Insights

Case Study: Small Software Company Funded by PE Firm and R&W Insurance Got the Deal Done
POSTED 11.19.19 Insurance

Steven Epstein, founder of RedCAT Systems, and his partners and management team had slowly but surely built their company in a highly specialized niche serving top clients, including those in the Fortune 500. They were ready to sell to take the company to the next level.

But this small, Colorado-based software company involved in HR and compensation solutions for clients like LinkedIn, Uber, NYSE, and many more wasn’t interested in being acquired by just anybody.

They were looking for a partner who wouldn’t accelerate growth too fast or take on too many new clients too quickly because they wanted to ensure a slow growth strategy that would keep current clients happy and give the new ones the same high level of customized service they’re known for. In their specialization of executive compensation, which has a lot of moving parts, this counts for a lot.

After a time, they found their match – a company that understood their business culture – and were recently funded by PE firm Broadtree Partners.

“We wanted to make sure that our clients were treated well. It’s a very high-level service. There’s really nothing that we would be asked that we weren’t able to fulfill on time, on budget, and pretty much the experience was exceptional. That’s why we were able to get the type of work that we do. And we wanted someone who would share that philosophy and maintain that while at the same time doing measured growth,” says Steven, of RedCAT.

As with any M&A transaction, there were some hiccups along the way… as well as one major obstacle that could’ve derailed the whole deal, and probably would have, if this transaction was being negotiated prior to 2019.

This is an in-depth examination of this real-world M&A transaction. We first got the story from the Buyer’s perspective – you can check out that article here. Now, we’re hearing from the Seller as we explore how the deal went down so that both sides were happy. Additionally, Steven was featured on my podcast, M&A Masters. You can listen to his episode here.

The Anatomy of a Deal

Once Broadtree and RedCAT had a signed a Letter of Intent, it took roughly nine months to close the deal.

One of the things that stalled the deal moving forward was due diligence. Broadtree was more used to dealing with larger companies that had more in-depth and detailed financial records that could be combed through. It took a while for RedCAT management to get all the required information together.

“As a company, if that was your plan [to be acquired], I would just keep much more meticulous track of every single document,” says Steven. “Every little bit of every single dollar that was ever spent took a lot of effort to come up with… and then thousands of pages of contracts we had already signed. Looking at and reviewing every single thing took quite a while.”

Tech due diligence – which involved making sure no code or other IP could be claimed by another party – also took some time to get through.

But what was the major sticking point?

One of RedCAT’s partners, who had been burned in business deals in the past, wanted some protection. Specifically, he wanted to use Representations and Warranty insurance so that less money (including his) would be held in escrow and there wouldn’t be any threat of clawback.

With R&W insurance, if there are any breaches in the Seller’s reps, it’s the insurance company – not the Seller – who reimburses the Buyer and pays the financial damages. Those claims do get paid, and this coverage is reasonably priced.

Often the Seller pays for the insurance because of these benefits. But there are plenty of reasons for a Buyer to get on board, too. For one, in case of a breach, they don’t have to go after their new team members (the Sellers) who’ve joined the company after the acquisition for damages – that’s very awkward. Also, there is no need for costly or time-consuming legal action. The claim gets paid, and everybody goes about their business.

“[R&W insurance] allayed our partner’s fears, basically of the deal and the liability,” says Steven. “If something did come up, I think it would be tremendously beneficial to have it. Let’s say we didn’t have R&W, and we put in $1.5, $2 million in escrow. And then some kind of obscure thing comes out, and we disagreed with it. That would cause a serious breach. Not only of, say it’s a million or two dollars, but then we probably wouldn’t want to stay on. And the effect is most likely the failure of the new business.”

The Status of R&W Coverage Today

Just a short time ago, this wouldn’t have been possible because insurers were only offering R&W coverage for larger deals. But recently, we’ve seen an increase in Underwriters crafting policies for transaction sizes under $20M, which opens up this insurance to a whole other section of the M&A world, including lower middle market companies like RedCAT.

For Steven, the R&W coverage offered more than financial protection.

“The peace of mind can be priceless. Just the feeling that I don’t have to worry about this. We’re covered. It’s not a thing that will A) damage the relationship and B) just consume life energy where you’re fighting about something that is likely frivolous.”

That’s a ringing endorsement for Representations and Warranty coverage. If this case study has interested you in this specialized type of insurance, tailor-made for M&A transactions, and now available for deal sizes under $20M, contact me, Patrick Stroth, at pstroth@rubiconins.com.