The typical insurance broker wants to serve all their clients’ needs, especially if it’s a large client that requires various types of insurance to cover its operations.
The motivation is to be there for the client, who you know well. And the extra commission doesn’t hurt either.
But although a broker may have the best intentions, if the insurance required is out of the broker’s area of expertise (and no broker is master of all), this practice is actually not good for clients. They’re just not going to get the best value out of their policy.
When it comes to Representations and Warranty (R&W) insurance, a highly specialized variety that covers M&A deals, this is definitely the case.
R&W insurance protects both Buyer and Seller if there is a financial loss resulting from a breach of the Seller’s representations that were outlined in a purchase-sale agreement.
If there is a breach, the insurer covers the losses because the coverage transfers the indemnity obligation from the Seller.
Buyers and Sellers entering into deals who are interested in one of these policies need a broker who specializes in R&W insurance and does it routinely. Not to mention that the broker must understand how M&A works.
In R&W insurance, it’s not what you know, it’s what you don’t know that will come back to bite you.
Here’s why: On the surface, the coverages from one R&W policy to another are very similar. It’s rare when R&W insurance policy verbiage diverges greatly and have material coverage missing, which often happens with other types of business insurance. Within various business insurance programs, many coverages considered “essential” by some are deemed “optional” by others and therefore omitted to save costs (i.e. Uninsured/Underinsured Motorists coverage).
The scope of coverage for an R&W policy is determined by two elements: The Seller’s reps and the degree to which the Buyer performed diligence on those reps.
The key difference between R&W policies comes from decisions Underwriters make as to what degree they’re willing to cover all or most of the Seller’s warranties. This decision is based on two elements: The Underwriters’ appetite for risk in a certain business sector and the amount of diligence performed by the Buyer. It’s essential for the insurance broker to determine to what extent each insurer is willing to cover the majority of warranties, and where there may be flexibility.
Unlike other instances when business insurance is considered, R&W is brought to bear in M&A transactions where 100’s of millions are at stake. That’s both exhilarating and terrifying for the parties. Often times, Buyers and Sellers haven’t used R&W before, so they have no idea what to expect from the process. They need a “steady hand” to guide them, manage their expectations and inform them as to what they can expect.
Brokers who lack experience in placing R&W will struggle to navigate the underwriting process. Ultimately, this can put their clients through unnecessary stress due to delays and “surprises” that an experienced player can anticipate and prepare for.
An example would be to prepare Buyers for the time and access Underwriters will need with the Buyer’s team to review the diligence performed and which outside parties participated. Brokers unfamiliar with R&W might fail to prepare their clients for this, which can result in a huge burden on the Buyer.
A broker’s relationships with Underwriters at different insurance companies is essential. Different insurers have different appetites for risk. A qualified broker, who are also experienced with M&A, knows who does what.
Some insurers are comfortable with healthcare deals and the added regulatory scrutiny they bring.
Some insurers are comfortable in the up-and-coming cannabis market. (Actually, there’s only one insurer in this market so far, but more will ultimately follow.)
Some insurers will cover certain deals but only with so many strings attached that the client won’t actually qualify, or the cost will be too high.
Insurance companies’ appetite for certain risks can change over time, and a savvy broker will keep track of these trends.
R&W policies cover complex business deals – and the Underwriters typically don’t know every industry well. That’s where the broker comes in to match the right Underwriter with experience – and interest – in a certain space for the deal.
A good broker/Underwriter relationship has other benefits.
First, a good broker sends information the Underwriters need without waiting for them to ask. That means coverage is obtained that much more quickly.
Just like anything in life, when you know someone, things just go smoother. This is particularly true on smaller deals, in which Underwriters have to deal with less due diligence provided by the Buyer.
Some insurers will penalize the Buyer for having less comprehensive due diligence. But a good broker can be a go-between and mediate in that case.
For example, say the financial statements were reviewed but not officially audited. The broker can explain why that was the case and why it’s okay. A trusted relationship makes it possible.
Typically, both Buyers and Sellers have their own brokers handling their respective insurance programs. When those brokers see the premium sizes (and the resulting commission) from R&W policies for big deals they say, “Sign me up.” They’re not qualified, but they’re certainly not leaving that money on the table and are willing to dabble if given the chance. This creates unnecessary friction between the parties as they argue on behalf of their “guy” or “gal”.
The best approach is to select an independent specialist who will only handle the R&W placement. There would be “zero conflict” with the incumbent brokers as R&W is a one-time deal that doesn’t touch any other policy.
That neutral broker will have a fiduciary responsibility to the Buyer (R&W policyholder) to provide the broadest level of protection, while committed to delivering a variety of options that are budget appropriate in the interests of the Seller (who often shares in the cost of R&W).
That’s why a neutral broker who knows R&W best practices and has the clients’ best interest at heart will get the ideal outcome for both sides.
There’s no shortcut for a broker who has experience and has had working relationships with Underwriters for years. With that comes mutual respect. If there are disagreements or contentious points, they are easier to work through.
In an M&A deal, Buyers and Sellers should not rely on a broker who does their other insurance to secure their R&W policy. Get a specialist.
A number of Underwriters have already “trained” me. I know the inside track. They know I’ll run the process the way they need to provide the best policy in a timely manner.
I’d be happy to discuss with you how Representations and Warranty insurance could benefit your next M&A deal, as well as the costs. Please contact me, Patrick Stroth, at firstname.lastname@example.org or 415-806-2356.
The pool of Buyers of technology companies is getting wider. Tech companies, as well as Private Equity firms, are now facing significant competition for quality acquisition targets from an unlikely source – non-tech strategics.
In fact, traditionally non-tech companies have become the most active acquirers of tech companies.
The most recent example is the $300M purchase of Dynamic Yield, an artificial intelligence (AI) company, by McDonald’s. It’s the fast food giant’s largest acquisition in 20 years. They plan to use Dynamic’s tech in order to improve drive-thru ordering, as well as digital products like self-serve kiosks and a mobile app.
“With this acquisition, we’re expanding both our ability to increase the role technology and data will play in our future and the speed with which we’ll be able to implement our vision of creating more personalized experiences for our customers,” says McDonald’s president and CEO, Steve Easterbrook in a statement.
But this practice isn’t new. Newspaper company Gannett purchased the remaining shares of online site Cars.com for $1.8B in 2014.
Brick-and-mortar businesses have good reasons to go on a tech buying spree. There are several drivers that explain this trend.
In the case of Gannett, the acquisition of Cars.com filled Gannett’s shrinking advertising revenue it and other traditional media outlets were losing to online advertising. Cars.com is a leading site for online research and shopping for new and used cars, which, before the internet, was the bread and butter of newspapers. It’s the perfect fit.
Other drivers for the acquisition of tech companies by non-tech strategic corporate acquirers include:
I believe the most important driver is the concept that today, every company is a technology company, no matter what the industry. Technology saturates the day-to-day operations of every business.
Quoting from Wired magazine, “The essence of the value of technology companies is – people. It isn’t just the intellectual property that a technology company creates, owns, and sells; it is the people who create that intellectual property and who bring fresh thinking and fresh ideas about how to solve problems, particularly problems that relate to the customer. Ultimately, every industry will become a technology industry and every company will have to become a technology company.”
This bodes well for owners and investors of emerging tech companies.
More Buyers increases competition for desirable targets. Add to that, non-tech strategics are willing to spend more than Financial Buyers such as Private Equity.
According to 451 Research, Strategic Buyers have paid 20% more for target companies than Financial Buyers. To avoid losing opportunities, look for Buyers from all sides to provide more aggressive terms to preempt auctions.
One way savvy Buyers compete is to deploy Representations and Warranty Insurance (R&W) to enhance their offers.
R&W coverage insures Buyers and Sellers from financial loss resulting from a breach of the Seller’s representations and warranties outlined in the purchase agreement.
R&W transfers the indemnity obligation away from the Seller over to an insurance company. With the indemnity risk removed, Sellers can reduce or eliminate escrow or hold-back provisions and collect more cash as closing.
Buyers benefit by enjoying the protection from a post-closing loss that can result in both a financial hit as well as the fallout from having to claw-back money from the newly added tech company principals.
In most cases, the Sellers are willing, if not eager, to cover the cost of the insurance in exchange for securing a clean exit from the deal, so Buyers benefit even further.
R&W coverage has been used routinely by Private Equity. However, Strategic Buyers are slow to engage in this useful tool.
If you’re working with a Strategic Buyer, there’s an above average chance they’ve never used R&W, so introducing the concept of transferring risk out of a deal at a modest cost would add tremendous value.
A great guide to promote an understanding of the benefits is a free report I’ve put together about how you apply for R&W coverage, the costs involved, when the topic of R&W should first be discussed, and more.
You can download it here: 8 Things You Need to Know About Representations and Warranty Insurance
The politics of healthcare is a mess in this country, as you know.
But Matthew Hanis, executive producer and host of the Business of Healthcare, is more interested in practical measures for incrementally improving a system that is the most expensive in the world and doesn’t offer a great quality of care in exchange.
