Insights

  • The First $1 Billion R&W Insurance Policy Issued – and What It Means for the Industry
    POSTED 9.10.19 M&A

    It’s a landmark moment in the world of M&A. Marsh JLT, the world’s largest insurance brokerage, has announced they successfully placed the first Transactional Liability policy at a $1 Billion Dollar Limit, the largest such policy ever written. As impressive as this may seem, it’s only a matter of time before a larger policy Limit is placed on an even bigger transaction. This is just one of the many data points outlined in the Marsh JLT 2019 M&A Trends report.

    The biggest takeaway is that if you have a billion-dollar deal – you need look no further than Marsh JLT. They have the resources and experience to handle these very opportunities. I’ve always believed the world needs the Mega Brokers like Marsh JLT because “someone” has to insure Disneyland! 

    This is just one indication of how the benefits of transactional insurance, especially R&W insurance, is being recognized by Buyers and Sellers and made an essential part of a growing number of transactions, even for transactions going as low as under $20M.

    According to Marsh JLT’s June 2019 Transactional Risk Insurance Report, which looked back at trends in this space in 2018, there are 25 firms offering this specialized type of insurance. That’s a sizeable increase from the handful offering this coverage just a few years ago.

    More policies are being written as well, with Marsh JLT alone experiencing a 40% increase in policy count, from 359 in 2017 to 504 in 2018. The median transaction value for those insured deals was $135M. The size of the average R&W policy placed is about 10% of the transaction value.

    Industry-wide, the number of M&A insurance policies rose for the fifth straight year, according to the Marsh JLT report, driven by strategic acquirers who are gaining confidence with this product. The number of R&W transactions conducted in this sector increased by 21% from 2017 to 2018. PE and other financial acquirers are already comfortable with this insurance, with PE being the majority users.

    Of the policies written, 99%, were Buy-Side R&W, leaving only 1% as Sell-Side R&W. Buy-Side policies continue to represent the vast majority because they provide broader protection (i.e. covering Seller fraud) and because they best facilitate a “clean exit” for Sellers, with no indemnity obligation and less, if any, money held in escrow.

    This allows the Seller to have most of the sales price in hand when the deal closes so they can move on to new investments or distribute funds to shareholders and investors. That’s the reason why Sellers, in many cases, are more than happy to pay for this coverage.

    Looking at trends and what the future holds, it’s clear that the increase in usage of R&W is the direct result of three factors that aren’t changing anytime soon:

    • On-going price reductions from the growing number of insurers entering the M&A space. The favorable pricing environment is expected to continue into 2020. Deductibles for R&W policies are just 1% of enterprise value for most transactions. It’s just 0.75% for deals over $500M.
    • R&W insurance is increasingly being used on larger transactions as past experience has strengthened consumer confidence in the product.
    • More strategic buyers are using the product for both competitive reasons and as an accommodation to target companies. Again, both sides of the table are coming to recognize the value of this coverage.

    It’s also important to note that Underwriters have more experience than ever in writing R&W and other transactional risk policies. This allows this component, including due diligence, to become a seamless part of an M&A deal.

    All this is taking place with a very healthy M&A environment as the background. The Marsh report notes that global M&A activity jumped 11.5% from 2017 to 2018 to $3.5T, even as the total number of deals actually fell. That’s the fifth year in a row that deal values have topped $3T. PE firm buyout activity, meanwhile, was valued at $557B, which is the highest level in 10 years.

    Expect to see increased use of R&W and other transactional risk insurance in the rest of 2019 and beyond.

    The great news for specialty firms, such as Rubicon M&A, is that Marsh’s growth into the billion-dollar deal level opens a wider gap of underserved deals as there are far more sub-$135M deals out there with the exact same needs for protection and service. We’re thrilled to have Marsh JLT out there to serve the mega-deals. We’ll handle the rest!

    To discuss how Representations and Warranty insurance can impact your next M&A deal, contact me, Patrick Stroth, at pstroth@rubiconins.com or 415-806-2356.

  • The Key Differences in Mindset Between Buyers and Sellers in M&A
    POSTED 8.27.19 M&A

    Going into an M&A deal there is always a “courtship” period where the Buyer is wining and dining the target company. If things go well, this leads to a Letter of Intent, which essentially states that the Buyer wants to buy the company, and the Seller agrees.

    This is where things get more complicated. The courtship – and romance – is over.

    Considering that a typical M&A deal is about as hard to complete as a Hollywood blockbuster, it’s a miracle these deals ever go through. There are so many elements that could derail them at any stage until the purchase and sale agreement is signed and the closing takes place.

    So what happens?

    If you’re a target company, you need to be aware of the mindset the Buyer takes on when approaching a deal.

    It helps you manage expectations when you sit across the table. As the target, you must realize that as desirable as you may be, you might not have as much leverage after the Letter of Intent.

    The Buyer’s attitude is that if they’re paying full price, then the target company has to perform to expectations or better once they assume control, even if there are unknown factors that come into play through no fault of the Seller. The Buyer believes the shareholders of the target company should take on all risks of the unknown, despite the due diligence they have done.

    That’s why in these types of deals, a significant portion of the sales price (8% to 10%, generally) is held in escrow for a period of a year or more, with the Buyer basically free to take funds if there have been any breaches with the representations and warranties in the sales contract to pay for the financial losses. They can even clawback more money beyond that amount.

