3. Preparations on the sell-side
Due to the high complexity, detailed and thorough planning and preparation are required at the operational level, but also from a financial, accounting, tax and legal perspective. This must extend not only to the carve-out but also to the subsequent divestment, which requires a huge effort and good coordination between the various parties involved and the internal experts and external advisors. Without a convincing business model and a detailed carve-out plan, the sale process will be slowed down, which could reduce the interest of potential acquirers and thus minimize the achievable purchase price. Therefore, planning is not only key to a successful implementation of the carve-out, but also to a timely, cost-efficient and smooth completion of the sale process, which helps to avoid or at least minimise the uninsurable risk of business interruptions.
Legal and external lawyers and consultants (with the involvement of a W&I insurance broker) should be involved in the project as early as possible. The first task is usually to analyse the status quo of the target business unit and its interdependencies with the other business units of the group. Once the standalone operating and financial model has been worked out, the tax and legal structuring can be completed. A legal carve-out plan must then be drawn up to govern the various steps required for the operational and legal separation of the target business from the rest of the group. The carve-out plan is closely linked to the purchase agreement, which should provide a detailed legal framework for the implementation of the carve-out. It is also of great importance in the W&I insurance process and should also be coordinated with the insurance broker as early as possible in order to incorporate its experience with carve-out transactions and to anticipate potential pitfalls in the insurance process. The operating model and carve-out plan should also be submitted to the potential insurers so that they understand the scope and implementation of the carve-out and can assess any risks themselves. The various steps overlap to some extent and need to be carried out in parallel with the preparation of and assistance with the due diligence documentation.
4. Use of W&I insurance
The use of W&I insurance has been the absolute market standard in private equity transactions for many years and has now also established itself as market standard in strategic M&A. Even today, strategic M&A transactions in the small and lower mid-cap segment are still sometimes conducted without the conclusion of W&I insurance policies. Particularly in case of the sale of family businesses, the use of an insurance solution is often dispensed with. The main reasons therefore are, among other things, the fact that the business owner is usually active in the management, has a good overview of all aspects of the sold business and thus often qualifies the risk of warranty breaches as manageable.
Until a few years ago, the use of W&I insurance in carve-out transactions was a rare exception. This is in particular due to the greatly increased complexity compared to ordinary transactions as well as the specific risks of carve-out transactions. In addition, the liability regime in the sale and purchase agreement has developed significantly in recent years in favour of the sellers, who – like the W&I insurers –benefit from lower maximum liability limits, leaner warranty catalogues and far-reaching knowledge and materiality qualifiers in the warranty catalogue. Not least as a result of this development, the use of W&I insurance on the buy-side has now also become the market standard in carve-out transactions. In the context of auction processes, this means that bidders are regularly required to complete the underwriting process by the time the final bid is submitted.
The scope of protection in carve-out transactions usually falls somewhat short of the protection in ordinary transactions. In particular, the successful implementation of the carve-out and the independent functioning of the carved-out business after completion are regularly excluded from insurance protection. However, recent developments suggest that insurers have become more willing to insure certain carve-out risks for additional premiums. This trend towards a more carve-out friendly W&I insurance environment is likely to continue, although this will require the detailed conduct of due diligence with particular attention to the specific carve-out risks.