We also talk about the M&A landscape in healthcare, including the trend towards increasing vertical integration, as well as…
Mentioned in This Episode: www.bohseries.com
Patrick Stroth: Hello there, I’m Patrick Stroth. Welcome to M&A Masters, where I speak with the leading experts in mergers and acquisition. We’re all about one thing here, that’s a clean exit for owners, founders, and their investors. Healthcare is literally a force of nature in our economy. It’s been in the news quite a bit lately and like it or not, as time goes on, everyone will be consuming more, not less of it.
Today we’ll discuss the future of healthcare from a business perspective, and how mergers and acquisitions will factor into the inevitable changes coming to healthcare. I’m pleased to be joined by Matthew Hanis, Executive Producer and host of Business of Healthcare. Now in his 13th season, BOH is an online platform where Matt interviews senior leaders in healthcare. BOH estimates that 118,000 decision-makers are responsible of 80% or more of the buy and sell sides of US healthcare. Just about 20,000 of these very decision-makers participate in BOH’s audience. That’s about one in six, which is a respectable share of any market. It is for this audience that BOH was purpose-built to identify and help propagate proven innovations, elevating mission and margin more rapidly. Wow, one in six, that’s nothing to sneeze at. Matt, thanks for joining me, and welcome to the program.
Matthew Hanis: Patrick, thank you so much for inviting me on.
Patrick Stroth: Now, we’ll get into Business of Health in a moment. First, tell us how’d you get to this point in your career?
Matthew Hanis: Well, I tried to make as many mistakes as possible, and this is the culmination. I’d spent about 25 years in healthcare, most of that time I’ve either worked on the vendor side, selling data solutions to health systems, larger payers of health plans, or working within a health system, Mercy in St. Louis, to have the experience of actually doing the work of healthcare. Ultimately, all of those experiences culminated in a passion for entrepreneurship and for finding the innovations that I felt could really transform our healthcare delivery system in the United States.
Patrick Stroth: When we see BOH’s core statement, which is mission and margin, with mission, we get that because healthcare and doing good and providing care to people, there’s a passion, the mission. It’s the margin that people start looking at real quick. Why don’t you explain what you mean by mission and margin in the Business of Healthcare.
Matthew Hanis: Healthcare makes up about a fifth of the US economy, and every sector of the economy is important, but healthcare one of our challenges though is the cost of healthcare has continued to rise at a rate faster than pretty much any other aspect of our economy. But when you look at the quality of healthcare as measured by access, patient satisfaction, survival, life expectancy, all the broad measures of healthcare, we don’t do very well in this country. We have a major portion of our economy, which is getting progressively more expensive, and on most measures of quality, it’s not very good.
I believe that this is unsustainable. Now, the laws of physics tell us that all systems come back into balance. There’s a couple of different ways that we can see the US healthcare system coming back into a healthy balance in terms of cost and quality. One of the ways though, which tends to be the primary focus right now is trying to cut payments to physicians, and try to manage healthcare by managing how consumers consume it and managing how it’s provided. Our belief is that these approaches are unsustainable and that there are at the same time, very, very sustainable ways to improve the effectiveness and efficiency of our healthcare system. That’s what we try to bring to bear.
Mission is really about all the things you and I can agree on, quality, access, patient satisfaction, physician and other provider satisfaction. Margin is recognizing that like any other part of the economy, the providers who deliver healthcare must be able to make a profit in order to make it a sustainable business. We just need to figure out how to balance that with the cost to the consumer.
Patrick Stroth: The problem that you mention out there which is making a challenge for us is that cost of healthcare continues to go up, quality continues to go down. I would think that a lot of people would think well, the more it’s intuitive almost that if you spend more you should get better quality. Are there any specific reasons why the cost goes up and yet we’re not getting the value, the benefit?
Matthew Hanis: Yes. There’s a couple of different reasons. One issue which is very microeconomics, is pricing. We know that one of the biggest drivers of the cost of healthcare is the price that’s charged for healthcare. There’s an enormous set of problems around understanding price. God forbid you should have to go to the hospital for surgery. It’s extremely difficult to understand what that’s going to cost you, and what the costs would be for you to go get that exact same procedure in other settings.
Why is it so complicated to understand price and the cost of healthcare? Well, I believe that a big part of that is we’ve got a lot of intermediaries in our delivery system. Too many intermediaries can cause such a separation between the consumer of healthcare, the provider of healthcare and the payer of healthcare, that we create a whole myriad of complexity. I think a big aspect that we can look at is, why do we have so many intermediaries, so many people that handle healthcare transactions multiple times? Why is it so hard to get that data to be meaningful to the consumer?
I think another cause that we face in our system is regulatory constraints. I’m not suggesting that healthcare should become an unregulated industry. I think we can all agree that just about any industry in the US, we want to have good regulation over healthcare to protect the consumer and protect the providers of healthcare. The problem that we face today though is that the regulatory environment that healthcare providers face is so confusing and so complex that it’s almost impossible to comply. I’ll give you a concrete example. A typical health system reports somewhere in the order of 4,000 different quality metrics each year. Most of those quality metrics, most of those 4,000 are actually redundant metrics that are being reported to different organizations in slightly different ways.
Another issue in the regulatory side are the constraints of the Stark Laws. The Stark Laws were created to prevent or to discourage physicians from referring patients to treatment from which the physician would profit. The problem with that is if we ask a physician to take accountability for a patient’s total spend, and for that patient’s quality of care and their overall quality of life, which is the concept of fee-for-value, if we were to ask physicians to do that, unlock their ability to make those decisions and to be able to refer patients to the providers that they most want to work with and potentially refer them to themselves, for things like imaging, and other services that are adjacent or ancillary to the primary purpose of care, these issues of so many intermediaries and the regulatory constraints that are so confusing, create an enormous part of the enormous waste of our delivery system. Today we spend about a third of our healthcare dollar on waste, things that do not provide value. A decent chunk of that waste is directly related to too many intermediaries and enormous regulatory constraints.
Patrick Stroth: Wow. I think when people look at healthcare, the only way you address this is, either you have the universal care, care for all, unlimited, which a lot of people would say, well that means care for nobody because the system would be overrun. Or, the other extreme is fear there would be extreme rationing out there, where some arbitrary person will dole out allocation healthcare by some abstract basis. You’ve got fear on both sides, but it’s really a false choice. It’s not all of one, all this or nothing. There are models that are being set up and there are ways that are being tried to go forward. Why don’t you talk about those types of models.
Matthew Hanis: One of the fundamental trends in healthcare is the shift from fee-for-service to fee-for-value. The basic idea is that today, when a physician bills for a service they provide, or a hospital bills for a surgery that was performed in one of their operating rooms, they essentially are billing for units of work performed. They’re not charging for a knee replacement, they’re charging for all of the components that go into a knee replacement. The concept of fee-for-value is that you charge, or pay provider for the outcome that they’re delivering. The knee was replaced, no infection occurred, the patient came out of the procedure with a responsible period of recovery. Those concepts around fee-for-value create far better aligned incentives between the providers of healthcare and the payers of healthcare.
I just want to touch on your point about, I think you touched on the Medicare for all concept. It’s important to recognize three things about our current US delivery system. First, we cost per capita somewhere between 30% more and 200% more than the rest of the delivery systems in the world, like that in Britain, Canada, Sweden or Switzerland. Before we toss those systems out as being un-American, or undesirable, consider the fact that they generally provide much better access to care. More people can get to care faster. They cost on a per capita basis, far less than our system does, and in general their consumers of healthcare report being better satisfied with the care that they received.
Now, I’m not arguing that those systems are perfect, and I’m certainly not arguing the idea that Medicare for all is a particularly good solution. But I would want to differentiate between the concept of a single payer system versus the concept of universal healthcare. A single payer system essential says, we’re all going to agree that one entity is going to pay for healthcare. Doesn’t say what the rules are about that. It’s just saying that each of us that pays money into healthcare is going to pay it to one place, and that entity is going to be the entity that pays the providers of healthcare. That’s how most of the delivery systems in the industrialized world operate.
In the United States we kind of have that, because 70% of healthcare provided in the United States is paid for by the government. Most people forget that it’s a relatively small portion of healthcare that’s paid for by the consumer and large employers. A single payer system does not necessarily mean universal healthcare. Universal healthcare takes it a step further and says, everybody gets healthcare and the government’s going to pay for it. Two really different ideas, but related.
Patrick Stroth: Well, let’s focus on M&A on the physician side of the industry, because we’ve got the large health systems, and we’ve got the large institutions and then you’ve got the pharmacy development, medical devices and everything like that. Let’s just look at the physician provider side of the industry. What do you see for the future of physicians in healthcare as we try to change into this fee-for-value emphasis?
Matthew Hanis: I think physician practices for the next 5 to 10 years are in a race for lives. What I mean by that is, if you take the concept of fee-for-value, which has generally pretty solid evidence to indicate that it produces better healthcare value for the consumer and the payer and the provider. If you agree with that premise, then that means that physicians are in a race to find ways to be in contractual arrangements where they have accountability. If I’m a primary care practice, it behooves me to try to enter into contracts where I take on the risk of a Medicaid population, a Medicare population, but I go directly to employers and contract with those employers to serve their employees and the employees families.