    Understandably, Sellers aren’t eager to take that risk… or take home significantly less funds at closing… money which owners and shareholders are eager to use to retire or invest in new projects.

    A Unique Insurance Product

    But, as we’ll see in a moment, there is a remedy that allows Sellers to protect themselves and not be required to leave any funds in escrow. In fact, they no longer have an indemnity obligation at all.

    On the other side, the Seller maintains they can only give assurances for issues they know about and outline in the representations and warranties in the contract. The target thinks the Buyer should take on all the risk after those issues are outlined.

    Clearly, the two sides are at odds. And this can make for difficult negotiations.

    But there is an insurance product that can make both sides happy, remove the need for money to be held back in escrow and fulfil any indemnity obligations in the event of a breach of the Seller reps. Deals as low as $15 million will be considered by insurance company Underwriters.

    Representations and Warranty insurance does this by transferring the indemnity obligation from the target to a third party – an insurance company.

    For example, say a chain of restaurants is purchased. But post-closing, the Buyer discovers that there are $1M of gift cards out there yet to be redeemed. Without R&W insurance, the Buyer would have to go after the Seller to cover their financial losses. But with this coverage, they simply file a claim with the insurer.

    Another big bonus: with this coverage in place, a deal is EIGHT TIMES more likely to close. Because the indemnity obligation has been removed from the Seller’s shoulders, that’s one less thing to negotiate. The process becomes that much smoother.

    The Nuts and Bolts of R&W

    The vast majority of policies are “Buyer side,” where the Buyer is the Insured Party, although often the Seller is the one to pay for it, and happy to do so, considering all the benefits.

    Securing this coverage is easy, and its cost is low. To secure a policy takes a couple of weeks at most, as the Underwriters review the due diligence performed by the Buyer. The rate is 2%-3% of the Policy Limit, including Underwriting fees and taxes. The price of R&W insurance has dropped considerably in the last several years, while the number of insurers offering this coverage has increased.

    Timing is critical. If you want R&W insurance to cover your next M&A deal, there should be a provision made at the Letter of Intent stage. If it’s put in place at that time, it can always be removed.

    If you’re interested in making Representations and Warranty insurance part of your next deal, contact me, Patrick Stroth, at pstroth@rubiconins.com.

  • ERPs
    POSTED 7.30.19 M&A

    The Software You Need to Scale Up Your Business

    As a company is scaling up, especially a startup, it wants to stay nimble and always moving forward to maintain momentum. At the same time, the systems they used in their startup phase – like QuickBooks – just might not be robust enough to manage their new incarnation.

    There are too many financial reports, people, and processes to keep track of with simple accounting software or spreadsheets. Not evolving and finding an efficient way to keep track of it all, and meet the needs of your growing company, will cause growth to stall.

    There is an ideal solution to help you put the systems you need in place to properly scale up your business. It’s a comprehensive software solution that can boost productivity and efficiency while decreasing costs by integrating:

    • Accounting
    • Human resources
    • Sales
    • Operations
    • Service
    • Your CRM
    • And more…

    … in one system. It gives you a 360-degree view of your business, 24/7, from anywhere in the world.

    An Enterprise Resource Planning (ERP) software solution can improve productivity, increase efficiencies, decrease costs, and streamline processes, and much, much more by automating front and back office processes like…

    • Financial management
    • Revenue management
    • Fixed assets
    • Order management
    • Billing
    • Inventory management
    • And more…

    What Makes an ERP So Powerful

    For any startup ready to take their business to the next level and grow, as well as make itself an attractive acquisition target, a solution like this is necessary.

    Cloud-based software NetSuite is the ERP system of choice. Forty thousand organizations across 160 countries use NetSuite to run their businesses. Seventy percent of all startups are transitioning from other legacy systems to NetSuite ERP.

    An ERP can be used by low level staff, as well as top managers, because the level of access can be customized to each user. NetSuite is ideal for companies scaling 1 to 10 to 100 people and expanding to multiple locations and is perfect for a workforce that is spread across multiple locations, has a large percentage of employees who work from home, or has a team that is regularly on the road or in the field, like salespeople.

    Because it’s cloud-based, it can be accessed by any computer around the world. And it also features an API that is easy to integrate with other systems.

    NetSuite features different “modules” that are added on to its core suite, including modules like financial management, payroll, order management, fixed assets, ecommerce, and more. It can be fully customized to meet a company’s needs.

    You can add or switch out modules as you need them – perfect for a rapidly growing business that needs to adapt quickly to the needs of the market.

    NetSuite grows as you grow, allowing you to add features and functionality as your business grows.

    All the Data You Need to Make Decisions in One Place

    This ERP gives real time visibility through dashboards and reporting throughout your organization. It’s a single platform that handles multiple services for your organization.

    Dashboards allow you to analyze and track system data on a variety of levels, including tracking KPIs like account balances and outstanding bills. But they can also organize deadlines, meetings, calls, and more.

    The order and billing management module integrates sales, finance, and fulfillment operations to be more efficient, improve quote accuracy, and reduce billing mistakes. It also automates your approval, invoicing, and payment management responsibilities.

    Fulfillment errors can be reduced with a module that centralizes customer, order, invoice, and shipping information, while integrating with shippers like UPS and FedEx.

