Considerations When Buying a Division or Assets From Large Seller

Buyer was targeting the purchase of a division/subsidiary of a large publicly traded company; division was approximately $200 million in revenue, representing a very small percentage of seller’s overall business. The division was also considered a high-risk company with significant cost and claims activity related to worker injury and vehicle use. This division was afforded insurance as part of the parent’s program. Under the parent’s program, there were significant deductible thresholds ranging from $1 million to $5 million which further complicated handling of pre-close insurance liabilities as well as impact to insurance cost post-transaction as a stand-alone business. The negotiated structure of transaction was for the buyer to assume pre-close insurance related liabilities which complicates insurance considerations further. Additional areas of concern included:

• Risk Transfer Loss of Economies of Scale. The division will need to secure coverage on a stand-alone basis and will lose benefits afforded by a large parent program as post-transaction no insurable interest will exist. Additionally, the deductible thresholds for the parent entity are greater than the risk tolerance levels that the divested entity could sustain on its own. As such, it is critical to quantify this potential financial impact as soon as possible in due diligence. In this case, the increase represents a $1.5 million - $2 million increase in cost.
  
  
• Self-Insured Expense. To compound matters relating to the expense, the seller has been under-expensing self-insured deductible claims/losses at the subsidiary by over $0.5 million, resulting in another significant impact to EBITDA post-close. This was likely not uncovered by the seller’s advisors as the amount, while significant for the division on a stand-alone basis, was immaterial to the seller entity as a whole.
  
  
• Adequacy and Location of Balance Sheet Reserves. As is often the case when there is an underreporting of self-insured expense, the balance sheet reserves were found to be inadequate by over $3 million. Additionally, the reserves were held on the parent’s balance sheet and these current and long-term liabilities, approximately $8 million, needed to be pushed down to the subsidiary balance sheet which impacted overall liquidity of the business on a stand-alone basis.

While the above is not all inclusive of the issues to uncovered and created potential issues, Alliant was able to identify the following opportunities to mitigate the magnitude of issues identified:

• High Claim Costs. Upon a benchmarking review, the claims costs appeared high by approximately 20-30% when compared to industry and jurisdictional peers. This was likely the result of a forgotten subsidiary by a large seller and by applying the right focus to pre- and post-loss initiatives, Alliant was confident that the cost could be reduced. After a couple years of work, the Alliant team was able to work with the stand-alone company to reduce expense by over $1 million.
  
  
• Unmanaged Legacy Reserves. Similar to the lack of focus on safety and post-incident actions, the division pre-close legacy reserves appeared quite high. Alliant worked with the stand-alone company to accelerate the closure of legacy claims and appropriately reduce balance sheet reserves. This resulted in a reduction of legacy Balance Sheet reserves by 25% or $2.2 million.