Those sorts of arrangements, manage care contracting if you will, are the strongest position for a physician to be in to get a market. If I as a physician practice hold contracts, either for the bundles of healthcare, like I’m a surgical practice, and the bundle for doing orthopedic surgery for a large employer, or I’m in the primary care space and I’m going to contract for the quality of care for an entire population, I’m guaranteed to be sitting at the bird’s eye view of how the money moves in healthcare. If I don’t have the contract for lives, that means that I’m going be subcontracted to somebody else.
I believe the essence of the M&A space for the physician world will be the race for lives. Those physician practices that have built the infrastructure and the capacity to take on population risk of various sorts, that can demonstrate their value in measurable ways, those organizations will continue to expand contractual relationships and exclusive network relationships with payers and ensure the flow of patients to their doors. That requires an enormous amount of work in infrastructure. Frankly, many physician practices are not spending those dollars. I think from an M&A perspective, I don’t think we’re going to see much more acquisition of physician practices by health systems. We’ve seen that market cool significantly. In fact, there’s signs of a number of physician practices unwinding their relationships with health systems.
What I do think we’ll see is acquisition and merger between physician practices, specialty groups merging into multi-specialty. I would expect that when you look at the 4,000 largest physician practices in the country, those organizations will likely consolidate. In 10 years from now I would predict that we’ll have half of those practices that occupy the largest group of physicians.
Patrick Stroth: You spoke awhile earlier about where we’ve got a big layer of intermediaries involved between provider and patient. If there was a way that if we had the physician practices moving toward this fee-for-value model than physician groups are going to be consolidating and one group will buy another, and so forth. Does that translate also to possibly them buying other facilities, imaging centers, surgery centers, physical therapy? Is there room for vertical integration and how would that look?
Matthew Hanis: Yeah. I think you’re spot-on. I feel like the trend there is a combination for the race for lives. If I’m a physician practice, I can provide a much better Population Health solution if I’ve got pretty good control over lab, pharmacy, imagining, rehab, physical therapy, those sets of services that are ancillary to the work of a physician, but are critical to achieving a particular outcome for a patient. That vertical integration trend, I think is very likely. I think that trend comes in two different flavors. One flavor is the vertical integration of healthcare service, like I just described. But the other is vertical integration in a manner to dis-intermediate many of the non-value producing participants in the healthcare ecosystem.
I’ll give you an example. If a physician practice had the ability to manage the total, all the healthcare transactions for one of their patients and they’re in a Population Health contractual arrangement, they probably are going have a much better understanding of the spend of that patient and be able to manage that spend more effectively. I can imagine, or I can see physician practices getting better at being able to do the data of Population Health and perhaps dis-intermediating stakeholders by directly contracting with employers, or contracting with employers in a manner that takes advantage of less brand name sorts of health plans, and more health plans that are designed to serve physician practice needs as much as they’re designed to serve large employer needs.
Patrick Stroth: Is there going to be need for some regulatory reform in order to do this?
Matthew Hanis: I think there is. We’ve already seen the Center for Medicare and Medicaid Services signaling that they want to soften or weaken the Stark regulations that prevent self-referral. We’re seeing several rulings that have come out of the Federal Trade Commission that solidify the ability for independent physician to contract together with health plans and other payers, without getting into anti-trust problems. I feel like from a regulatory perspective the three big things to be watch are Stark Laws, anti-trust law, and then a third area which is CON, certificate of need. Certificate of need constrains in about 20 states of the 50 states in the Union, about 20 states use CON laws to constrain the ability to create new imaging centers or add new surgery suites. Those constraints on the surface, make enormous amount of sense because they prevent the addition of unnecessary healthcare services, which often lead to an increase in utilization.
The problem with CON laws is they often get in the way of a physician practice being able to add imaging and other services to their capabilities of achieving that vertical integration. From an M&A perspective, the loosening of those laws would suggest an acceleration in the merger of physician practices and the expansion of practices to this vertical integration process.
Patrick Stroth: Could you see owners of medical facilities, I don’t know if they’re exclusively physicians as opposed to medical groups and physician practices by law, have to be owned by and run by a physician. But when you’ve got things like kidney dialysis centers, or labs, those don’t have to be owned by physicians. Could there be a situation in M&A where you could see a multi-state network of labs buying physician groups? Could that happen?
Matthew Hanis: I don’t know that I’m aware of that particular example occurring, but I’m 100% sure that there’s strange bedfellows in the outcome of these acquisitions. For example, United Healthcare acquiring DaVita, the largest dialysis business. Well, turns out United Healthcare is currently the largest employer of physicians in the United States. That’s kind of a surprising number because we all think of them as a health insurer, but in fact, they’re a provider of healthcare.
We also see retail pharmacy businesses moving aggressively into the providing of healthcare services. Being able to walk into a clinic at a Walgreens, to get your care taken care of. In those cases it’s not actually in most cases the entity, like the pharmacy is not necessarily employing the physician, but they’re contractually enabling the physician to practice care, and there’s movement of money. I would argue that, if it isn’t a merger on in fact, in many cases, it’s a merger in reality.
Patrick Stroth: The great interviews you have and they’re in HD quality videos and so forth, on Business of Healthcare. Matt, how can our listeners find you?
Matthew Hanis: Absolutely. They can find us on our website at BOHseries.com, or they can search for us on the web. Search on Business of Healthcare and our red logo, you’ll see us pop-up pretty high on the list, both our website, our podcast channels, or LinkedIn and our Twitter as well.
Patrick Stroth: Matt, thank you again for joining us, and we’ll talk again soon.
Matthew Hanis: Thanks so much Patrick. Thank you for having me.
The NFL Draft takes place this year from April 25 – 27. It’s an exciting time for fans, with millions watching the telecast as players in suits are selected and hold up their new team’s jersey for the cameras… smiling from ear to ear.
The ceremony is a culmination of months, even years, of speculation by fans and commentators. And the picks could impact a franchise’s prospects for a playoff spot, even the Super Bowl, for years to come.
There are many factors that go into what player a team selects. Their performance at the college level, their stats, their physical fitness, their commitment to a team, salary requirements… but there are some other elements that don’t make it into the mainstream coverage.
Picking up a star player (or one with potential to be a star player) is a huge investment, money wise and in terms of opportunity cost. So that’s why NFL teams conduct thorough due diligence of every potential pick. They actually hire private investigators to do background checks to check for legal issues, drug problems, or whatever else could be a liability.
It’s comparable to the due diligence a Buyer does when considering acquiring a company in the M&A world. As part of that process, the financials are gone over backwards and forwards, and often Buyers will even conduct background checks on top executives to make sure they are on the level.
There is a lot on the line. A bad decision in a draft pick, and the General Manager or even the Head Coach can get fired. Make the wrong acquisition, and the CEO of the purchasing company could be fired.
Think back about 20 years ago. Tennessee starring quarterback Peyton Manning was the number one draft pick in the 1998 draft. Heisman Trophy finalist from Washington State, Ryan Leaf, was the second overall pick. There were high hopes for both. Manning, as you know had an illustrious career. Leaf… well, had a brief, lackluster career followed by drug abuse and jail time.
You can bet the teams that picked Leaf and Manning had both done extensive diligence on these players. But that research can’t uncover everything or predict every potential issue.
It’s the same during due diligence in the run up to an M&A deal. With the complexity of today’s transactions, it’s harder than ever to conduct effective and thorough due diligence… it’s easy to miss issues that could turn into a breach of representations that could result in financial damages.
Buyers in today’s competitive, fast-moving market are looking at, on average, three to four acquisitions in the coming year and are using due diligence to determine the highest “draft picks.” But, as we’ve seen, even the high picks on paper don’t always pan out.
In professional sports, the team has to eat the cost of a lackluster player and are often contractually obligated to keep paying them even with lack of performance.
Fortunately, in M&A, there is a tool Buyers can use to insulate themselves from issues that pop up post-closing. Damages resulting from a breach in a representation in the purchase sale agreement can actually be paid without hassle by a third party.
All that needs to be done is for a Representations and Warranty insurance policy to be put in place. Both Buyers and Sellers like R&W coverage because it smooths out negotiations, the Seller takes home more money at closing, and, again, the insurer will pay the Buyer if there are breaches post-closing.
This coverage is affordable and easy to get. Premium insurers will charge 2% – 4% of the policy limit. The Underwriting fee, which is $25k – $50K (depending on the size of the deal) and policy taxes are based the Buyer’s state of domicile, ranging from 3% – 7% of the premium.
It’s a small price to pay for the peace of mind. And you can bet NFL teams would love to have similar coverage in place to insure themselves against a bad pick.
I don’t know who’s going to be the top pick in this year’s NFL Draft. But I do know that as we get into the heart of 2019 and M&A activity is on track for another record year, the protection offered by R&W insurance is essential.
I’ve put together a special report outlining all the advantages of R&W insurance, as well as the process for securing this coverage. If you’re looking at acquisitions in 2019, it’s worth a close look.
You can download this report here: 8 Things You Need to Know About Representations and Warranty Insurance.
When we talk about M&A, it’s tempting to focus on the deals involving PE and VC firms because this sector has had record activity in the last several years.
But let’s not forget another facet of M&A: corporate acquisition, by which a company buys another company or portion of that company (usually smaller than the Buyer) to expand their business. Technically, the Buyer has to purchase all or most of the shares of the target company.