    You can monitor your supply chain from end to end, procurement to payment. And it improves collaboration and communication between vendors and customers.

    But NetSuite doesn’t only tell what happened in the past or what’s currently happening in your business.

    Importantly, with NetSuite dashboards, you can conduct the financial planning that helps you achieve your company’s goals. You can conduct “what-if” financial modeling to help budgeting and forecasting, which allows you to plan your next move more effectively.

    The impact on your business is felt in several other ways.

    Employees can be more productive because you can reduce spreadsheet-based processes by up to 70%. With NetSuite, you’ll have one backoffice system that handles financials, fulfillment, inventory, and sales. Using real-time dashboards, scorecards, and KPIs you can constantly and accurately monitor the daily cash balance.

    You also enjoy reduced IT costs; it’s estimated that companies can save up to 93% in IT costs because they don’t have to maintain, integrate, and upgrade different applications that NetSuite does in one place.

    Next Steps

    If you’re ready to move out of the startup phase, it’s clear you need an ERP to help manage your business. But it’s not a matter of a simple download.

    In order to truly optimize this powerful tool, it’s best to engage an Authorized NetSuite Provider (ANSP) who can walk you through the process from concept to integration (including training) to ongoing servicing.

    An ANSP will ensure that companies realize their full “NetSuite potential.” Particularly, for companies that currently use NetSuite, engagement with an ANSP can be of tremendous value.

    Looking for an ANSP? Drop me an e-mail at pstroth@rubiconins.com, and I’ll send you the contact details for the leading ANSP in Silicon Valley.

  • Sub-$20 Million Dollar Deals Can Now Be Covered By R&W Insurance
    POSTED 7.16.19 Insurance, M&A

    As more players in the world of M&A come to realize its tremendous value, there have been several big changes in the use of Representations and Warranty (R&W) insurance to protect Buyers and Sellers post-transaction. (Any financial loss resulting from a breach of the Seller’s representations in the purchase-sale agreement are paid by the insurer because they take on the indemnity obligation from the Seller.)

    I’ve mentioned previously that the number of insurance companies offering this specialized type of coverage is more than 20 today, compared to just four in 2014.

    There are also more policies being written than ever before. A part of that is the fact that just a few years ago insurers only felt comfortable insuring deals of $100M or more, and then only with audited financials.

    Now, they are offering coverage for deals under $20M… in fact, they’ll now go as low as $15M… without requiring a strict financial audit during the due diligence process.

    The reason? The R&W market has matured, so to speak. Insurance companies are more comfortable with it as they’ve had successful experiences with larger deals. Underwriters are familiar with the product and the claims process. (Only about 20% of deals result in claims.)

    Now, insurers are looking to increase their bandwidth and increase the number of clients they cover. And that means they have to look at smaller clients.

    The risks are smaller and can’t be mitigated as much as with larger clients. But by bringing down the rates enough, they can cover the small deals. And because the amounts involved are so low, there isn’t much financial risk.

    Still, sub-$20M deals are different in a few key ways:

    • Fewer insurance companies are willing to cover the small deals.
    • There are few Brokers who truly understand R&W insurance and have the right experience.
    • Of the Brokers who do understand it, there is an even shallower pool of those who are willing – or able – to do work on smaller deals. (Many Brokers prefer the larger risks – and the higher commissions – that come with the big transactions.)
    • Brokers working these small deals need to know which insurance companies will take on these deals and the Underwriters with the right experience on these policies.
    • In smaller deals, you have less experienced parties on the buy side and sell side. For most, it’ll be the first time they’ve encountered R&W insurance, and the Buyer is not inclined to learn about it, so it’s critical that an experienced broker is engaged to guide the parties through the process.
    • The Seller really drives demand on this product, often not being willing to move forward on a deal without it. And for good reason, as they can’t afford to have millions of dollars of exposure out there. They’re not serial entrepreneurs who can survive that loss. They’re ready to collect more cash at closing so they can pay out investors and move on with their lives.
    • Despite the smaller deal size, pricing is still in the $200,000 to $300,000 range, including all fees, premium, and taxes, which is similar to what policyholders pay for much larger deals. Insurers aren’t willing to take any less to make it worth their while.
    • Buyers must do third-party due diligence on the acquisition target’s tax situation, IP, financials, operations, HR, and more as those are the biggest exposures out there.

    There are many more M&A deals on the smaller side that don’t get the press of the big-name transactions. And I think the use of R&W insurance to cover transactions at any level can only go up as it becomes more well-known, especially among PE firms and VC funds.

    I’m an optimist by nature. But if there is a slowdown in the economy, you will see a lot of owners and founders running to the door to close out business – that’ll cause a spike in sub-$100M transactions.

    And in order to capitalize on their return and secure more cash at closing in uncertain economic times, they’ll want an R&W policy covering the deal.

    If you’re involved in an M&A deal under $20M and are interested in the protection that comes with Representations and Warranty insurance, I’d invite you call me, Patrick Stroth, at 415-806-2356 or send an email to pstroth@rubiconins.com. I’m experienced in deals of all sizes and I have the contacts at the insurers to secure the coverage you need.

