Buying or selling a business can involve tough negotiating. You need to tackle stumbling blocks as they arise or the deal may stall or fail.
Maintaining the momentum of merger or acquisition negotiations is probably the most important element in reaching an agreement. If the common problems of deal broking cause the parties to keep leaving the negotiating table for periods of time, the will to complete the transaction can evaporate. Eventually the deal fails.
Mergers and acquisitions (M&A) form a key plank of many enterprises' strategies for growing shareholder value. If one deal falters, a buyer may quickly find a new opportunity. This is bad news not only for the vendor but for everyone involved. Both parties will normally have already committed substantial sums in professional fees.
Conflicting perceptions
All M&A deals centre around the perceptions of the parties involved. Price is the first hurdle. The vendor's and buyer's views of the worth of the business worth rarely correspond.
After agreeing on price, the parties then have to negotiate the sale and purchase contract. The buyer usually tries to obtain comprehensive warranties and indemnities to cover the wide range of potential corporate liabilities being acquired with the business. This can delay reaching agreement - and sometimes even break a deal. Through the disclosure process, the buyer attempts to identify all facts that may have an impact on the contract. Again, perceptions play a major part in keeping the deal on the rails through this stage. What one side considers as immaterial to the sale and purchase agreement, the other will see as having potential for financial catastrophe. This applies to both the vendor - who may have to pay out huge sums for warranty breaches - and the buyer who finds that the vendor does not have the requisite funds when called upon to indemnify the liability.
Managing the problems
Wranglings often lead to one or other party leaving the negotiating table for weeks at a time. This can eventually sap the will and confidence of all those involved. It is crucial to manage problems carefully, to minimise their impact on the momentum of the negotiation. Warranty and indemnity insurance is often an appropriate solution It isn't just a matter of arranging off-the-shelf cover. The advisers involved in the deal, ranging from corporate financiers to lawyers, need to work closely with the underwriters to identify each problem and devise specific solutions. Sometimes, this problem-solving process throws up other issues. The insurers may need to appoint additional specialist advisers, who are better placed to quantify the level of exposure accurately.
The important point is that vendor and buyer only need to agree on the proposed solution put before them, rather than work through a complex issue. While they keep talking, the deal has a much greater chance of success.
To match the international status of many M&As, there are no geographical limits for warranty and indemnity insurance. It can be underwritten in any legal jurisdiction in the world. Typically, it covers the full period of the warranty dictated in the sale and purchase agreement, normally two to three years. Where the warranty covers tax liability, it may extend to up to seven years. Maximum cover for liabilities is generally £100 million on any one risk, but higher limits are available.
The vendor normally pays the premium. After all, it is in the vendor's interest for the deal to go through at the agreed price. However, everyone benefits from reaching an agreement smoothly without wasting time or incurring unnecessary costs.--
Eddie Barnes is managing director, Special Risk Services Underwriting Agency, Tel 020 7454 1800. E-mail: eddie_barnes@srsua.com
Case studies
The following recent case studies, in which SRS was involved, demonstrate the problem-solving process in practice:
A major city financial institution with an extensive discretionary fund management arm was in the process of being sold when disclosure problems arose. Not unreasonably, the purchaser sought extensive warranties regarding compliance and regulatory liabilities. It became concerned when it was unable to measure the potential liability for future compliance claims, leaving it with unlimited exposure. It did not wish to rely on its ability to sue under the warranties and demanded a full indemnity from the vendor. The latter was unable to accept this, as it was not in control of the day-to-day running of the business. It so happened that this particular business area was run by independent management, who held a small percentage of the equity but did not themselves have sufficient personal assets to stand behind unlimited indemnity.
We appointed a specialist firm of consultants experienced in Personal Investment Authority (PIA) regulations to advise. Their team went into the discretionary management arm of the client in order to review its compliance procedures fully for any known problems, previous PIA investigation results, and to discover any outstanding issues which had yet to be addressed.
Following this full review, they were able to quantify the potential financial impact and report within four working days. It was then subsequently possible to create a solution which insured the element of excess liability over and above that which the parties were prepared to indemnify themselves.
A large proportion of the business of a potential acquisition involved selling pension products. Like other pension providers, new legislation required it lo review its historic sales to identify clients who might have been badly advised and to whom compensation might be payable.
Industry practice involved sampling a number of cases on a pre-determined ratio to the whole of the book of business. Mathematical calculations then produced a notional figure for which to make provision. The buyer was wary of the accuracy of this calculation. We employed specialists to carry out a full review of the potential liability. They identified a sum believed to be more accurate. With the level of exposure identified and accepted by the parties, insurance covered any amounts exceeding the figure, and the purchase proceeded..
During the course of disclosure in the sale of an aircraft leasing company, it was discovered that its Memorandum and Articles of Association did not actually allow it to grant leases. Thus, every lease on its books was completely void and unenforceable. The sole asset being acquired by the purchaser was the rental stream flowing from these leases. With no legally enforceable contracts, the buyer would be unable to sue for payment if any client defaulted. We designed cover which guaranteed payment to the new owner if it were unable to enforce any of its leases. This not only kept negotiations going but made the sale possible.