The conditions are right for increased activity here:
Private equity gets all the attention… its share of M&A transactions is growing year after year. It’s “sexy.” But corporate acquisition still represents the majority of deals each year.
According to Pitchbook’s Annual M&A Report for 2018, here’s how many corporate acquisition deals there were in the U.S. and Europe for the last few years, along with the percentage of total deals they represented:
As you can see, Private Equity is closing in somewhat. But the corporate acquisition is holding strong.
We can see that corporate acquisition is a widespread practice. But why would a company decide to grow through acquisition rather than “organically?” It can be an ideal tool for growth. But it’s not taken lightly.
Corporations have whole departments dedicated to strategic acquisition strategy. There are several objectives but three main ones:
The idea is for the purchasing company to grow stronger, of course.
But the corporate acquisition isn’t without risks. That is why corporate acquirers should take a page from PE firms when it comes to protecting their deals with a specialized type of coverage: Representations and Warranty (R&W) insurance. Savvy PE acquirers are increasingly using this type of coverage because deals today are so complex and fast-paced… and that means issues can be missed in the due diligence to the tune of millions, even billions, of dollars.
When this insurance is in place, if there is a breach of Seller Representations post-closing, a third-party, the insurer, pays the damages directly to the Buyer.
In addition, (R&W) insurance is low cost, makes for less contentious negotiations, and the Seller takes home more money at closing because less cash is held in escrow. And, unlike what you might have experienced with other types of insurance, R&W claims are paid in the vast majority of cases.
For more information on how R&W insurance can transform your next corporate acquisition, you can check out this special report that showcases all its benefits, the costs, and how to secure it.
This episode was originally published on May 23, 2018.
M&A activity has been heating up in the last few years… and 2019 is no exception. At the same time there has been a lot of movement in the healthcare sector, but due to its unique nature, special care has to be taken when dealing with acquisitions in this industry.
Patrick Krause, a director at investment bank MHT Partners focused on healthcare, has shepherded a lot of deals in this sector. He shares how he helps turn M&A transactions into win-win-win deals, where both Buyers and Sellers are happy – and patients benefit, too.
Tune in to find out…
Mentioned in This Episode: mhtpartners.com
Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters, where I speak with the top experts in mergers and acquisitions, and we’re all about one thing here, that’s a clean exit for owners and founders. This week, I’m joined by Patrick Krause. Patrick is a director of MHT Partners and also the co-head of their healthcare services. MHT Partners is an investment banking firm with offices in San Francisco, Dallas, and Boston. Patrick has advised on numerous transactions during his career, including sell-side and buy-side advisory work, as well as various strategic advisory assignments. Again, this is all exclusively within the healthcare sector. Patrick, welcome aboard today.
Patrick Krause: Well, thank you, Patrick. It’s a pleasure to sit down and chat with you a little bit here today. Hopefully, we can make it fun and informative for our listeners.
Patrick Stroth: I don’t think that’s going to be a problem. Tell me now, how did you get started in investment banking in general, but then also specifically where you focused on one sector as an expertise, which is healthcare? Walk us through how you got there.
Patrick Krause: Happy to. So, I’ve spent the bulk of my career working at the confluence of healthcare, finance, and technology. Upon graduating from the University of Michigan, which seems like a million years ago, I came out to the Bay Area and really cut my teeth as a consultant working for Deloitte. I worked across a number of their different groups, but almost exclusively serving their large global healthcare clients, ranging from integrated models like Kaiser to large biotech companies like Gentech, Roche, and really everywhere in between on the healthcare value chain, hospitals, provider groups. It really gave me an opportunity to deepen my skillset there. The range of my assignments varied from technology implementations, to the development of financial controls, to audit work, so between the operational exposure and the ability to build a deep skillset, and then move to investment banking was a straight forward one.
I worked at a number of post-merger acquisition deals, diligence deals for private equity businesses, all related to healthcare, knew that I’d been bitten by the deal bug. At the time there was not an opportunity to do more transaction oriented work at Deloitte, so I went back to business school and got my MBA with the intent of getting more hands-on deal experience, either at a bank or as a corporate development officer at a business, and have been fortunate to have the opportunity to do both. Prior to joining MHT Partners, I had a quick stop at Novartis’ Molecular Diagnostics Group doing some business development, corporate development work. Then, linked up with the founders of MHT Partners, as they were leaving their respective prior firms, to come onboard and help build-out our healthcare practice, which is what I do today. I lead our practice, and again, focus on serving founders, owners, entrepreneurs, private equity groups, as they seek to craft and execute healthcare strategies designed to maximize outcomes for the party.
Patrick Stroth: Well, I like how you went and characterized it, you got bit by the deal bug. I think that’s something that’s kind of common in this industry right now. As an investment banker, now your expertise is, not on the diagnostic side, but it’s helping owners and founders sell their businesses faster, and for a greater return, and making it overall smoother. Now, healthcare is very, very different from other sectors like tech or consumer products, okay? Both based on their ownership structure and then also operationally, there’s a lot less outsourcing that can be in done in healthcare. Why don’t you describe the differences between the healthcare sector versus pretty much any other sector out there?
Patrick Krause: Yeah. It’s certainly an interesting place to play as a banker. I think the realization that folks need to come to is, first and foremost it is, it’s a people driven business, whether they’re relying on providers to deliver great care or taking great care of your patients, it’s really driven by the interactions between different folks. Being able to speak the language of medicine and business helps bridge the gap. It helps to be more effective when you’re crafting the deal. Investing and healthcare is obviously a process which requires some thoughtfulness, just to ensure that you’re compliant with the rules and regulations that are in place in our country, generally speaking, with good reason. That is such that business concerns don’t necessarily drive medical decisions or outcomes.
We talked a little about this in prior conversations, to buy a healthcare company that actually is responsible for delivering care, a couple extra steps are involved. It’s not like, you know, a sales force going out and acquiring Realsoft, which just happened, or you negotiate a deal and you’re done, you can directly buy the company. Physicians and physician practices in this country are required to be owned by physicians, to be compliant with corporate practice of medicine. I’m not a lawyer, I’ll say that. I just play one on TV. A good transaction attorney can help you through all this, as well. But, in order for someone to directly invest in a private practice, there’s typically an interim step, whereby, we create a management service organization, or anther legal entity that that private equity group can invest in, that group does the administrative work and kind of back office work that physicians tend to loath, while the physician retains ownership of their business, and then signs an agreement to share revenue with the MSO, enabling the private equity group or other non-physician to invest in the brackets.
It’s a little more convoluted than a traditional sale. But, we found over the years, that it’s an effective way to get these deals done, appropriately align incentives, and really capitalize on the value proposition that we all believe in on these deals, which is, you free doctors up to focus on the delivery of high quality patient care, you hand-off some of the administrative tasks, and as you become a bigger organization, not only can you see more patients, make healthcare more accessible, hopefully, you make it more efficient and more cost effective for folks.
Patrick Stroth: Yeah. That’s something that, you know, you can only outsource so much of the admin work and the file keeping, and so forth. It’s the actually delivery of care, it’s impossible to outsource, but as you get larger groups, if groups come together, and organizations get bigger, there’s a lot more sharing, and it improves, like you said, the accessibility. That’s a real key point that is a big differentiator. The other thing we could get into a little later on, that you mentioned, is the regulatory burden is unavoidable in this sector. Now, my experience in the healthcare sector in the last 20 years is largely on the insurance side, doing the directors and the officers, and the regulatory, and cyber coverage, things like that. When I first got into the sector, I thought of two things. There were doctors and there were hospitals. That’s what every person sees on the street and everything. I didn’t realize that there’s this entire universe of other businesses like the MSOs that are established just to support, and facilitate, and supply the delivery of care.
Now, when we’ve spoken before, you have a real neat, clean way of dissecting that huge diverse universe into really simple to understand, I would say, buckets, for lack of a better word. Tell me about these buckets. What’s the differentiation between each, and then how are they exposed or not exposed or what are their big concerns facing an M&A transaction?
Patrick Krause: Yeah. I don’t think there’s a lot of original thought in this. This is how we at MHT have elected to kind of segment the healthcare universe.
Patrick Stroth: Oh, no. You take credit for it. You made a very user friendly way. So, go ahead and take credit for it.
Patrick Krause: Well, we have a fairly broad mandate in terms of where we like to play. That translates into four industries, sub-vertical. I’ll start with the first. It’s really been the cornerstone of our healthcare practice, and that’s specialty physician groups, whether it’s hospital-based specialties like anesthesiology, radiology, cardiology, or it’s more consumer-facing medical fields like dermatology, ophthalmology, dental, and physical therapy. We’ve seen a lot of activity in the space. I’ve done a number of deals in this space.
Key challenges there are, obviously, making sure that all the partners incentives are appropriately aligned, risk and compliance is appropriately addressed, and then making sure that you’re delivering high quality care. At the end of the day, as a physician, you’re only product is a satisfied customer, meaning, is a well patient or is a better patient, and really having that high touch, and focusing on people is important, and that drives the culture and the business. Making sure you get a group of physicians aligned with the same mindset is a big part of the battle.
