Mergers and acquisitions can help businesses fuel growth and achieve their goals, but the M&A process can expose businesses to liability risks. Business insurance for transactional risks, also known as mergers and acquisitions insurance, is an essential element of a sound risk management strategy.
How Mergers & Acquisitions Fuel Growth
Mergers and acquisitions are two separate but related corporate transactions. In a merger, two organizations join to form a new organization. In an acquisition, one organization buys another organization and takes over.
Strategic acquisitions and mergers can help businesses achieve a level of growth that may not be possible otherwise. For example, a company that wants to expand into a new territory or market could do so by acquiring another company that is already established in that territory or market. Mergers and acquisitions can also be a practical way to gain more customers, talent, and capital so that the organizations involved are more competitive.
Transactional Risks and M&A Risk Management
M&A deals are common due to the many advantages, but there are also significant risks. These risks may be financial, operational or legal in nature.
· Financial Risks: The deal may not be as profitable as anticipated. For example, a company may end up overpaying for a company because its assets were inflated, its liabilities were downplayed, or its future potential for success was exaggerated. Due diligence in M&A activity can reduce these risks, but it is still possible for unknown elements to cause problems during a deal.
· Operation Risks: The integration of the two companies may not go smoothly. For example, if Company A is disliked for any reason, customers of Company B may leave when they discover that it has been purchased by Company A. Integrating workforces can also be challenging, especially when different company cultures are involved. Merging technological systems and business processes can also be complicated, possibly resulting in unforeseen losses.
· Legal Risks: The deal could be legally challenged. For example, government agencies could argue that the merger or acquisition would create a monopoly. Publicly traded companies could also be accused of failing to provide the disclosures required by the SEC.
The Potential for M&A Litigation
When M&A deals do not go smoothly, lawsuits can result. Although lawsuits can vary, here are some common claims:
· Breach of Fiduciary Duty. Shareholders could accuse directors of a breach of a fiduciary duty for failing to maximize shareholder value.
· Breach of Representations and Warranties. The buyer could accuse the seller of providing inaccurate, incomplete or false information, resulting in overpayment.
· Lack of Due Diligence. Stakeholders could file a lawsuit claiming that the decision makers failed to assess the risks adequately, resulting in financial loss.
Impact on Business Insurance for M&A Deals
An M&A deal involves risks that may not be adequately covered under regular business insurance. However, there are specific insurance products designed to control risks associated with M&A activity.
· Representations and warranties insurance, or R&W insurance, provides coverage for unknown exposures in an M&A transaction. According to the American Bar Association, approximately one-third of M&A deal disputes involve the seller’s representations and warranties. R&W insurance provides coverage for unforeseen costs caused that result from representations or warranties.
· Contingent liability insurance provides coverage for known exposures in an M&A transaction. For example, if a company being acquired is known to have employment disputes or other litigation exposures, contingent liability insurance can provide risk transfer.
· Tax liability insurance provides coverage when there is a known tax liability, but the amount of the liability is unknown.
· D&O insurance, or D&O insurance, provides coverage for lawsuits against business leaders for certain actions performed in the course of their duties, often involving things like breaches of duty and negligence. It is not designed solely for M&A activity, and businesses that are not going through M&A deals can also benefit from coverage. However, during mergers and acquisitions, directors are making high-stakes decisions, so securing D&O coverage takes on a heightened level of importance. Organizations should also insurance that their D&O policies are suitable for new risks.
Mitigating Risks with Transactional Risk Insurance Solutions
Transactional risk insurance is often seen as a way to protect organizations and the directors who serve them from litigation. While this is important, insurance plays another vital role in M&A activity. By controlling risks, insurance can actually help M&A deals happen in the first place.
Many M&A deals fall through because the two organizations involved cannot agree on terms. For example, imagine that Company A wants to buy Company B, but there are concerns regarding the tax liability. The leaders at Company B try to reassure the leaders at Company A that it will not be a problem, but there are doubts. The leaders at Company A are worried that they will be sued by stakeholders if the tax liability is more than anticipated. The deal could fall through as a result. However, by purchasing tax liability insurance, this risk can be managed, and the deal can proceed.
Likewise, R&W and contingent liability insurance can help smooth over negotiations to support dealmaking. With insurance in place, the buyer has peace of mind knowing that unforeseen liabilities or liabilities that are more extensive than expected are covered.
Choosing the Right Mergers and Acquisitions Insurance Partner
Mergers and acquisitions are complicated, and the insurance required for them can also be complicated. An insurance agency that’s experienced in M&A insurance can provide insights as well as access to coverage to help businesses cover their risks adequately.
Each deal is unique, so a personalized approach is critical. This can help businesses avoid dangerous coverage gaps that could lead to uncovered litigation. It can also help businesses avoid paying for coverage they don’t need.
Do You Need M&A Transaction Insurance?
Do you need help securing insurance for mergers and crafting your business risk management strategy? Watkins can work with you to understand your unique needs and exposures and provide tailored M&A insurance solutions. If you’re interested in learning more, reach out to us to set up a discussion.
