Making M&A’s work

Numerous studies conducted over the years on the relative performance of M&A transactions suggests that a substantial proportion of mergers and acquisitions underperform their industry index - or fail to achieve the financial, human or growth synergies pr

However, another key contributor to such underperformance is the frequent “incomplete appreciation of the cost of poor risk analysis and mitigation in the M&A processes” says Spiros Fatouros, Private Equity and M&A Practice Leader, Marsh Africa.

With Africa tipped to be the M&A hub of the next decade, when it comes to acquisitions “a clear understanding of the target’s risks and their impact on the valuation, future performance and financial structure of the transaction can lower the level of uncertainty and reduce the risk of surprises after the deal closes” explains Fatouros. Similarly, on the disposals front, increasingly thorough due diligence processes often bring unexpected risks to light, jeopardising deals from the outset. “Addressing these issues before a sale process is initiated can provide ammunition to counter price reductions or help maximise value” says Fatouros.

On the acquisitions front providing information underpinned by insurance solutions can support and augment the work of the bankers and lawyers by:

• Providing a more efficient purchase price;
• Improving the sale and purchase agreement;
• Driving a smoother and faster integration post-closing.

On the disposals front Marsh has found that some of the reasons for corporates not maximizing value on divestments include:

• Overstated self-insurance accruals understate Operating Income, leading to the acceptance of too low an offer price;
• Post completion deal crises, such as divested operations not making a clean break and legacy liabilities reverting to the parent along with unforeseen warranty and indemnity claims.

“But what does this actually mean when it comes to getting the nuts and bolts right in an M&A process?” asks Fatouros.

Practical examples on the acquisitions side include:

• Identifying gaps in the insurance cover purchased for the benefit of the target. For example, low limits of liability purchased for public or product liability, no business interruption cover, or poor or absent crime or directors and officers insurance – meaning limited or no cover for legacy liabilities. Certainly, “if this is identified prior to completion, the cost of retrospective protection could be factored into the deal negotiations by the buyer - whether through contractual negotiation in the Sale and Purchase Agreement or risk transfer to the insurance market,” explains Fatouros.

• Understanding whether a target company might have obtained insurance through its parent company and whether these policy limits have been eroded by other subsidiaries of the group, leaving little or no cover for the target in respect of prior losses.

• Understanding and navigating different territories’ insurance regulations in cases where the target operates in multiple jurisdictions.

• Identifying where and when large retentions were used historically “allows us to assess the provisions that the target company has made in their financial statements for these future obligations and making the necessary adjustments for any short-falls” says Fatouros.

• Deciding whether to rely on the vendor’s warranties and indemnities.

• Using insurance to wrap-up any known liabilities that might otherwise provide stumbling blocks to the deal, effectively removing the obligation from either the seller or buyer to shoulder the known liabilities, such as environmental and certain contingent tax liabilities.

Practical examples on the disposal side include:

• Quantifying expected liabilities in respect of retained insurance losses enabling the seller to make the best decision on whether to retain the liabilities themselves or sell them for the right price.

• Where the company being sold is a subsidiary of a larger vendor group, comparing the true, stand alone insurance cost of the business being sold with the insurance allocation from the parent company, highlighting any differences that may emerge.

• Addressing risk and insurance issues under the Sale and Purchase Agreement. For example, a company selling an asset unknowingly agreed in its SPA to retain all liability in respect of asbestos risk. If this had not been spotted and covered “the seller would have continued to be liable for any claims against their disposed operation for at least the next decade” warned Fatouros.

• Ring fencing liability issues, especially environmental liabilities, using insurance where appropriate thereby taking them off balance sheet and effectively allowing the deal to close.

• Limiting the seller’s post sale liability without reducing the amount of protection afforded the buyer allows a seller to maintain corporate governance and protect shareholder value by limiting potential losses arising from warranty claims post completion. This also allows a potential buyer to offer full price for the business ,rather than a price discounted due to lack of clarity on possible future claims.

22 years of first-hand experience in M&A related risks has taught Marsh that there is no one-size-fits-all M&A package. “We have also learned the critical questions to ask - and in which circumstances” says Fatouros. This history enables a better understanding of the dangers inherent in M&A deals while providing solutions for the risks that this process may uncover.

In the final analysis, “it is only through an informed application of this hard-won knowledge and experience that M&A’s can be assured of success” concludes Fatouros.