The use of W&I insurance in the context of company acquisitions has become standard procedure. Through the targeted use of synthetic elements in the W&I policy, the parties can optimally cover the needs of both sides and create a coverage position that ensures maximum exclusion of liability for the sellers on the one hand and comprehensive coverage for the buyers on the other. From the seller’s point of view, it is advisable to plan W&I insurance and especially the use of synthetic solutions into the process at an early stage.
After the use of W&I insurances and other M&A insurance solutions has become a common, naturally used and frequently assumed tool in larger transactions in recent years, more recent developments show the increased use of synthetic solutions. In the following, “synthetic solutions” are understood to be all arrangements that provide for a liability in the relationship between the insurer and the policyholder with regard to guarantees or indemnities that is not inherent in the purchase contract – i.e. between the seller and the policyholder. This includes both certain so-called “enhancements” of agreed guarantees as well as the completely independent coverage of certain risks, for example through a purely synthetic tax indemnity. It can be seen that the targeted use of synthetic elements not only provides further liability relief for the seller, but also brings attractive advantages for the buyer in a transaction designed around the use of an M&A insurance policy. The following article presents the targeted use of synthetic elements in the context of a typical sales process and at the same time shows that such arrangements can also be used sensibly in mid-cap transactions.
2. Integration into the M&A process
The integration of a W&I insurance policy into the sales process should take place as early as possible in order to be able to approach a broad number of providers, to close any gaps in the due diligence that is fundamental to the W&I insurance policy and thus ultimately to achieve an optimal coverage position.
Depending on the details of the sales process, the procedure is somewhat different: In a 1:1 situation, it may well be expedient for the buyer or even the parties to jointly engage a broker to find a suitable provider. Here, the cover position is based on a pre-negotiated, possibly already signed purchase agreement and an attempt is made to achieve the greatest possible cover for this negotiated position.
However, the focus of this article will be on the sale of a company within the framework of a structured auction process. In such a process, too, a purchase agreement was traditionally negotiated first, which was then placed on the market via a broker. If it was not possible to obtain coverage for certain points, either the scope of the guarantees was adjusted or, under certain circumstances, the seller’s liability was agreed.
Recently, however, a different procedure has become established, at least for larger transactions (upper mid-cap and large-cap), which among other things allows the targeted use of synthetic elements. Here, the seller first drafts a purchase agreement with a realistically expected final set of guarantees and has a broker conduct a market approach before negotiations begin. Instead of only presenting a draft of the purchase agreement to be negotiated in the bidding process, the seller then gives the bidders access to the broker’s NBI report (Non-binding indications – an overview of the offers of the approached providers of W&I policies). The bidders then negotiate a W&I policy with the preferred provider before submitting their final offer and on the basis of their final, regularly pre-negotiated mark-up. The cover position agreed there is used as a basis for the final offer, so that further discussions about cover are regularly no longer necessary – or no longer to any relevant extent – after the offer has been submitted and the policy can be concluded quickly. This then includes, in particular, agreeing on synthetic aspects with the selected insurer in order to arrive at a coverage of risks that is sufficient for the bidder.
3. Drafting the purchase contract
The same transaction structure is increasingly found in smaller mid-cap transactions. However, as some bidders in these structures regularly have less experience with W&I insurance, closer guidance from the investment bank managing the transaction and the advising lawyers is necessary in this respect. This should already be taken into account when drafting the first seller’s agreement. In practice, it has become apparent that the use of synthetic structures is increasingly assumed and that the seller’s drafts have once again become much more seller- friendly. In order to avoid frictions, especially in smaller transactions, it is not only advisable to make explicit references to the possibilities of synthetic cover to less experienced bidders, but it should also be clear from the draft SPA and the NBI report which synthetic elements are associated with which additional costs in order to avoid later discussions on the bearing of costs.