But, certainly, an important part of healthcare system in this country, it’s the folks that are on the battle lines every day, taking good care of people. Gosh, it’s been a pretty exciting place to be an investor the last five or six years. I cannot think of a more active period of investment in that space in a long time.
The second industry vertical that we spend a lot of time on is post-acute care. It’s kind of a catchall for us. But what that means is, the treatment of folks outside of a hospital or clinical setting. It could be home health, it could be hospice, it could be behavioral health.
Patrick Stroth: Physical therapy too?
Patrick Krause: That’s more reliant on providers.
Patrick Stroth: Okay.
Patrick Krause: We tend to keep that in the first group, but point well taken. I suppose it could be in that bucket, as well. But, the element here, the interesting thing for investors has been a lot of the dynamic that we see in our country. For better or worse, we are a graying nation. Folks are getting older. Folks are needing to consume more healthcare services. A hospital is not always the best setting for that. It’s not your home. It’s expensive. It could be a risk of infection, just by being around people that are sick. Taking care of people in their home is a compassionate, cost effective way to deliver care. We see that as a pretty exciting area of growth in the coming years. It’s not without its challenges, as well. Reimbursements have stabilized over the past several years. But, a business that has yet to find a model where you can scale over larger regions, just because it’s so focused on the provision of care by a local population and skilled nurses, or physicians assistants to take care of people.
As you’re thinking about how to allocate risk, whether on a deal or after a deal has been identified, and you’re thinking about how to translate that allocation of risk into your purchase agreement, you need to make sure you’ve got a good handle on providers, credentialing, their past record, make sure that incentives are appropriately aligned, so that those providers stick around. Turn can be kind of a scary component in this industry.
Again, it all comes down to taking good care of the patients. I think culture is an important thing to look at when you’re evaluating any opportunity to doing a deal in this space, as well, it’s a good thing to take a look at. And, throwing a bone to Patrick, it’s one where insurance is your friend, and you have to make sure you have the right product in place, and risk appropriately identified, allocated, mitigated.
Patrick Stroth: Gotcha.
Patrick Krause: Last big bucket for us is technology driven products and services. That could be true healthcare IT point solutions or products geared towards serving commercial payers like revenue cycle management, billing, coding, scribing, things like that. Or, you could have a different risk profile. It’s more product driven and technology driven, so you want to make sure that there’s no infringement of IP, there’s kind of a uniqueness or a dependability to that technology. And, you want to make sure that you’ve got an exciting, addressable market to go after.
Last bucket, a smaller one, but one that’s important to us, as well, is other healthcare services. You’re familiar working in that space too. That could be pharma services, like CROs. It could be the delivery of goods and products to a hospital or a clinic, it could be some of those products themselves. It’s another area that we like. Again, just different risk profile in that it is not driven by people or providers per se, but by products and services. There a more traditional business risk profile exists around customer concentration, products, cost of acquiring or creating products, cost of selling products, all those good things.
But, it’s a broad mandate for us. It’s a great big world out there from a healthcare perspective. It continues to be an exciting place to play from and M&A perspective, from a strategy perspective. Gosh, we have a ways to go, but if we can take some of the other business principles from other industries and apply them to healthcare, hopefully, we can get better outcomes, make it more affordable, more accessible for everybody.
Patrick Stroth: Well, I think great item that you pointed out there, that a lot of people overlook, it’s more of a millennium-type of term is called culture. And, particularly in a post-acute care, where we’ve got nursing homes or assisted living facilities, and everybody can recall those terrible news stories about elder abuse and everything, and these disconnections within the system that doesn’t bring the care that should have been brought, a lot of that is cultural, and it’s just having that culture of wanting to deliver the best care, the best services, and stand behind it. You see the physicians are pressing that because it’s literally their name on the door or their name on the practice. As you get to these other things, I can’t tell you how you can possibly understate the importance in culture with the post-acute care because that’s where you’ve got behavioral health, you’ve got a lot of these other things that are the softer-type, longer term issues that you’ve got to keep that great sense of excellence. That’s great that you pointed that out with these.
As you look, because you’re dealing with the founders and owners, many of them are physicians, some of them aren’t, they’re in the medical tech area, what’s the difference, where some founders, they succeed in getting what they want out of their deal? They get it set up, they get what they want, and then their peers will struggle. Maybe you can differentiate it between a physician owned practices or physician owned companies and non-physician owned companies, but where’s the drop-off, where some struggle and others seem to get right to go, right to where they need to be?
Patrick Krause: Well, being ready, it’s kind of the biggest thing that you can do to be success in a transaction. I mean that in multiple ways. One, obviously, it’s important to have your house in order, to make sure that you’ve got processes documented, that you’ve got your financials cleaned up and on an accrual basis, if possible. But, I also mean, you need to be ready emotionally. In some instances, seek control of a business that you’ve built for 30 years. Be able to bring on a partner that is going to have thoughts on how you run your business, and be ready to let go on something that you’ve spent a career building. Some folks are ready to do that, others are less so. But, being able to really understand why you want to do a transaction, why it’s the right time, and being able to let go, so to speak, can help a lot.
A good advisor will be able to talk you through that. At the risk of seeming shamelessly self-serving, it’s very important to pick the right advisors to guide you through this process, accounting, financial, deal related. They’ll be a sounding board. They can help depersonalize a lot of the issues that come up on a transaction. Just like a good lawyer would not choose to represent themselves in a deal, a good advisor can kind of take you out of some of the more contentious conversations.
Patrick Stroth: I don’t want to interrupt you too much there, but I do want to really highlight this because I think it’s a real big point, of having somebody as a third party, intermediary there that can be diplomatic, can listen to the various players, and give honest feedback without being emotionally tied or defensive with the other sides, I think that’s a great role that experts like you play in this. This is a very emotional time, you may have different objectives on the seller’s side, and being able to negotiate within that selling team before going off to the buyer, I think is critical with what you do.
Patrick Krause: I couldn’t agree more. Just depersonalizing it, and knowing that somebody there’s to be your arms and legs will make all the difference in a transaction. There’s no secret to it. It’s hard work. Maybe that is the secret. It’s just like anything else, stay organized, be fair in your puts and your takes, and you’ll get through it. A lot of folks, it ends up being a great experience. It’s a chance for folks to realize some liquidity. It’s a chance for folks to effect a generational shift in their business, such that it survives beyond the first generation of the founders, or to find a partner to help grow and achieve the growth that you see for the business.
Patrick Stroth: I think another real big benefit of having someone like you involved is, for a lot of these, especially physicians, but a lot of these owner and founders, with some exceptions, this is their one deal. This is their one time. You’ve been involved in hundreds of these deals. I think, not only have you seen these processes work, you know who the real good buyers are, as opposed to the other buyers that may not have the best intentions in the world, and may make a perspective seller spin their wheels only to grind them down, where you’ve got others that they may not offer the best price outright, but they’re going to be a lot easier to deal with, and you know their buying habits.
Patrick Krause: That’s right. You make a great point there, Patrick. A good advisor, particularly one that focused on an industry, will have been down the road a few times with a few of the buyers that you’d be reaching out to in that process, give you insights into how to negotiate, what’s important to them. That in turn allows you to position a seller’s business to get the most of what’s important to you, the seller. A good banker or advisor will be able to help you do just that.
Another key consideration is whether you want to sell all of it, all your business, so to speak, or if you want to find a partner and continue to work with them to grow it. That can certainly influence your buyer choice, as well, whether you sell out entirely or you identify a partner to move forward with, can give you unique opportunities, different in several regards. But, I think the key point is a process, well-designed, will create options for you, such that you can evaluate buyers, you can match price points to roles going forward, such that you can get most of what you want. It might not be everything, but if you have a couple options to pick from, you can usually get what’s more important to you.
Patrick Stroth: Is there a particular size practice or metric for people that are listening that want to get ahold of you? What size practice or maybe value is an area that you fall in with your clients?
Patrick Krause: That’s a good question. I think there’s a degree or flexibility on our end in terms of the mandates that we take on, but I think if you were looking at averages for MHT Partners as a firm, we typically represent companies with around five million dollars in EBT, earnings before income, tax, and depreciation. That’s not to say that we wouldn’t work with bigger companies or smaller companies, just on average that’s where we tend to shake out. That’s more of a function of the lifecycle that the companies that we represent are in, right? They tend to be a little bit older and more established. The owners might be looking for an exit or a liquidity event and it just happens to be where they are. But, no hard and fast rules. The only real criteria for us is to work with great companies, niche market leaders in their states, and usually uniquely differentiated from their peers.
Patrick Stroth: The best way then for listeners then to decide whether MHT would be a fit for them is, they need to reach out to you directly. How can our listeners find you?
Patrick Krause: They can certainly find us on the internet, mhtpartners.com. You could always reach out to me directly. I’d welcome the conversation. You can call me in the office, that’s 415-446-9511 or email me at email@example.com. Would love to be helpful however I can be.
Patrick Stroth: Well, fantastic. Well, this is diverse, very technical, very specific type of area to get into. I’m sure a lot of people listening are going to have further questions for you. And so, I encourage everybody to reach out the Patrick. He’s going to be absolutely responsive and maybe there’s a fit, maybe not, but the thing is having a conversation with these experts, really enhances your chance of having a clean exit. I want to thank Patrick for helping us and sharing his knowledge with a very, very highly regulated technical industry that is enormous. We wish you all the best of luck, Patrick. Thanks again for joining us.
