These risks can be seen in various aspects of the business, including commercial, people, and operations. Managing these risks is a crucial component of any M&A process.
- Commercial risks include due diligence, warranty and indemnity, and contingent risk
- People risks involve issues related to company culture, rewards and benefits, and engagement
- Operational risks focus on feasibility, governance, and implementation.
Insurance due diligence
Insurance due diligence is a sensible approach for the buying business to take. It involves a thorough assessment of the target’s insurance programme and the consequent report can be shared with stakeholders. It is an opportunity to confirm that the target business’ coverage is legally compliant, and fit for purpose in relation to its business activities. It will address what policies can survive completion, and in view of the change in ownership, specifically focus on the ongoing, and runoff D&O. If there are gaps then these can be addressed between the businesses as part of the negotiations so the parties can agree the total cost of risk.
Cyber is an example where we often see inadequate cover. Also underinsurance is a market-wide issue due to inflation; are the sums insured adequately stated? The due diligence will also consider how anticipated future trends may impact the programme and benchmark the target’s claims experience in relation to its peers. This can give a helpful insight into the risk management culture within the business and its management. It can also assist in obtaining a wider warranty and indemnity policy.
Benefits of warranty and indemnity cover
Traditionally, as part of the Sale and Purchase Agreement (SPA), the seller provides warranties or statements about the business, which the buyer relies upon amongst other things, to make an offer. The seller would have a liability cap in the contract should there be a breach of warranty. In the event of a breach of warranty the buyer could potentially sue the seller. Increasingly now we see the seller limit their liability, to say £1, and encourage the buyer to take out a buyside W&I policy. This is often driven by the seller as it provides them with a cleaner exit, i.e. no need to hold back funds in escrow. However, benefits for the buyer include protecting shareholder relationships with management post-merger, i.e. management giving the warranties are likely to now be in the buyers business. If other bidders are not using W&I, you may have the advantage in a competitive process, as it will be attractive to the seller supporting their clean exit. The policy can also cover fraudulent misrepresentation of the seller. It is not however, a substitute for a properly negotiated transaction, where due diligence and disclosure is still key. Indeed, the robustness of the policy is dependent on the quality of the due diligence, hence insurance. Many buyers like the fact that the underwriting process involves a review of all the due diligence, so it’s like an extra pair of eyes.
While W&I protects against the possible unknowns that slip through the DD net, if known exposures relating to tax, for example, surface during due diligence, these can also potentially be covered by contingent risk insurance.
People risk: M&A megatrends and blindspots
There are several galvanising changes that are significantly impacting M&A at a global level. The fourth industrial revolution is upon us and new tech like AI and machine learning are changing the workplace at an exponential rate. Climate change and political instability have forced the migration of populations, creating talent vacuums in certain parts of the world and an abundance in others. In the UK, the skills imbalance is accelerating, and retaining talent is a growing challenge.