  • Craig Lilly | 3 Reasons Foreign Companies Are Looking at U.S. Acquisitions
    POSTED 7.9.19 M&A

    When we usually see cross-border deals, it’s a U.S. company acquiring a foreign business. But increasingly the reverse is happening, says Craig Lilly, corporate partner at the Palo Alto office of Baker McKenzie, and there are three primary drivers for that trend.

    But cross-border deals with foreign buyers aren’t without their pitfalls, especially with newly enacted regulatory and anti-trust and merger controls – at that’s just the start. Just look at what is happening with Chinese telecom giant Huawei.

    Cross-border M&A is far from a done deal. Foreign companies are still acquiring U.S. companies, says Craig, but just engaging experts like his company to shepherd the transaction.

    We talk about where cross-border M&A is headed in 2019 and beyond, as well as…

    • The two biggest concerns in cross-border deals
    • How changes at CFIUS have vastly changed the playing field
    • When a cross border deal isn’t really a cross border deal – and why
    • How American companies are taking advantage of Asian company’s hesitancy
    • And more

    Listen now…

    Mentioned in This Episode: www.bakermckenzie.com and Winning Strategies in Cross Border Deals Tips for Success Presentation

    Episode Transcript:

    Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters where I speak to 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 Craig Lilly, M&A and corporate partner at the law firm Baker McKenzie in their Palo Alto office. Craig’s practice focuses on acquisitions, divestitures, joint ventures, and strategic investments.

    But it’s in complex cross border deals where he’s really developed great expertise and he’s now thought of as an industry leader. Craig’s been a regular contributor on Bloomberg, the Wall Street Journal, and other M&A specific publications. Craig, welcome to the program and thanks for joining me today.

    Craig Lilly: Thank you, Patrick. I’m glad to be on the program.

    Patrick Stroth: Well, Craig, now that we’re getting past the first quarter here in 2019 rather than just focusing on cross border deals which we’re going to get into in depth. Tell me what your perspective is as an expert on what the state of M&A is here in 2019.

    Craig Lilly: Well, I think MNA is very strong and still in 2019, the values is increasing even though the volume may be slightly lower. 79% of executives say that the M&A will increase in or remain the same in 2019. We’re seeing record amounts of a private equity raise as well as venture raise which is really good for the ecosystem in mergers and acquisitions. In the last 12 months alone, we’ve seen over 3.6 trillion in deal value over 19,000 deals in US and Europe. So that’s a very strong technology M&A is up 20%.

    Also, we’re seeing M&A more institutionalized. 20% of all targets, Pat, are backed by either private equity venture firms or professional investors. Also, there’s record levels of what we’d call dry powder or money to make acquisitions. The PE dry powder is estimated to be over 1.7 trillion and also, the top five tech companies alone have over 340 billion in dry powder. And that includes Apple, Google, Microsoft, Facebook, and Amazon. So the key M&A drivers that we’re seeing are really for strategics are customer expansion and diversification. And so those are all I think big drivers for M&A and which will continue in 2019.

    Patrick Stroth: Well, we’ve got just a confluence of changes that have been happening over the world where you’ve got either the world getting flatter or a lot of capital looking for places to be put and maybe people aren’t looking at their backyards anymore. They’re looking overseas. They’re looking cross border. And which is why I wanted to come speak with you about this. But before we get into the technical issues on cross border and the ins and outs of it. Give us a little bit of context for you. What brought you into becoming an M&A attorney first and then to specialize in cross border acquisitions?

    Craig Lilly: Well, I had a background in financing and accounting so I was always interested in M&A and investments which really drew me into it. I originally worked in private equity back in the cottage days of private equity when it was a very early industry. And then I started working in technology over the last 16 years or so. And one of the things to that really interests me about the technology and in M&A is that companies at earlier and earlier stages are expanding internationally which is a big driver of cross border M&A. So those are the things that really interest me is the international aspects, the complexity, and also getting to learn new industries and verticals.

    Patrick Stroth: So what makes a deal a cross border transaction? Is it as simple as we think just anything outside the US borders?

    Craig Lilly: Well, really it’s really any deal with foreign aspects. It could be the buyer or the seller or material assets or it could be a US company acquiring another US company that has material foreign assets as subsidiaries. So typically almost every kind of major US corporation has some type of foreign aspects. So all those acquisitions even though it may be a domestic acquisition really is a cross border because of the foreign aspects or subsidiaries that a US company may have.

    And we’re seeing this in an earlier stages of the companies. A lot of early companies are young companies are expanding overseas whether to develop technology, develop manufacturing or to acquire customers through diversification.

    Patrick Stroth: A lot of times we’re thinking of US going outside and looking to foreign markets for acquisition targets. But it’s also on the flip side, according to what you just told us where you’ve got foreign-owned companies coming to the US which intuitively we think that the US is too expensive a market for targets. But that’s not necessarily the case. There are things that must be driving these foreign-owned companies to come and invest in the US. What drives the demand from their side to come here?

    Craig Lilly: I think it’s three primary drivers for foreign companies to want to make acquisitions in the US. The first one obviously is technology. We’re seeing the fourth industrial revolution happen here in United States where technology is embedded in almost every different vertical or industry whether it’s automotive or manufacturing or artificial intelligence within industrial manufacturing. And so that’s spurring a lot of the investments and acquisitions by foreign acquirers here in the US.

