Taking the risk out of buying and selling businesses
Mergers, acquisitions, buy-outs, hostile take-overs or simply buying or selling businesses are transactions with a high level of risk.
“Despite senior teams arming themselves with well interrogated financial statements, minutely researched market projections, and world class organisational due diligence processes it is surprising how often inaccuracies creep in” says Angela Jack, Senior Manager, Directors & Officers Liability, Alexander Forbes Risk.
Financial statements often incorrectly state the value of a business. Market research is often wrong. Or, more pertinently, trading conditions change so dramatically between the initial assessment of a business and the date of purchase that due diligence that looked water tight ten months ago looks outright frightening in the present.
Mostly though, adds Jack, “Deals fall through because the parties involved either fail to come to terms, or one of them fails to meet their obligations under the initial agreement.”
Representations and Warranties Insurance (RWI) evolved to help manage the potentially devastating financial implications of a failed transaction. While able to sand alone, traditionally RWI is provided as part of a broader suite of general Merges and Acquisition cover.
In short, “RWI ensures that the sellers get their money out while assisting buyers meet their payment obligations within guaranteed timeframes” says Jack.
This eliminates the payment delays, uncertainty, lack of trust, anxiety and panicked withdrawal that so often derails the purchase of businesses.
Since RWI is transaction specific it is tailored to cover the representations and warranties entailed in the purchase and sale agreements particular to every transaction. As such, RWI tailors a suite of cover to deal with the particular range of risks that apply in each transaction.
These can include:
- Financial statement representation
- Tax liabilities
- Environmental risks
- Political risks
- Intellectual property liabilities
- Copyright, patent, trademark and trade secret liabilities
- Employee fiduciary and benefit liabilities, for example, the provision of pension and provident schemes, post retirement medical aids etc.
So, in short, if a buyer does not receive what they thought they would receive when purchasing a business, RWIbridges the gap between the initial representations and warranties agreed and any eventual inability to meet these obligations.
No two RWI policies are the same,eachmirror the specificrequirementsof each deal.As such various industry sectorspurchaseonly those elements ofcoverappropriate to their business needs.
For example, “if you are a mine, the environmental component of your RWI cover would be large. If you are in the financial sector the financial statements representation component of your RWI might be your biggest exposure”explains Jack.
Risk cover aside, RWI also facilitates transactions financially. For example, should a private equity purchaser raise two billion rand to purchase a business it may be a requirement to keep at least 100 million rand in the business. RWI will insure the business for the 100 million rand- allowing the private equity purchaser to invest this elsewhere.
Similarly, if a purchased company agrees to receive payment in earnings from the new company RWI can insure this payout, eliminating the risk of not being paid.
From a South African perspective “a slowing economymight notnecessarily mean fewer mergers and acquisitions, business purchases or consolidations” argues Jack.
In fact mergers and acquisitions often increase in difficult times as industries consolidate - or bigger businesses buy out struggling smaller businesses etc.
In these cases RWI “acts as the ultimate deal equaliser, leveling the playing field between buyer and seller - no matter how unevenly they may be matched in size or capital” concludes Jack.