Patrick Krause: My pleasure.
In recent years, the number of companies with “institutional backing,” i.e. they are assets of Private Equity or Venture Capital firms, has grown dramatically. And that means that the number of companies backed PE and VC firms that are being acquired is increasing, too.
In fact, according to Pitchbook’s 2018 Annual M&A Report, there were a record number of those types of acquisitions in 2017 and the trend continued in 2018 with another record at 20%.
The simple fact that there are more of these types of companies, means more will be acquired.
But also consider that the target companies are more sophisticated than a typical founder-owned firm, making them more attractive to Buyers, who would rather deal with professional investors. This, of course, means savvy, experienced parties on either side of the table, leading to, as the Pitchbook report put it: “…increased price discipline, possibly leading to more aggressive price negotiation from Sellers and fewer cheap deals.”
But because these types of companies are enjoying increased valuation, Sellers are more likely to sell companies in their portfolio. Over half of PE-backed exits in 2018 involved sales to other PE firms, which is called a secondary buyout.
Of course, this means that the share of founder-owned businesses being acquired is shrinking. And although the percentage of publicly traded companies being acquired was actually increasing until 2018, this amount is expected to drop steadily as the number of publicly traded companies overall continues to decrease and economic uncertainty makes Buyers hesitant to make these sorts of deals.
But why are the numbers of PE and VC backed companies growing? In the case of VC especially, that funding source has become very popular among startups that are ready to scale up to either go public or be acquired (which is usually what happens).
Expect to see the acquisition of companies with institutional backing to continue in 2019. We’ll see if we have another record year.
One thing both Buyers and Sellers should consider in these types of deals where portfolio companies are changing hands is Representations and Warranty insurance.
With this coverage, if there is a breach of the Seller’s Representations, the insurer pays the financial damages suffered by the Buyer as a result of the breach.
In today’s complex deals, R&W insurance is a must in my mind for any M&A transaction. But it’s especially necessary when portfolio companies are being acquired. With a full portfolio, the Seller won’t know each individual business well… and might not recognize potential issues.
There’s been one case I’ve been keeping an eye on that’s a perfect illustration of this.
Back in 2013, Citadel Plastics Holdings, a portfolio company of PE firm, HGGC (formerly known as Huntsman Gay Capital Partners), acquired Lucent Polymers. Then in 2015, A Schulman Inc. bought Citadel. But the next year, A Schulman discovered that Lucent had falsified test results to show its products were Underwriters Laboratory certified. Next step, a lawsuit seeking $272 million in damages from Citadel Plastics that has yet to be resolved.
In this case, the PE firm didn’t know what its portfolio company was up to and paid the price. But, if there had been R&W coverage in place, there would be no legal issues because the insurance company would have paid the damages.
As a PE or VC firm looking at acquisitions in 2019, it’s clear that R&W insurance is the protection you need, especially when acquiring portfolio companies.
I’m happy to chat with you about what’s covered, the price, and the process for securing a policy – which is much cheaper and easier than you might think.
You can call me at 415-806-2356 or send an email to firstname.lastname@example.org, and we can set up a time to chat.
We’re living in a Golden Age of Mergers and Acquisitions. The numbers are in and… there were $2.2 trillion in M&A transactions in 2018 in the United States alone, compared to just over $2 trillion in 2017. That marks the fourth year where the level has breached $2 trillion.
Some other signs of this very healthy M&A environment:
Although there was a slight dip in 2018 in the number of deals done (11,208 compared to 12,647 in 2017), I expect this trend of increasing M&A activity to continue. Here’s why:
The consensus is that going forward in 2019 and beyond, we’re going to see more deals, and bigger deals. This is despite ongoing global economic uncertainty, rising interest rates, anti-trust issues, the impact of tariffs, capital market volatility, and some concern that the economic conditions that have driven the rising trend could turn.
A recent survey of 1,000 PE firms and M&A corporate executives conducted by Deloitte bears this out.
The main reason for this rising trend: the PE firms at the forefront have larger funds, and they’re not sitting on that money. They’re leading the charge. In fact, in that Deloitte survey, an impressive 94% of PE executives at funds over $5 billion expect more deals in 2019.
This is confirmed when you look at what’s happened over the last few years. According to PitchBook’s annual report, PE firms accounted for 34.2% of M&A deals in 2018; that share of the market has risen steadily since it was at 25.4% in 2015.
(Not to be discounted as an element of this trend, is the growing corporate M&A strategy of acquiring companies to expand their customer base and/or diversify their offerings. Corporations also have more cash on hand due to the recent tax reform. They view M&A as the best way to grow.)
Another trend we’ve seen, especially among savvy PE firms, is the increasing use of Representations and Warranty (R&W) insurance to cover deals.
According to a study from Harvard Law School, the number of R&W policies written has grown from a few hundred just five years ago to more than 1,500 in 2017. Their report also notes that more than 20 insurance companies are now writing these policies.
Essentially, this specialized coverage puts the risk of breach of Representations in the hands of a third party: the insurer. That gives peace of mind to both Buyer and Seller and speeds up negotiations because a main sticking point, indemnity, is off the table.
The Seller gets more cash at closing because less money is held in escrow (and won’t be at risk if there is a breach). The Buyer won’t have to pursue the Seller in case of a breach; the insurance company will pay claims promptly. And with 19.4% of deals subject to a claim in 2018, at least at insurer AIG, it’s clear why this protection is important.
With the complexity of today’s deals, it’s easy to miss something in the due diligence process, and R&W insurance insulates you from that risk. And, it’s much more affordable than you might think.
If you’re part of this rising trend in M&A activity, you should consider making R&W insurance part of your next deal.
I’d be happy to discuss with you what these policies cover, how you apply, and the estimated cost. I can easily put together a quote with just a few pieces of information from you.
I can be reached at 415-806-2356 or by email: email@example.com
Domestically, the trend for M&A is robust, with nowhere to go but up in the next year in terms of the number and size of deals. There were $2.2 trillion in M&A transactions in 2018, with six deals above $50 billion. That’s the fourth year in a row above $2 trillion. Median deal sizes are also going up, doubling in the last four years to hit $60 million in 2018.
It’s a rosy picture on the domestic front.
But when it comes to cross-border deals, in which a foreign company acquires a U.S. company, we have a seen a slowdown.
According to a recent report from PitchBook, cross-border activity decreased in 2018, hitting the lowest level in four years, continuing a trend that started in 2017. There were only 2,192 cross-border transactions worth $655.6 billion in 2018, compared to 2,983 in 2015.
There are a few factors at play here:
It’s important to note that European companies conduct the majority of M&A deals with U.S. companies. Mexico is also a major player, and continues to be, despite recent tension.
But China is the one to watch as until recently it was rapidly gaining ground, growing from just 1% of U.S. cross-border deals in 2010 to a high of 9.4% in 2016. But there is a slowdown there too, with only 5.6% of deals coming from China in 2018, no doubt the result of recent tariff disputes.
Let’s look closely at China.
Chinese companies are especially interested in anything related to technology: telecoms, aerospace, etc. And they had money to drive prices up to the point that domestic Buyers couldn’t keep up. That was the main factor in the meteoric rise up until 2016.
But now, they’re facing regulatory roadblocks, on top of trade tensions and tariff issues.
The Committee on Foreign Investment in the United States (CFIUS) is the agency tasked with examining cross-border deals closely to ensure the transaction does not threaten national security and is in the best interest of the country.
I was actually involved in a deal where CFIUS got involved – luckily it was much smoother. Startup car rental company Silvercar, a U.S. company, was being bought by Audi through its U.S. subsidiary. But because Audi itself is a German company, CFIUS had to approve the deal.
Taken more seriously are instances where a U.S. tech company designs and manufactures communications equipment for the U.S. military. Being acquired by a Chinese company, which would then have access to classified data, would be a no-go, according to CFIUS.
If this seems familiar, you might have seen Chinese telecommunications giant Huawei, which makes smartphones and other devices, in the news recently. The U.S. has accused the company of espionage and being a threat to the country’s national security because of its alleged business deals in Iran that violated sanctions against that country. This culminated in the arrest of the CEO in Canada back in December, with anticipated extradition to the U.S.
The company and the Chinese government contend they are being unfairly targeted and have filed suit in the U.S. Whatever the case may be, or how this plays out, it’s clear this tension isn’t going anywhere any time soon.
Concerns over Chinese purchases of U.S. companies isn’t limited to technology or aerospace. Technology is getting embedded into traditional industries such as transportation, industrial, manufacturing and agriculture, so involvement by CFIUS will only increase.
Whatever the causes of the general slowdown in cross-border deals (exacerbated by the U.S. government shutdown, during which there were no CFIUS reviews done), I believe that this could mean opportunity.
When deep-pocketed foreign companies are taken out of the equation, at least to some extent, that puts U.S. Buyers in a better position to land deals at better prices. I expect to see a continued growth in domestic M&A activity in the coming year.