    The second is just customer acquisition. Companies are looking to acquire customers and essentially diversify their base. And a third driver really is not only the diversification within a customer base but diversifying their own different revenue streams where they could be diversifying in a new analogous business that maybe is very synergistic with your existing line of businesses.

    Patrick Stroth: I agree. One of the things that changed my perspective when we talked about this a while ago was that the focus always on customer basis and so forth. People immediately think China or India where they’re billions of potential customers out there completely overlooking the fact that while we may not have the largest population. We probably have one of the richest. So if you can make a stand here in America with a very friendly consumer base, you’ll do very, very well. And that was one of the things that really came up when you and I were talking about the US being such a great target for them. This can’t all be that easy. What are the challenges that are germane to cross border deals versus ups or domestic deal?

    Craig Lilly: Well, there’s definitely changes or challenges in regulatory, whether they are antitrust or merger controls. Obviously, CFIUS which we’ll get into later is a major challenge for companies investing in the US and CFIUS is the Committee on Foreign Investments in the United States. And also, structure and tax issues. Furthermore, key issues when a foreign company comes here is complying with employment laws. It could be unions or the WARN Act. When you want to terminate employees. Intellectual property, data privacy, and security are a major concern as well.

    You’re seeing often more and more companies are having inadvertent data breaches. So that’s a key issue for any company in any type of transaction particularly for cross border where you could have cultural issues and other different challenges in data privacy. Also, anti-corruption is always a big challenge for companies and having internal compliance programs implemented to correctly deal with those types of issues. And obviously, in any type of transaction diligence, culture, deal execution, and also, post-closing integration is a major issue. And in post-closing integration, something doesn’t start after closing. It really starts very early in the acquisition process.

    Patrick Stroth: Can I ask you this is a little off topic but with all of those challenges that are there that’s probably a role that you and your firm will give guidance to if you can’t have absolute on the ground consulting recommendations you have resources or can provide resources to companies to address those various areas of concern?

    Craig Lilly: All right. We have great breadth in over 45 countries around the world and have over 70 offices. So we have experts in all these areas. And really that’s what you need is a specialist or cross border specialist teams because of the numerous landlines involved in foreign deals and some of the really kind of two big areas that companies are very concerned a bit right now obviously is data privacy. But also the anti-corruption issues that are involved and because of the stiff penalties can be imposed and that’s really you outbound or inbound.

    And so we see companies take a very in-depth look at that. One of the things we also look at every transaction, we try to very early on the process is sit down with a client and discuss what are the really high-risk areas, where is really the concerns for the company, where’s the value? It could be in the intellectual property and so we’re going to really take a deep dive in intellectual property to potentially a freedom operate analysis to make sure that they’re protected. And if they do buy the company that they have the freedom to use it the way that they intended to have synergies with their existing businesses.

    Patrick Stroth: Talk about CFIUS a little bit. Should every company now be aware of it, not just the ones that are the traditional chemicals and military applications number one? And then number two, CFIUS is US. Explain what happens if other countries have something similar.

    Craig Lilly: Well, the Committee on Foreign Investments in the US or CFIUS is where a foreign company proposes to acquire a target a US business that generally either produces designs, test, manufactures, fabricates or develops one or more critical technologies. And because of the recent changes in the law, even a 1% investment in a company with critical technologies could trigger a CFIUS filing. So its critical technologies has been expanded for CFIUS and includes such things as defense articles, and defense services, commodity software, and technologies on commerce control list or controlled for reasons relating to the national security, chemical or biological weapons, missile technologies or for reasons relating to regional stability or surreptitious listening.

    It also can include energy and things subject to Department of Energy regulations such as nuclear equipment, software, and technologies, and also includes emerging and foundational technologies which is not to be defined which is very broad. There’s actually currently 27 pilot program industries identified by NAICS code which will require mandatory filings. Also, CFIUS applies if the target owns, operates or manufacturers or supplies critical infrastructure or real estate.

    And critical infrastructure is broadly defined. It can include systems and assets so vital to the United States that the incapacity or destruction would have a debilitating impact on national security. For example, the purchase or lease or incession of a foreign person to a foreign person or any of real estate is located in the United States and is located within an airport or a maritime port or close in proximity to a US military installation that is sensitive for national security reasons.

    And why should an acquirer be concerned about CFIUS? Well, US Treasury which oversees this can unwind the transaction or impose very harsh equitable remedies and fine. Also, each party can pay up to the amount of the purchase price for the fine. And yes, other countries do have similar laws. The EU also has a similar law. Seven transactions last year were blocked by the EU and we had over 14 deals either blocked or abandoned during the last few years. Over 240 deals were actually formally reviewed by the US in last year. And so CFIUS has very wide overreaching kind of application.

    Previously before the recent changes, a company that was making an acquisition in the US could make an investment of 9.9% or less without being subject to CFIUS. But now it applies even to a 1% investment in critical technologies and that’s a mandatory filing. So it’s a very broad expansive type of law and it’s not just only in the US. EU also has these laws as well and a lot of people also are also concerned about China. And why is China’s such a huge presence in cross border here over the last decade? Well, in 2008, China inbound was 1 billion. However, eight years later, by 2016 inbound was 48 billion.

