Before embarking on a merger or acquisition there are many things to consider. Business owners need to understand if the business is in good financial health and, if they are considering buying, the level of liquidity needed to acquire a business successfully. Planning your funding will be key as well as understanding the valuation of the business as it stands.
Undertaking a merger or making an acquisition of another business is complicated and carries a number of risks to both buyer and seller.
Buyers need clarity over the business and its associated risks they are acquiring, and sellers want to know that once the deal is signed and agreed, they can move on to their next venture safe in the knowledge the deal is finalised with as clean an exit as possible.
So what insurance should buyers and sellers consider that can help protect them when they are undertaking a transaction? There are a number of different insurance products that can help give peace of mind.
The most widely used is Warranty and Indemnity (W&I) Insurance. The use of W&I insurance is now a common feature of M&A transactions. When buying or selling a company, a W&I policy can be used to insure the vendor’s warranties and tax indemnity within a Share Purchase Agreement (SPA).
From a seller perspective, W&I insurance allows the following:
- A clean exit and allows the distribution or reinvestment of sale proceeds, or wind up fund
- Elimination of the need for escrow as you can limit liability to £1
- Help if vendor is unable or unwilling to give financial support behind warranties
- The management team retained with the new company are protected
- Comfort for seller should the buyer have a reputation for litigation
And from a buyer perspective, it gives the following:
- Comfort to debt providers if concerns exist over financial position of seller
- A competitive advantage in auction process (as they don’t require a high liability cap as taking out insurance)
- Buyer can go direct to policy, rather than sue the seller (whose management may now be buyside)
- Insurers effectively diligence the buyers diligence – extra pair of eyes
It covers breaches of representations and warranties, and covers loss or liability arising from unknown or undisclosed matters and indemnities. The insurer effectively “steps into the shoes” of the party giving the contractual promises.
The vast majority of W&I policies are buyside (the buyer is the insured party) which offers advantages over a seller purchased policy as the buyer can claim directly against the insurer without having to seek recourse from the seller, enabling a clean exit for the sellers.
Each W&I insurance policy is tailored to meet the specific needs of a deal and is a non-renewable, single premium product with the premium being paid upon completion of the transaction. The process for placing W&I Insurance can generally be completed within two weeks, working in tandem with the deal process.
Another product which businesses should consider is Tax Liability Insurance (“TLI”). This is designed to transfer a tax liability (arising from an uncertain tax position) from a company’s balance sheet to an insurance company, or within an M&A context it allows the seller to transfer their indemnity for a tax risk to an insurer enabling the seller to achieve a ‘clean exit’. Cover offered by a tax liability policy is flexible and typically includes the following:
- Any tax payable
- Any penalties and interest payable to the tax authorities
- The cost of dealing with a tax authority enquiry, dispute or litigation
- Any tax incurred on the insurance proceeds received
Policies are available either pre- or post-transaction and the benefits of a tax liability insurance policy include; giving certainty and managing negative financial impacts by transforming potential tax liability into a quantified insurance cost; allowing the issue to be accounted for precisely; enhancing or preserving the value of a business or a particular asset; and enabling a solution when buyers and sellers do not want (or do not have time) to obtain prior clearance from tax authorities.
It is a very effective tool within an M&A context as it can enable the seller to avoid having to give an indemnity, price chip, or escrow for a known but legally uncertain tax risk. As with W&I insurance, depending on the complexity of the risk, tax liability insurance can be arranged in a relatively short period of time in order to meet the demands of commercial timelines.
If you are considering either selling your business, or merging or buying a competitor, talk to our specialists today.
These are brief product descriptions only. Please refer to the policy documentation paying particular attention to the terms and conditions, exclusions, warranties, subjectivities, excesses and any endorsements.