How To Manage M&A Risks

Imagine that after completing months of negotiations, due diligence and a major acquisition, you discover that the company you have just acquired is riddled with problems. What recourse, at this point, would you have? 

One option would be to do nothing. Perhaps the problems aren’t material or there are persuasive reasons to overlook them, such as the need to integrate the new company quickly and avoid a long legal battle.  Or perhaps you wish to avoid souring your relationship with the sellers, who are now your management team at the company.  A second option would be to seek compensation from the sellers – and perhaps, have that long and, potentially acrimonious legal battle after all.

Clearly, neither approach is very attractive. Fortunately, there is a valuable and increasingly popular tool that can be put to use to help M&A transactions go more smoothly and avoid (or at least reduce the risk of) the types of scenario just described.  If one of the parties to the transaction had taken out W&I insurance when the deal was signed, a third alternative would have been available; that is, recourse against the W&I insurance policy.

Once viewed as an esoteric piece of financial engineering, buyers, sellers and their advisors now recognize W&I insurance as a central tool in facilitating M&A transactions. W&I insurance offers a tailored product designed to cover breaches in warranties and indemnities (or representations and warranties) that are provided by sellers in M&A transactions. In doing so, W&I insurance can significantly reduce parties’ inherent risk in doing a transaction. This in turn can help to minimize the time needed to reach agreement and close the deal.

Accelerating the close

Leading law firms are increasingly advising their M&A clients to structure deals using W&I insurance.  Sophisticated brokers and insurers now employ M&A professionals who are accustomed to the pace and compressed timetables often involved in deal-work.  

Benefits of W&I insurance

A seller-side W&I policy covers the seller for any innocent misrepresentations it might make in its own representations and warranties.  A buyer-side W&I policy covers the buyer against the seller’s misrepresentations (innocent or otherwise).

Seller benefits

  • Reduce the risk of contingent liabilities arising from future claims, allowing sellers to exit a business cleanly
  • Allow the distribution of all (or most) of the sale proceeds to investors or use proceeds to pay down existing debt
  • Protect passive sellers who have not controlled or been actively involved in the management of the target from unintentional non-disclosure or breaches of the transaction documents
  • Expedite a sale and potentially increase the purchase price by eliminating obstacles to closing, such as indemnity negotiations

Buyer benefits

  • Supplement protection for breaches of warranties both in terms of value and certainty of payment
  • Extend the duration of warranties, affording buyers additional time to detect and report problems that may exist within the acquired business
  • Differentiate a bid in a competitive auction by negotiating more limited recourse from the sellers and supplementing that contractual recourse with insurance
  • Protect relationships with sellers who may become the buyer’s key employees or commercial business partners after the transaction

Did you find this article interesting?  You can download our "Representations and Warranties Insurance Global Claims Study" below for more information on the risks that can be associated with mergers and acquisitions, and discover how Representations and Warranties insurance can help these transactions progress more smoothly.

Companies and individuals should not solely rely on the information or suggestions provided in this article and should seek the advice of an independent advisor for more complete information concerning their particular circumstances and any statements made in this material.

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