    So that alone has led to a lot of the concern over CFIUS. Also, there are a lot of changes in capital markets and venture capital. Previously DARPA was very heavily involved if there was some type of sensitive technology being developed. But because of the expansion in private markets and venture capital, there’s all types of new technologies that are being developed where DARPA is not involved at all anymore. It used to be decades ago, DARPA would be almost involved in any type of development of critical technologies because it was usually done by larger companies. Because of the expansive venture capital over the last 20 or more years. Now we’re seeing critical technologies being developed even with very small companies.

    Patrick Stroth: At what stage are you filing for CFIUS? Is this where you pass a letter of intent and you’re beginning to get things structured up there or is it something where it can be preemptively checked before advancing too far into an M&A transaction?

    Craig Lilly: Well, generally, we will recommend clients to do a CFIUS assessment of the risk very early on prior to the letter of intent stage. Typically, companies will be even talking with the Treasury even during this letter of intent stage. And that’s generally what we recommend so that we can basically get some initial advice from the Treasury as to whether this is a very high-risk type of assessment which would require a filing. And in most cases, it can be a mandatory filing.

    But typically, you will file this generally right around or medially before the execution of the contract. And that’s just to sign a contract where you may later do the acquisition usually in a two-step type transaction.

    Patrick Stroth: The other question for you. Its something we didn’t talk about. But you triggered my thought process here. Compared to a US deal, I know every deal is different depending in industry and size and everything but are cross border deals routinely larger? And if so, how much larger than a domestic deal for technology or pick a case study?

    Craig Lilly: Well, historically, we saw a lot of large investments but now we’re seeing even the very small investments. There has been just a rush of investments over the last decade of all types of foreign and Asian investors in the US it was particularly with technology companies and so that’s helped a big surge in venture capital investment as well. But we’re seeing across the board obviously, some of the investments by some of the Asian investors has decreased over the last year just because of some of the CFIUS concerns in the regulatory landscape. But there’s no particular size for cross border or a foreign investment we’re seeing across the board all different shapes and sizes just like you would see with a domestic acquisition.

    Patrick Stroth: And assuming that CFIUS gets taken care of. There are the other kinds of risks out there that are germane to M&A. A lot of those risks can be mitigated or controlled or completely eliminated with ensuring a deal through rep and warranty insurance and it’s been used at an increasing rate in domestic deals. How has rep and warranty impacted cross border M&A?

    Craig Lilly: Well, representation and warranty insurance actually was more expensive in the EU and in Europe before it really came to the US. And so it’s very prevalent in Europe and generally, there’s lower price premiums as well. As you know, representation and warranty insurance essentially allows sellers to walk away with more cash at closing while giving buyer’s interest protected in the form of an insurance policy against loss.

    So typically whether it’s in domestic buyers in Europe or otherwise, there’s been the landscape for representation and warranty insurance and in Europe, particularly is fairly widely accepted. And because it’s a less litigious type environment to typically the prices and premiums and risk retention’s are much lower for a Europe-type acquisition.

    Patrick Stroth: Craig, you mentioned China before and how they ramped up very extensively of going from a billion dollars in deals and then a very short term, they come up to $48 billion in transactions. What do you see aside from the slow down right now which could be temporary but what do you see going forward both in Asia and cross border M&A overall? What trends do you see there?

    Craig Lilly: Well, it definitely a cross border M&A has slowed down because of CFIUS and you’ve seen with the recent trade restrictions that were imposed on the Huawei by the US that that’s a definitely an impact on perception at least for Asian investors here in the US. I definitely think it’ll probably be very slow for a lot of the Asian investments in the US. I do think you’ll see more and more US buyers throughout the world whether it’s in Asia or in Europe. I think some of the big drivers for that though is just because there’s a lot of dry powder available for not only private equity funds but also a lot of the large institutional and strategics.

    As I mentioned before, the top five tech companies are 340 billion in dry powder. But also you’re seeing a lot of kind of old-line companies that are really trying to expand whether it’s through technology whether it’s a FinTech or an agricultural tech or some other kind of emerging tech or they’re trying to diversify their customer base or their revenue streams. And also you’re seeing obviously you see continued outsourcing whether it’s through manufacturing or assembling happen and that’s throughout Asia. And also we’re even seeing a lot more in Mexico and Latin America because of the close proximity and probably the more respect or for the cultural aspects of the United States including protection of IP.

    So I think we’ll see kind of more and more US companies do a lot more cross border. The acquisition of tech is obviously a very driving aspect but obviously, the customers diversification, aqua hires, and other things too. And I think you’re seeing this across all different types of verticals whether its artificial intelligence or robotics, FinTech. Of course, auto tech’s been a very big area servicing a lot more of different transportation companies that are trying to expand and drilling through multiple verticals here. It’s a whole… Electric car, autonomous vehicles. The communication slash smart car and also ride sharing too as well. Those are all things that are kind of driving the transportation industry and I think we’ll continue to see that.

    Patrick Stroth: So we’ll be doing a lot more US buying outside our borders as opposed to the last couple of years where we’ve had predominantly Asians coming and buying into the US. That trend looks supportive because it seems that there are more and more service providers out there and advisors such as Baker McKenzie that can make things easier for US buyers to go abroad where they probably were reluctant to do that because of a lot of the bear traps out there that they didn’t know what they didn’t know. And they’ve got resources like yours now that they can bring to bear that will help. At the same time, CFIUS is making it harder for the foreign-owned companies to come in and maybe easier for us to go out. So it may have not the same sustainability or robust outlook as you do domestic but it’s still fairly positive. Would you agree?