For more analysis on why domestic M&A will continue its upward trend, be sure to download my free report: The 13 Factors Contributing to the M&A Boom
What did due diligence in M&A deals look like before virtual data rooms? Teams of lawyers and other experts combing through paper files stacked floor to ceiling in a conference room.
With the virtual data room, explains Darryl Grant of Toppan Merrill, those days are long gone.
Today, sharing a company’s financials, contracts, and other pertinent information with potential buyers is a simple matter of uploading some documents and sending an email.
We talk about how this speeds up the process and ensures transactions move more quickly through the marketplace, as well as…
Mentioned in This Episode: www.toppanmerrill.com
Patrick Stroth: Hello, there. I’m Patrick Stroth. Welcome to M&A Masters, where I speak with the leading experts in mergers and acquisitions, and we’re all about one thing here. That’s a clean exit for owners, founders, and their investors. Today I’m joined by Darryl Grant, Senior Vice President of the newly minted Toppan Merrill. Toppan Merrill provides innovative SaaS solutions that deliver high fidelity SEC regulatory filings, XBRL solutions, and virtual data room due diligence services.
Darryl co-leads Toppan Merrill’s Bay Area capital markets team working directly with C suite execs, law firms, corporate finance, and legal departments to manage IPOs, mergers, spinoffs, along with all routine SEC filing requirements. Today, we’re focusing on Toppan Merrill’s virtual data room, or as the millennials like to say, VDR services, along with due diligence services for mergers and acquisitions. Darryl, welcome to the podcast and thanks for joining me today.
Darryl Grant: Thank you for having me.
Patrick Stroth: To give our audience a little bit of a context about you before we get into all things Toppan Merrill, tell me what led you to this point in your career.
Darryl Grant: A long journey, but we’ll try to keep it as brief as possible. I started out my career in New York City in the late ’90s back in 1999 just before the 2000 stock market bubble crash and etc. I always wanted to be in the capital markets. My college career and finance training gave me the aspiration of being an investment banker, but I ended up deciding to become a financial printer.
My first IPO was Intercontinental Exchange, who later went on to acquire the New York Stock Exchange. Once I did that first IPO, it led me to want to do more in the space and have an opportunity to do some of the most largest mergers in stock market history, including the market sharing cloud merger, the Pfizer YF merger, and most notably, the JP Morgan Chase Bank One merger. I came to climb the ladder, working for customer service, and to various management roles, including leading our XBRL efforts for a company called Bowen in New York City.
Then, five years ago, I moved here to Silicon Valley and I took a role as an internal global account manager working with capital markets accounts for companies that were going through a scale of acquisitions, spinoff, etc. Then I landed here in Merrill about two and a half years ago as senior VP, formerly managing director, and I got a taste of what it meant to really support companies because in this role I’m responsible for connecting our clients with solutions that fit their most prominent needs. And because we talk about M&A space, the Merrill virtual data room has been a market leading product for the last 15 years. It’s just been sensational to support companies going through an M&A do due diligence with their technology.
Patrick Stroth: It’s interesting you mention that you’d been working with financial printers and then moved over into this other space. Even though we’ve gone from a very paper-intensive to a “paperless” world, it’s amazing how much there’s a need for the printers and the record keepers, record makers, in the support services, isn’t it?
Darryl Grant: It really is. The world of virtual data rooms really kicked off back around the time that Enron was going through their challenges, and it was a lot of due diligence that was required, as you would think, with a transaction that size. Even in that time, the virtual data room didn’t exist. People still flew into large conference rooms reviewing banker boxes full of documents with someone guarding the door to make sure that no lawyer, investor, banker, etc., were to leave with any of those very sensitive documents.
You can imagine what that looked like over the course of the weeks, these papers getting wrangled and also searching for specific information within these large conference rooms, sometimes banker boxes to the ceiling full of documents. But Enron tapped Merrill and drew other companies, and we put together what was then one of the first virtual data rooms in the market. Fast forward to today, everything’s done digital. All of these transactions are moving quickly through the marketplace as a result of stakeholders having instant accessibility and also tracking mechanisms in place to a proprietary virtual data room like Merrill’s.
Patrick Stroth: Wow. So you could say that, while Enron may have spawned a lot of negative things, specifically I’m thinking about Sarbanes-Oxley and the big regulatory environment that followed right after, one of the good things was that technological emergence of an electronic room to replace the banker’s box. So that’s a nice byproduct from Enron.
Darryl Grant: Absolutely.
Patrick Stroth: I think that’s a great story to bring forward. I’m going to totally steal that from you. For our listeners of the podcast, at least they’ll know where I came up with that idea. What types of deals or industries are best suited for using a data room? We understand that the data room is there and it’s replacing those warehouses in law firms or whatever with the big box of information. But are there particular deals, types, sizes, or industries that are better suited, or is this one size fits all?
Darryl Grant: It’s one size fits all. The beauty of our technology is that it can fit mergers such as a LinkedIn Microsoft, which is a massive acquisition between two companies and merger. We were fortunate enough to have our technology be a part of that process. But it could scale down to a $10 million acquisition, or it can be a sell-side event. It can be if you’re a life science company, in licensing, out licensing of your drug products. It can be used for FDA approvals as a portal in that space. It’s really more if it’s in multiple communication pools. Sideline topic, it can be used for fundraising if you are going through an equity event where you’re raising capital for venture firms or others.
Any matter of due diligence where you are thinking about sharing sensitive documents that you want no one else in the world to see outside of your firewall, virtual data rooms are the perfect lock box to invite parties in and give you full visibility as to what those parties are looking at and how long they’re looking at specific pages, which gives insightful intelligence around the interest of those investing parties now allowing you as the seller of your assets to have full transparency into what people are doing, and that’ll give you some foresight into what questions they may ask you, which now facilitates the deal. So we’ve seen deal traction actually accelerate through our virtual data room technology.
Patrick Stroth: I can imagine, yeah. I would almost describe as, while it is a data room, I would almost re-characterize it as a data vault because of the security and stuff. I want to skip a little bit ahead on some of my notes with this. Our listeners can’t see what a data room is. I mean, conceptually, you get an idea that this is an electronic version of having all of your records in one spot, maybe like a Dropbox but a very secure one.
But for our listeners who can’t really see what a data room looks like, why don’t you describe just how the process works from opening an account, how documents are put in there, how security is done, how access is granted? Because I know there are different levels of security where you can have certain general files accessible to multiple parties and then keep everything else confidential, and then open up permissions and tracking who looks at. Walk me through that, as a prospective customer, how you would onboard somebody and what would it look like.
Darryl Grant: The onboarding process … Thank you, Patrick … is very straightforward in the spirit of today’s business applications, or email. Let’s say you’re the user. The first thing you would get is a link from our team, inviting you into your virtual data room after it’s been set up. You open up that link and it would immediately take you to your log-in page. From that log-in page, you would create your username and password, log in, you’ll have your Terms and Conditions that will be already pre-populated, you accept those terms and conditions.
It’s usually you can set it up as a user, as an administrator, you can set it up as a one-time click or you can make parties agree to this due diligence disclosure every time you log in. But once you’re in the room, you’re essentially looking at the entire landscape of what you would need. So left, there’s a file folder structure already laid out which tells you what the hierarchy of your respective index is for your virtual data room, and that’s something that can be set up by our team, set up by the individual user. You would simply just right click and it’s updating information through your keyboard.
Once you’re in that room, if you, say, had 5,000 to 10,000 or 20,000 pages of documents that are on your desktop or in your internal hard drive set up in a folder, you can simply drag and drop that entire folder as it stands with all of the internal folders, hierarchy, indices, labeled, and all the documents included would move right into that virtual data room as they were on your desktop, which is easy to set up.
Then, once set up, you add users. Those users are then … You can grant those users access on multiple levels. You could say, if you print or download, or even more exciting in today’s world is you can have administrative rights to revoke access from folks. With those options, you say, “Okay, these guys are just being introduced to our data room. We don’t want them to see too much. You have view only access.” Now, the deal starts to heat up and you say, “Okay, you can have view, print, and download access.” And now the deal’s really taking root and you’re excited and traction is there and you say, “Okay, I want that download access but I still would like control,” you can set your permissions to the extent that when that party downloads that document you still have control over that document remotely.
So if the deal dies, if things pivot, you can revoke access without having access to their computer. You can do it all through a desktop through our virtual data room. It is the most secure platform on the market. It has all of the certifications, including ISO 27001, SOC 2 Type 2, GDPR, and extensively there’s penetration tests done on our platform on a monthly basis to ensure that we have the highest security in the marketplace. That’s generally how it would feel as a user and some of the security components that ensure that all system documentation is kept safe.
Patrick Stroth: I can imagine just the usages come up. Can you give me a feel for the growth of usage with virtual data rooms from your experience?
Darryl Grant: Exponentially, everyone who is entering into a sell-side or a buy-side event generally would have a banker that they have advocating, help them facilitate the transaction. The banker, nine out of ten times, well, ten out of ten times these days, will say, “Hey, you need to get an enterprise-grade data room,” which would be us or one of our peers, ours being the leading product in the market today.
