As we consider the potential sales of assets during the COVID-19 crisis, we can draw on our experiences from 2008, when many companies sold underperforming divisions or areas of their business that were deemed “non-core” in order to raise cash in the wake of the Great Recession. Having represented many private equity buyers in these “special situations,” we know that transactional risk, insurance, employee benefits, and human capital products and services are a much more important part of the conversation than in a typical acquisition.
These areas are usually viewed as a Buyer’s concern, however, they get intensified in these transactions leaving Buyer and Seller with a lot to understand within a short exclusivity period. The following summarizes some of the unique aspects of these transactions that make propping up the New Company (NewCo) very challenging:
Reps & Warranties insurance is an integral part of most leveraged buyouts (LBO’s) and virtually every private equity buyer is familiar with its utility. However, R&W underwriters will likely have more questions than usual in order to get comfortable covering the myriad of Tax risks that are unique to these deals. As a result, a separate Tax insurance policy could become a consideration and create a separate workstream that might be new to some Buyers.
Employee Benefits incl. 401(k)
For most companies, employee benefits is the second highest spend after payroll. In this type of transaction, Seller’s employee benefits offering will likely have “large company” features and preferred pricing. Buyer’s broker will have to quickly determine what it will cost to replicate the current benefits offering in order to limit employee disruption. Completing all of this pre-acquisition is critical to understanding how this will affect NewCo’s benefits spend in the short and long-term. We expect the information flow to be inconsistent, which can exacerbate the challenges.
NewCo’s insurance program will look much different than Seller’s. NewCo will have policies with lower limits, lower deductibles, and possibly fewer lines of coverage. Designing the program and estimating the cost is one thing, but it is vital to craft a solution that satisfies customer and vendor requirements and addresses legacy exposures that are assumed in the purchase agreement. At the same time, insurance coverages like Property, Auto, Workers’ Compensation, General Liability, etc. should not be addressed through a Transition Services Agreement. These policies should be replaced at close.
Human Capital / HR Services
Depending on the specific skill sets of the HR professionals that come with the acquisition, NewCo might have to outsource some important strategic, technical, and administrative facets of the HR function until the post-close team can be fully staffed.
How Seller can Simplify the Process
Addressing the aforementioned items will take a significant amount of time, have an impact on valuation, and create disruption for employees that are going through enough already. It is very difficult for all of this to happen in “LBO time” if Buyer starts their process at the term sheet stage. That’s why we recommend some proactive planning on behalf of Seller that results in a package that can be offered to Buyer that avoids extensive negotiation and makes for a smoother process:
- Require Buyer to Purchase Reps & Warranties Insurance in the Term Sheet: Reps and Warranties Insurance facilitates transactions by transferring some, or all, of a Seller’s indemnification obligations for breaches of reps and warranties to a third-party insurer, typically benefiting both Buyer and Seller. Policies can be placed on behalf of the Buyer or Seller, but policies are almost always purchased by the Buyer.
- Take the Time to Understand How Tax Insurance Works: Carve-outs result in unique tax questions and issues. Reps & Warranties underwriters will have more questions than usual in order to get comfortable covering tax matters on a carve-out the way that they would on a typical acquisition. That’s why it’s important to know the ins and outs of Tax insurance before the sale process starts.
- Determine How Legacy Liabilities Will Be Addressed: A Seller might be unable or unwilling to expose their balance sheet to pre-close claims reported post-close. Especially if Seller has very high retentions (deductibles) for many of their insurance policies or choose to self-insure some exposures. In those cases, taking responsibility for these legacy exposures can have a significant impact on transaction proceeds. There are insurance solutions that Buyer can utilize to transfer this risk for most lines of coverage. It can be time consuming to find solutions, so it will be important for Buyer to know how this will be handled early in the process. Buyer might prefer to find their own solutions for these scenarios because these claims will be reported on their watch potentially impacting their customer relationships and market reputation.