    Craig Lilly: No, I agree. And also we’re seeing kind of a trend that’s really developed over the last few years is that you’ll see a US slash Delaware Corporation basically as a holding company but really their operations are really abroad and even though any M&A or acquisition is of the Delaware company as a domestic acquisition, essentially the company is a foreign company. And so we’ve seen a lot more of those types of transactions and that’s obviously been spurred by the not a venture capital investment here in the United States as well. And I think we’ll see that continue.

    That’s why I’m saying M&A is also becoming more institutional-wise where 20% of all targets are backed by some type of institutional investor whether its private equity or venture capital. So I think we’ll see that continue. Obviously, we’ll see a lot of I think secondary private equity sales. And what that means is one private equity funds selling a portfolio company to another private equity fund. Now those type of exits account for somewhere close to 30% now of all private equity exits. I think that trend will continue as well.

    Patrick Stroth: Well, you’ve got a lot there for us to consider, particularly just not the cultural differences but a lot of the other regulatory and compliance traps and so forth and just how things are different outside. But that shouldn’t stop you from taking advantage of some great opportunities out there. And if there are organizations like you and Baker McKenzie that can be brought to help smooth that transition, that’s all the better for a lot of owners and founders out there. Craig, how can our audience reach you? Because I’m sure they’ve got a lot more questions than I can give you.

    Craig Lilly: Well, I’ll have a presentation which I’ll have on Rubicon’s website after this. And then also you can reach me at our website or my email address which is just craig.lilly@bakermckenzie.com. Also, you can reach me through my phone number 650-251-5947 plus I’ll have a cross border presentation that I’ll post on Rubicon’s website that can be accessible and will have my information as well.

    Patrick Stroth: Well, that’s absolutely fantastic. Thank you very much. And you can check the show notes here under the insights tab at Rubicon, R-U-B-I-C-O-N-I-N-S as in Sam, rubiconins.com. Go to the insights tab there and you’ll have the show notes along with a link to Craig’s presentation and you can also reach out to Craig directly. Craig, very informative. You cracked open a lot of different avenues of thought there so I greatly appreciate it. My audience will appreciate it as well. Have a good day. Thanks so much for joining us today.

    Craig Lilly: Thank you, Patrick, very much.

     

  • An Overview of Tax Liability Insurance
    POSTED 6.18.19 Insurance, M&A

    With any merger or acquisition, tax liability is a major concern because when you buy a company you assume its tax obligations. And you can bet the IRS is keeping close tabs on every transaction for taxable events, not to mention state tax authorities.

    Not paying attention to tax treatments that apply to acquisitions could cost a Buyer significantly, and perhaps negate any advantage they had in the deal at all. For example, say a Buyer purchases because they think it has favorable tax deals, but the taxing authority disagrees. Then they’re on the hook for the tax bill.

    But for a low premium, tax insurance, with policy terms generally set at six years, would protect against that disastrous event. Think of tax insurance as an “add-on” to Representations and Warranty insurance, kind of like you add earthquake or hurricane coverage to your homeowner’s policy.

    That might be putting it too lightly, actually. Tax insurance protects a taxpayer (in this case, the acquiring company) if there is a failure of tax position arising from an M&A transaction, as well as reorganizations, accounting treatments, or investments.

    A few examples of where tax liability insurance would be applicable (thanks to RT ProExec Transactional Risk’s recent white paper for this info and other helpful tips in this post):

    1. Historic tax positions of a target entity in an M&A transaction
    2. Investment in clean energy (e.g. solar), new market, rehabilitation, and other investor tax credits
    3. Real Estate Investment Trusts (“REIT”) and their representations as to their REIT status in an acquisition
    4. Foreign tax credits
    5. Preservation of (or availability of exceptions to any limitations to) net operating losses and other tax attributes following a transaction
    6. Transfer pricing
    7. Tax treatment of reorganizations, recapitalizations and/or spin-offs
    8. Debt v. Equity analysis
    9. Capital gain versus ordinary income treatment
    10. Deductibility of expenses (as opposed to capitalization)
    11. Excessive compensation
    12. Deferred compensation
    13. Whether withholding taxes are imposed
    14. Whether distributions constitute a “disguised sale”
    15. Valuation risks
    16. S Corporations and 338(h)(10) elections

    Checking tax status is, of course, part of any Buyer’s due diligence. An outstanding tax bill is easy to find. But certain tax treatments the Seller insists are correct and up to standard, may not be. The Buyer, relying on its tax attorney’s specialized tax expertise, can insist those issues be taken care of pre-sale because they are exposures.

    In the past, Sellers could go to the IRS and ask, “Is this an exposure?” and get a Private Letter Ruling okaying the request. But with the IRS swamped these days, they’re not really issued anymore.

    Where Tax Insurance Comes In

    When there are tax issues that come up for debate during due diligence for an M&A transaction, both sides bring in tax attorneys and each side makes the best determination in their opinion if this is a taxable transaction or not. They could take a light touch or be very conservative.

    The Buyer will likely insist that a portion of any tax liability goes to the Seller, whose expert says they don’t agree with that determination. If there is a disagreement – get tax insurance.

