coverage efficiencies (or inefficiencies) that can be maximized (or minimized) at close and post-close|
Transaction Timeline from an Insurance Perspective
In any given transaction, various factors can alter the timeline. The two main insurance-related workstreams are the RWI and due diligence processes. Understanding how these two simultaneous workstreams weave into the transaction timeline will help you avoid delays.
Our Guide identifies and explains the typical process for a stock buy-out transaction:
Phase 1: Pre-LOI (Letter of Intent) Through Execution of LOI. Many deal teams make the mistake of involving the insurance advisor too late. However, pre-LOI is often the time when an RWI broker partner is selected and gets involved. We recommend including a fully vetted RWI proposal when a private equity firm nears completion of the LOI and looks toward submitting a second or final round bid for a target.
The pre-LOI stage also is a good time to get the administrative work on the due diligence side completed, such as mutual NDA execution, formalized engagement letters, initial diligence information checklists, and data room access.
|LOI Best Practices from an Insurance Perspective|
|Involve your insurance advisor early in the deal process|
|Include a vetted RWI proposal near completion of the LOI|
|Complete administrative work on the due diligence side|
|Get familiar with the target company by reviewing the confidential information memorandum, financials, management presentations, and initial insurance-related information|
Phase 2: Period of Exclusivity and Insurance Due Diligence. Once the LOI has been executed and a definite close date is on the horizon, the buyer typically will kick off all third-party diligence workstreams. Insurance and Employee Benefits due diligence should be one of these workstreams.
The insurance advisor should be considered an extension of the deal team and a partner in EBITDA protection, as well as in risk mitigation and long-term insurance strategy.
Phase 3: Pathway to Close and Closing. Once the due diligence is completed, here are the steps that need to happen prior to closing:
- RWI Phase II Underwriting Process
- Coordination of Run-Off Coverage for Any Policies That Have a Change in Control Provision
- Go-Forward Coverage Solicitation
- Certificate of Insurance Coordination
Phase 4: Post-Close Brokerage and Implementation. Post-close is when the advisor begins to implement any recommendations not implemented at close. It’s also when the due diligence advisory team works with the management team to develop a comprehensive insurance and risk management strategy for the short, medium, and long term.
Key Insurance Due Diligence Findings
Our Guide discusses the trends Woodruff Sawyer is seeing in middle-market private and growth equity transactions:
No Comprehensive, Strategic Approach to Insurance and Risk Management: The insurance advisor should recommend ways to both professionalize and raise the level of sophistication of the insurance program post-close to maximize EBITDA protection over the lifecycle of the investment.
Missing Key Coverages: Examples include Management Liability (Directors and Officers Liability), Commercial Crime, Cyber Liability, and Product Recall Liability.
Inadequate Limits: Examples include Cyber Liability, Business Income and Extra Expense, Contingent Business Income, and Products Liability.
RWI Used on Most Transactions: There is continued growth and interest in smaller deals, with certain markets seeking to provide simpler coverage for lower pricing with a streamlined underwriting process. Cyber Liability remains the underwriter’s greatest concern when looking at insurance diligence and is worth exploring early in the quoting process. We are also seeing almost every RWI broker implementing new fee structures for compensation.
Changing Rates: While the Cyber Liability market is normalizing, the Commercial Property marketplace continues to be challenging, given recent catastrophic events.
For an in-depth look at the insurance due diligence process and how it can help you close deals faster and with more certainty, view or download your copy of the Guide to Transactional Risk: Insurance Due Diligence for Private Equity and M&A.
Why Does Due Diligence Matter?