Considerations When Buying a Division or Assets From Large Seller
When buyers are contemplating the purchase of a subsidiary or assets from a large seller, there are several additional items to consider when conducting insurance due diligence. Particular focus on expense methodology, balance sheet reserves and where reserves are held as well as access to seller’s pre-close insurance policies is critical.
Buying a subsidiary or assets from a large seller can be a complicated process, and navigating insurance due diligence is no exception. With potential risks lurking around every corner, it's crucial to pay particular attention to expense methodology, balance sheet reserves, and access to pre-close insurance policies. These factors can significantly impact the outcome of a transaction, making it critical to conduct thorough due diligence and understand the implications of each consideration.
This case study outlines some of the issues that can arise when buying a division of a large seller. The items identified below are not meant to be all inclusive and there are several other considerations which should be considered, including: access to seller insurance policies, settlement of claims, sharing of technology systems and impact on cyber insurance, directors & officers liability, environmental, etc.
Buyer: Private Equity Firm
Target: Division of Large Publicly Traded Company
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.
Alliant note and disclaimer: This document is designed to provide general information and guidance. Please note that prior to implementation your legal counsel should review all details or policy information. Alliant Insurance Services does not provide legal advice or legal opinions. If a legal opinion is needed, please seek the services of your own legal advisor or ask Alliant Insurance Services for a referral. This document is provided on an “as is” basis without any warranty of any kind. Alliant Insurance Services disclaims any liability for any loss or damage from reliance on this document.
Thanks for your message.
We’ll be in touch shortly.
News & Resources
M&A Roundtable: Reps and Warranties Insurance Impact on Healthcare
Jon Gilbert and Kaitlyn Murphy speak with Brian Barger and Larry Shapiro, Alliant, to highlight the importance of Reps & Warranties insurance for healthcare and what trends to expect in 2023. They discuss the unique elements of healthcare investments, regulatory requirements and how private equity buyers can prepare for the best outcomes.
M&A Roundtable: Portfolio Management Practices and Challenges
Jon Gilbert and Tim Conlon sit down with Matt Cole, SBJ Capital, to discuss the techniques the firm has used to safeguard their portfolio companies. They reveal the challenges faced over the last year, how to integrate safety and risk management practices, retain a reliable labor force and how cybersecurity has impacted portfolio companies.
M&A Roundtable: Supply Chain Risk and the Impact on Portfolio Companies
Jon Gilbert and Tim Conlon, Alliant M&A, sit with Jon Van Tuin, P4G Capital, to discuss how portfolio companies have been impacted by supply chain risk, how they can manage that risk and what the remainder of 2022 and 2023 has in store for the M&A market.