Employee Benefits incl. 401(k)
- Identify the Employees That Will Be Part of the Deal: There are enough factors and variables that go into the derivation of employee benefits costs that projections will always be the result of as much art as science. Employee benefits costs are driven by many factors, but age, gender, and state of residence of employees are some of the largest determinants.
- Share the Utilization of Employee Perks and Point Solutions: NewCo probably won’t be able to replicate everything that’s included in Seller’s employee benefits offering. Sharing what the employees will utilize will be very helpful to Buyer.
- Start Thinking About a Transition Services Agreement: It takes at least 90 days to properly market, present, choose technology systems, and implement a new employee benefits program for NewCo. In order to limit disruption to employees, Seller will likely be asked to enter a TSA for some period post-close. If Seller is self-funded for Medical and other policies, it can create complications when quantifying the cost for post-close claims. Thus, making it important to end the TSA arrangement as soon as possible.
- Determine Coverage and Limits Requirements in Customer Contracts: Limits and deductibles purchased are driven in large part by contractual requirements. Clearly laying out NewCo’s top 10-20 customers and listing the limits and deductibles that are required will give Buyer a starting point.
- Try to Allocate Historical Insurance Claims Down to the Division You’re Selling: Historical claim experience can be among NewCo’s most influential cost determinants. Most large companies either do not allocate individual claims down to operating divisions, or they don’t track them in a way that perfectly aligns with the part of the business that’s being sold. While this data is typically among the most difficult information to obtain, trying to figure out which claims can be attributed to NewCo will be very helpful.
- Identify the Facilities and Equipment That Will Be Part of the Deal: In some cases, seemingly unimportant items, such as a building’s square footage, construction type (e.g. wood frame vs. steel vs. non-combustible), or the type of fire suppression equipment in place, can make a big impact on insurance premiums.
- Document Which HR Functions the Ongoing Team Can and Cannot Perform: It is unlikely that Buyer will obtain a fully functional HR team in the acquisition, so outsourcing becomes a serious consideration. You can help Buyer by documenting which skill sets are not included in the team that’s going with the deal. That could include select, high touch processes, such as on/off boarding, recruitment, and leave of absence administration. In some situations, they might have to outsource all employee relations, HR compliance, and payroll.
About the Authors:
M&A: Josh Warren is a Senior Vice President and M&A Advisory Practice Leader at ABD Insurance and Financial Services. Prior to joining ABD, Josh spent 15 years at Equity Risk Partners, an insurance brokerage and consulting firm concentrating exclusively on alternative asset managers. In 2013 and 2015, Josh was named a Power Broker by Risk & Insurance Magazine in the Finance – Private Equity category. He can be reached at firstname.lastname@example.org or 312-300-5759.
Transactional Products: Matt Somma is a Vice President in the ABD M&A Advisory Practice. Matt focuses on Transactional Risk solutions such as Reps & Warranties, Tax Liability, and Contingent Liability. Matt’s responsibilities include leadership, placement, and claims handling of Transactional Risk products such as Reps and Warranties and Tax Liability. Prior to joining ABD, Matt was a corporate attorney specializing in M&A and project finance, as well as a Transactional Risk Underwriter at The Hartford and BlueChip. He can be reached at email@example.com or 203-585-3552.
Employee Benefits: Carolyn Locke is a Vice President in the ABD Employee Benefits Practice. Carolyn focuses on employee benefit consulting to support clients’ financial objectives, while also enhancing the member experience. Carolyn and her team of experts specialize in building unique total rewards programs and leveraging technology to provide the optimal employee experience throughout the entire employee lifecycle.
HR Services: Megan Coen is an Executive HR Consultant / Vice President in the ABD HR Services Practice. As an Executive HR Consultant, Megan brings a diverse HR background spanning over 10 years to the ABD SharedHR team. Her career has encompassed recruiting, immigration and global mobility, benefits, performance management, employee relations, M&A, PEO extraction, and HR Technology.