Clearing the M&A minefields: risk management due diligence

By Todd Miller, Oswald Companies

Risk management due diligence in a private equity deal is often the difference between a smooth transaction and one that is burdened with delays, excessive costs and damages to goodwill. Investors are wise to consider insurance issues early in any transaction, as time investments are needed to properly evaluate threats inherent to future insurance arrangements.

Key person life insurance

The placement of key person life insurance in advance of a transaction’s closing is needed any time a new CEO takes over. The finance packages for most deals will require it. Considering that the typical life insurance policy needs six to eight weeks to be medically underwritten, this is an issue that demands early attention. A “bridge” policy, which can be placed within a week, is an expensive alternative that can be avoided.

Employee benefit programs

Materially different risks exist between fully insured and self-insured employee benefit programs. The buyer’s appetite for these associated risks can differ too. The restructuring of benefit programs to fit the buyer’s risk tolerance can be affected more readily in advance of a deal, as placing new coverage can take a minimum of four to six weeks.

Management liability

Existing policies for directors & officers, employment practices and fiduciary liability terminate immediately when ownership changes, which means new coverages are essential when a transaction closes. Benchmarking studies reveal that the probability of management liability claims increases significantly when a change in ownership occurs. The underwriters of these coverages recognize that a new business is being created from the standpoint of a potentially leveraged balance sheet, new management and changes to operations. Careful consideration needs to be given to management liability coverages and the underwriting concerns of carriers in order to get the best deal and avoid coverage gaps – or worse – a lapse in protection.

Workers’ compensation

A rise in workers’ compensation claims often follows the arrival of new management or a corporate restructuring. A resulting increased focus on strategic concerns can lead to less attention on daily operational matters. When these changes coincide with a plant closure, the risk of employee morale depreciating invites more chance for workplace injuries. If a business funds its losses with retrospective or large deductible programs, significant tail liability exposures are possible when winding down claims. These exposures make the value of a game plan for addressing these risks critical to deal success.

Property insurance

Many times real estate is not part of a deal, so considering the insurance implications of a newly formed lease arrangement is critical to success. Careful inspection of a lease needs to be performed to ensure that any insurance is structured correctly and provides appropriate coverage for all parties. Otherwise, investors risk adopting a new lease that is more favorable to the landlord, forcing provisions for more coverage than anticipated. Analysis of lease terms is critical to properly insuring the business interests of investors.

Surety bonds

A business that requires performance or surety bonds is generally impacted with stringent underwriting terms, and possibly restructured collateral requirements, once a balance sheet is more leveraged. A surety’s requirement for any personal guarantees might also be problematic. Investors are wise to explore these issues in advance with a surety professional, especially when the business is highly dependent on surety bonds for successful operations and revenue streams.

Evaluating these risks is critical when mapping a pathway around threats to ideal success. An upfront investment in risk management expertise can allow a private equity team to maintain focus, control costs and realize the rewards of enhanced reputation.

Todd Miller is an account representative with Oswald Companies, OSCPA’s insurance advocate. Miller can be reached at tmiller@oswaldcompanies.com or 614.246.8502.

More news