Now, there’s obviously other different technologies that are out there that … Well, actually, ironically, they in some ways found our niche when you talk about the consumer versions of the box, Dropbox just by name. I have nothing against those firms, but the file sharing environments really started, as I mentioned earlier, dating back to those earlier days around Enron. At Merrill, we never took it down a consumer route but for an M&A transaction that data room is now being used, our technology or our peers, for nearly 100% of the transactions out there in the marketplace, especially if it’s of the magnitude of the LinkedIn Microsoft or NetSuite Oracle, just a few that we’ve done.
Patrick Stroth: Yeah, it’s become virtually ubiquitous. It’s a check the boxes. This is one of your must-haves you have to have. Otherwise, you run the risk of, if you want to put your company off for sale, you’re going to have prospective buyers and they’re going to need information and you can’t field all those requests and then respond real-time for them. It’s better if it’s off at a secure location. You’ve got somebody else monitoring it. So it’s just a logical first step. How would you say that Toppan Merrill’s different from other virtual data rooms?
Darryl Grant: One clear differentiator that jumps off the page is the speed of our technology. It’s the result of a significant investment, a re-architecture which has taken about four years to come to market and has been in market for over a year now, that is 5X faster than our room and we’ve done speed tests on other platform of our peers and we’re close to 5X faster than any of those others. So speed is one of the key factors.
Another key factor is security. It is the most secure platform in the market as far as we can tell based on our penetration testing and also our certifications. I think the third and the biggest component, which our customers tend to lean on more than they plan to before they open up that room, is our service. Our 24/7 service operations are there to support our clients.
It’s not a paid service, so they can call and use these services as much as they need. And what does service mean? If you need to have documentation uploaded, our team can do that for you. If you need to add users, our team can do that for you. If you want to delete users, our team can do that for you. If you want to prepare an index for a specific transaction because we’ve seen thousands and thousands of these transactions we know what these indices look like and your index for what documents you should be including in your due diligence.
A lot of times we put things in front of clients and they’ll say, “Wow, I forgot to include X, Y, and Z. Thank you.” Our team can do that. And furthermore, we offer a consultation to say what the timing typically would look like in terms of setting up your room, executing your room, inviting users, and etc., and also the reporting systems which is like no other. We have dashboards that will show you down to the page level how users are behaving and interacting with your sensitive documentation.
That visibility is leading the market in very impactful ways, and our customers have intelligence to the extent that today’s being Wednesday. If you have a call scheduled on a Friday, you can go into this data room on Thursday night and see exactly what investors are looking at so when that call happens on Friday, you’re way ahead of every question that they’re asking because you can see where they’re spending their time, and that’s been very valuable.
Patrick Stroth: I can imagine that. I mean, if you’re looking at a potential M&A transaction with a competitor, let’s say, and you can see how much time is the competitor looking at your schedules and looking at your financials as opposed to looking at your client list. You can get some insights there, I think, is helpful. That, I think, also you just dovetailed into it on your due diligence services. Because you’ve seen thousands and thousands, literally, of these transactions, you know what information is critical and what information’s nice to have but it’s not as essential.
That also helps with the sophistication and how serious you are as a player in M&As. If you’re prepared, you’ll have all the documents lined up, and I think it’s helpful having used a sounding board to say, “Hey, we just checked the list of all the stuff. Why isn’t this here?” It may be material, may not. But that’s nice having that extra set of eyes looking over your materials as you get ready to essentially stage your house for sale.
Darryl Grant: Absolutely.
Patrick Stroth: Well, you kind of referenced into this because you have seen literally thousands of M&A deals, probably more in the last couple years than you have previously. Can you give us any insight on any trends you’re seeing in tech, investors in M&A in general? What have you seen in terms of either deal flow, deal size, just snapshot of a trend that would be helpful for the audience just to be aware of this, as somebody who’s seen thousands of these deals?
Darryl Grant: Yeah, I think what is really compelling is, use an example, what happened with Adaptive Insights recently. They were three days away from ringing the bell in New York and they were acquired by Workday. So what we’re seeing is that once companies disclose their financials, etc., through an S-1 filing with the SEC and that public filing, then buyers tend to line up and the opportunities for a sell-side event tend to increase, especially in the life science space. But when you talk about tech companies, that is, I think, becoming more and more prominent.
But furthermore, we talk about M&A transactions and trends, they’re … I think this is tried and true that most companies will exit via sell-side compared to those who will exit via IPO. I think those trend lines are still strong and we don’t see much of a divergence from historical traction in that regard. I think something that’d be interesting for the audience to know in terms of in the day, is that the devaluations we see are equally staggering as you would anticipate with comparing them to prior rounds and equity raises. We’re starting to see a lot of companies really maximizing their value in an M&A environment as opposed to, say, an IPO.
Patrick Stroth: I mean, last year, 2018, how many IPOs were there, like 30? As opposed to maybe …
Darryl Grant: I think if we look at the global stats, it’s somewhere north of 270. I think locally in the Bay Area it was just north of 30. Last year was a strong year for IPOs, and I think 2019 has the legs to replicate a lot of what happened last year and potentially break some of those records, even with the government shutdown because we’re still very early in the year. But overall, you’ll see a lot more sell-side M&A events than you will these larger-
Patrick Stroth: Oh, I think, yeah. I forget which organization it was, Middle Markets Magazine or whatever. One of those sources quoted that it was about roughly between 1,000 and 1,200 middle market M&A transactions happening per quarter, steadily for the last couple of years. So there are exponentially more M&A transactions than there are IPOs, and that’s a great insight that once you get out there with your S-1 filing, you pretty much hard and fast set a rate, and if somebody can go north of that, that’s a great buying opportunity out there.
Darryl Grant: Absolutely. And then furthermore, we look at companies that are going through these sell-side events. It’s competitive. Your strategic partner or buyer is looking at multiple companies within your space and they’re intelligent about the space that they’ve already been shopping for a while, which typically most companies are, and their analysts are sharp. So you do want to gain an edge. However that you can gain that edge is smaller than they seem, it can move the needle. And if you’re showing up to a buyer with an unsophisticated data room that’s generally used for consumer usage, it does give you a disadvantage. So using the enterprise-grade data room, not because it’s a product of ours. It’s not why we recommend it. I truly recommend it because I know for certain that it does facilitate a better deal outcome for anyone selling their company.
Patrick Stroth: I don’t think there’s any better reason in M&A when you have a service out there to consider as the judge of whether or not the service is accurate is, does it make consummating a deal and successfully closing easier or harder? And if it’s the former, you go with it. If it’s the latter, you stay away. It’s just that simple.
Darryl Grant: Absolutely, and buyers are smart. They do due diligence all the time. So when they receive a link from, say, a Toppan Merrill data room or they see our data site one, “Okay, this company is on it. They’re sharp. What we’re potentially going to buy has been securely managed, so I feel good about this transaction already.” Versus the three other links that they may get that may not be enterprise-grade data rooms. Your company may not be on par in terms of value, but yours certainly gets a better look and a more sophisticated look when you use enterprise-grade data rooms. My mother used to always say, “Don’t be penny rich and dollar poor,” so it’s worth a spend.
Patrick Stroth: That’s absolutely correct. Another quick thing on the trends. Give me a balance between financial buyers and strategic buyers like corp dev or whatever. Are you seeing changes in the amount? Who needs who in terms of the number of transactions, corp or private equity or financial buyers?
Darryl Grant: I think the splits are … I wait for the numbers to flesh out. I think they’re pretty much on par with what we’ve seen in the past. The CDC space has grown exponentially. I think every large multinational or large corporate firm issuer has a venture arm and they look at strategic ways to grow because organic growth is somewhat easier that way sometimes instead of doing all of the development yourself. I think that those trend lines will continue to grow, and we’ve seen them grow over the last couple of years. But private equity’s still very much involved in the space. They are experts in some areas in terms of maximizing value and turning companies around, so I think we’ll continue to see that.
Sometimes it happens strategically, like Cavium recently was acquired and part of that acquisition was intentional by both parties because the private equity firm has some specialties that help them accelerate what they were planning to do with their products. I think we’ll continue to see CDCs and strategics be more engaged and involved in their buying habits, and they’re getting in a lot earlier. They’re very much engaged into Series A, Series B, Series C companies to build a rapport and relationship with founders, and they’ll be a part of introductory and support them prior to a and acquisition, whereas private equity tends to participate a little bit later sometimes. But strategically, I think over time we’ll continue to see more and more corporations buying other companies and leading that trend.
Patrick Stroth: All of that is good for us in the M&A business, so appreciate all that and some great insights here today from Darryl Grant. Darryl, how can our audience reach you to go get a demo of Toppan Merrill’s data room or the other services they have, just to kick the tires and see how it could work for them? How can they get ahold of you?
Darryl Grant: Absolutely. If you’re looking to get in touch with me, you can reach me on email at Darryl, D-A-R-R-Y-L, Grant, G-R-A-N-T, @toppanmerrill.com, T-O-P-P-A-N, M-E-R-R-I-L-L, .com. If that’s too much, just reach me on my mobile directly at 917-847-4111. I’m a native New Yorker and I can’t let my New York phone number go, so I’ve been in the Bay Area for five years. Your best bet on reaching me is there.
Patrick Stroth: Excellent. Darryl, thank you again, and we’ll be talking to you for other insights on Toppan Merrill. Have a good afternoon, Darryl.
Darryl Grant: Thank you so much.