Securing the Deal

Selling a company is never easy, but these days, corporate dealmakers often feel as if they are walking a tightrope. One false step, and increasingly they can be held personally liable if something goes wrong. All too often, corporate bosses can end up in the law courts, defending their reputation - and sometimes their bank balance too.

It's no surprise then that in recent years a thriving industry has grown up offering tailored insurance products designed to minimise the risks in any M&A deal.

WARRANTY AND INDEMNITY INSURANCE

Warranty and indemnity insurance is a valuable tool designed to protect dealmakers from financial losses by eliminating their exposure to accuracies in the warranties contained in a sale or purchase agreement. W&I policies can protect sellers from losses made by the buyer if there are breaches of warranties after a deal has gone through.

"These are not standard policies you can just pull off the shelf," explains Andrew Hunt, head of the private equity and M&A practice at insurance specialists Marsh in London. "They are all very much bespoke contracts. The key question we ask ourselves at the outset is: how can we use insurance to overcome a deal obstacle?"

This kind of insurance has grown steadily in popularity and sophistication in recent years. The first contracts were pioneered in the UK and US insurance markets during the late 1970s.

Typically, the early contracts were purchased as a 'sleep-easy' by individuals who were selling small- to mid-sized businesses they had originally set up themselves.

"Most of these guys just wanted a simple policy that would ensure they weren't liable if something went wrong and the buyer came after them for some reason," says Hunt. Since then, the range and complexity of W&I insurance products have changed almost beyond recognition.

NEW POLICIES

It's not just sellers who are now benefiting from W&I insurance. Buy-side policies are increasingly popular, by offering indemnity for losses caused by breaches of warranties given by the seller. These products now attract a far wider spread of customers than previously.

They range from private equity groups undertaking secondary buy-outs to hedge funds acquiring corporate assets from financially distressed sellers. The popularity of W&I insurance has also been given a boost because it offers an alternative to the prospect of money being tied up in escrow accounts for long periods of time until the warranty has expired.

Many high-profile corporate deals now involve W&I cover. Increasingly, these products are being applied to smooth tricky disposals of problem assets languishing in private equity disposals.

Moreover, in an age of growing corporate caution, with executive board members increasingly concerned about their professional and personal liability if things go wrong, W&I insurance is an attractive solution.

POLICY TRENDS

These days, buy-side policies are proving to be just as popular as sell-side policies while the average transaction size has also grown significantly. W&I insurance has been placed on transactions from £1m to more than £1bn, according to Edwin Charnaud, COO of Marsh's European equity and M&A practice.

The amount of cover purchased is also rising, from £5m up to as much as £100m. Charnaud also points out that this kind of insurance is also enjoying a brisk geographic expansion. There has been a surge in popularity in Asia and continental Europe, regions which had previously lagged behind the UK and USA.

Arndt Reinhard of AIG's M&A team in Frankfurt says: "We've seen rising interest, although there is still a lot of marketing work to do so that dealmakers are aware of it and think of it as a viable solution."

"It is best suited to the secondary buy-out and private equity markets. The product is now two to three years old in continental Europe so it is quite mature. The players recognise that it works and we have built up a reputation for doing good deals."

GROWING MARKET

Hard figures on the total current size of the European W&I market are difficult to come by. Marsh (which claims to be the market leader) says over the last 24 months its team has been responsible for 65% of all European 'transactional risk placements' – equivalent to an insurance capacity of more than €500m.

Meanwhile, Robert Brown, an expert from Chubb Insurance in London says, "The demand is there and the signs are quite strong."

"There was a downturn following 9/11, simply due to the reduced number of deals. But there has been a steady pick-up in the last few years with the recovery of the market. All of the leading M&A law firms, private equity groups and accountants are now familiar with the product."

There is also mounting evidence that dealmakers are using this kind of insurance to help them raise financing from banks and other financial institutions. Increasingly, many deals are not simply between buyer and seller. With secondary funding lying behind each party, the needs of these funders also have to be taken into account.

W&I POLICY ADVICE

So what guidelines should a company follow if it is interested in taking out insurance of this kind? The golden rule is to seek out specialist advice. Generalist insurance groups are unlikely to have the in-house knowledge or resources to deal with the complex insurance issues associated with M&A transactions.

Consequently, an insurance broker is probably the best first port of call. Independent specialist firms such as Willis, Marsh and AON all have dedicated teams who deal with this kind of cover.

Their job will be to examine the deal in question, assess the inherent risks and then guide the potential customer towards a suitable underwriter to handle the insurance transaction. This next stage will probably involve a specialist insurance firm such as Chubb or AIG.

"Sometimes, particularly with the bigger transactions, there may be a number of insurers who will prefer to share the risk," says Chubb's Robert Brown. "We look at the various transaction documents, accounts and due diligence. We assess the risks ourselves and get input from our own advisors and accountants."

GETTING SPECIALIST HELP

Both insurers and brokers emphasise the importance of getting specialists involved at an early stage in a deal. That way they can then work with a company from the start and not intrude on or disrupt a transaction.

"If you leave things to the last minute, there is less room for negotiation," says one insurer, adding that an all-too common mistake is to call in insurance specialists at the very last minute – when there is simply not enough time for them make a realistic appraisal of all the risks and cover that might be necessary.

Companies should also think carefully about their choice of insurer. A specialist underwriter who understands the needs of your business and is also financially stable is obviously preferable.

If there is a claim, the insurer needs to have sufficient expertise to deal with what are often very complicated cases. Meanwhile, there is little point in transferring risk to a company that has a lower credit rating than the policy holder.

Marsh's Andrew Hunt also warns that W&I insurance needs to be viewed in the right way. "W&I is not a panacea for all ills in a transaction – nor is it a replacement for good due diligence."

"It should be viewed as an enhancement and an underpinning of a deal – something that will provide a comfort zone on both sides of the deal. It can be very effective. We need to understand a customer's risks and then shape a solution."