Risk and insurance diligence are often overlooked in small and mid-sized business M&A deals. In this video, I’ll explain why I think that’s a mistake and provide examples of situations where our advice helped ease transactions and provided value to the buyers and sellers.
Hi, I’m Gordon Coyle. Welcome to my website, where we talk about the risk and insurance issues on business owners’ minds. As an expert business insurance broker, I help business owners make better decisions around insurance. If I can help you, please reach out and connect.
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So, let’s start by defining how I define risk diligence for small or mid-sized transactions. Typically, these are deals under $25M in enterprise value and very often in the $2M to $5M EV range. Business brokers, M&A advisors, and other transactional professionals in various industries often facilitate transactions.
Now, let me describe what risk diligence is for this market segment.
Risk diligence involves having a skilled broker or a consultant examine the target company’s insurance policies and related reports in depth for the buyer’s benefit. Risk diligence gives the parties to the transaction a better understanding of several critical factors, including:
- The adequacy of existing coverages, the need for adjustments post-close, and what budget considerations need to be made for those adjustments.
- The existence of coverage gaps and exclusions or missing coverage forms that may affect the buyer. Again, the cost considerations to fix these problems are also important.
- Assessment of insurance costs moving forward.
- Understanding the claim experience and potential “rough spots” operationally that could be problematic for obtaining insurance, or pricing increases in the future.
- Discuss the required run-off of claims-made policies and how to handle them.
- Recommendations for post-acquisition insurance strategies.
- Analysis of claims and pending claims and addressing potential claim severity issues that can impact costs and enterprise value.
Overall, risk diligence gives the buyer a comprehensive understanding of the seller’s risk landscape and how well it has been managed. It enables more informed decision-making and a strategic planning process for onboarding the acquired entity.
A thorough risk diligence process helps mitigate potential unaddressed risks in the transaction, leaving the buyer open to unplanned costs, potential liability, and financial losses post-close.
Without this level of assurance, buyers may unknowingly acquire unnecessary risks and costs that impair the value of a deal.
Why does risk diligence make sense?
I have been pulled into last-minute negotiations to resolve insurance issues not discussed or reviewed before a deal’s closing. The finish line is not a good time to find out that insurance protections are missing or that the current policies are not assumable.
Being prepared and informed well before a closing helps eliminate surprises and unnecessary fire drills. I realize that everyone wants to close a deal on time, so engaging us in risk diligence early helps avoid problems.
Examples of issues identified
Here are a few examples of how our risk diligence reports have turned up in the small business market over the past few months.
- A seller had over 100 employees but never purchased Employment Practice Liability insurance for potential wrongful employment act claims. The buyer, a bit more savvy, required coverage to be in place retroactively for claims that could arise post-close for acts that took place before the close. We arranged the coverage, the buyer was happy, and the deal closed on time.
- On a buyer’s behalf, we analyzed a contracting firm’s insurance policies. We identified that the payroll used in rating the company’s general liability policy appeared to “be off” by more than $200,000. This policy was to be replaced post-close and would have created a $6,000 additional premium on audit. That amount was marked off in the seller’s proceeds to account for that difference.
- In a distribution company, where several trucks were used daily for deliveries, we told the buyer to ask the seller for a historical report on all the drivers’ motor vehicle reports. The seller never ran MVRs, which they should have, so we suggested that the buyer obtain permission. They got the MVRs and found that several drivers should have been ineligible for driving duties. This put the deal on ice until the seller could find and hire eligible drivers. The buyer was disappointed but happy we identified this potential liability risk before they inherited a pool of drivers with poor driving records.
- In my final example, the seller is an e-commerce business, and we identified several missing coverage parts; most importantly, cyber insurance protection was missing. We estimated the cost of re-building the coverage portfolio, including the missing coverages, so the buyer could properly establish their pro forma budgets.
While some of these issues may seem minor, they weren’t minor to the buyers we worked with. Getting the protection right and knowing the problems were discussed and covered were critically important for the buyers and their offers on these deals.
What does risk diligence cost?
For most small business deals under $10M in enterprise value, we charge a flat fee of $2,500. For EVs over $10M I’m open to negotiate these fees. I’m also open to negotiating special rates for buyout firms with a regular volume of deal flow.
One last point.
I am a big fan of M&A insurance, a form of coverage that both buyers and sellers can deploy to protect them from potential liabilities arising from the representations and warranties made in a transaction. I’ve made a video of that, which can be viewed here.
If you want more information on how we approach mergers and acquisitions, including our diligence services, and how we can shepherd your deal regarding insurance, please reach out and connect. Hit the Get Insured Button above to get started.
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