    Underwriters will get letters from tax attorneys from both sides outlining their arguments, along with supporting documents. It’s quite simple underwriting.

    Underwriters want to see:

    • Name and address of the insured.
    • Covered tax descriptions of detailed descriptions of the underlying transaction and the relevant tax issues.
    • Draft opinion from a tax advisor.
    • The tax backgrounds of the Buyer and Seller.
    • Limit of liability the insured would desire.
    • A potential loss calculation, including additional taxes, interest, penalties, claim expenses, and gross-up.

    It generally takes the Underwriters about three to four days to deliver a preliminary response.

    In some cases, M&A transactions can become tax-free transactions or tax-free exchanges. Of course, the IRS can always disagree and insist on back taxes and fines.

    Some things to keep in mind:

    When Underwriters aren’t confident about a specific tax position, they may set retention at where they think the tax authority would settle. When they are more confident, they will be okay with minimal retention by the insured or none at all.

    If a tax memo convinces them that the IRS agrees that it is not a taxable event – good. If not, the IRS triggers an inspection.

    The insurance will pay the legal costs to fight the IRS, as well as taxes, penalties, and fines if they lose. And, get this. If your insurance win was, let’s say, $5 million and the IRS says, “You just made $5 million in income,” the insurance will pay tax on that as well. That is known as a “gross-up.”

    Tax liability insurance is more expensive than R&W (it generally costs between 3% to 6% of the limit), but it makes sense as the stakes are higher. So it should be an important part of any M&A transaction.

    If you’d like to discuss how to protect yourself with tax liability insurance and how it coordinates with R&W coverage (because R&W does not include a Seller’s identified or disclosed tax risks), please call me, Patrick Stroth, at (415) 806-2356 or email me at pstroth@rubiconins.com, to further discuss this vital insurance protection.

  • Why Companies Should Consider an IPO Instead of M&A
    POSTED 6.4.19 M&A

    Most companies are built for acquisition, and they can either go M&A, which is the usual route, or go through an IPO. But M&A isn’t right for every company, and there are certain cases where a company should consider an IPO instead.

    To set some context. There were 190 IPOs in 2018, compared to 11,208 M&A transactions. For many companies, an acquisition just makes for a cleaner exit.

    The big-name IPOs get a lot of attention in the press. But generally, they’re not good for investors because the majority of growth for those unicorns is already done. And you can’t expect much return.

    For example, rideshare app Lyft got big fanfare for its IPO, but its stock price soon dropped. And now investors are suing Lyft for allegedly making misleading statements ahead of the public offering that inflated the share price. Shares are down 4% over the last month.

    If your company has particular capital needs for expansion, an IPO can be a good way to secure that money. This is particularly the case where private money is hard to come by.

    Why would a smaller company reject an IPO? The owner/founder is concerned about giving up control; if they go public, they’ll have to answer to the board. Keep in mind that if the owner still holds a majority of the shares, the board acts as a sounding board and can give advice, but he or she can essentially do what they want.

    Just think of Jeff Bezos and Mark Zuckerberg.

    When you have a board, you may not be as autonomous as you want to be, but it’s good to have oversight. Look at Elon Musk and how his social media comments, public behavior, and business decisions have been causing trouble for his companies.

    The idea of having a big personality like Musk out there isn’t always the best for a company. It might be good for startup getting to $2 to $3 million. But after that you need adults in the room. A good board can rein in a founder while still letting their creativity flourish.

    Owners are also concerned that if they go public, all their dreams and plans for their business go out the window. They feel they are giving long-term flexibility for short-term goals… that the focus will be on looking good on quarterly reports.

    But a good leader will be able to integrate the long-term vision and still meet quarterly goals. Example: Jeff Bezos.

    There’s never been a better time to go public for companies with those needs.

    It’s a more business friendly environment now. Compliance reporting requirements are more routine and not as cumbersome as they once were. After several years into Sarbanes-Oxley, the process has been streamlined.

    IPO is not the killer it was seven or eight years ago.

    And even simply starting the IPO process can have an unexpected benefit. The first step if you’re considering an IPO is the S1 Filing. It’s the first set of disclosures to the SEC. The minute you submit it, that report, full of financial information about your company, becomes public record.

    Strategic buyers will get a copy and know how much your company is worth… and consider buying it in an M&A deal. The valuation comes back at $100M, and they offer $200M.

    It’s a good idea to put up a for sale sign.

    Whether a company pursues an IPO or an exit through M&A depends on several factors specific to that business. But both can be viable options to be examined.

    We focus a lot on M&A and IPOs in the tech space. And it can be helpful to examine the trends impacting Silicon Valley.

    Download this free report for what’s on the horizon in this sector:

    2019 Silicon Valley Trends Cheat Sheet

  • Gretchen West | The 3 Biggest Benefits of Drone Technology
    POSTED 5.28.19 M&A, M&A Masters Podcast

    When you hear the word drone, you might think of the military uses, the proposed Amazon.com delivery drones, or those jokers who shut down airports by flying drones around runways.

    But drones are serious business, says Gretchen West of Hogan Lovells in Silicon Valley.

    There are little-known commercial uses of drones that save time, money, and lives that will only expand in the near future… as long as government regulations can keep pace with development of new technology.

    The industry is maturing quickly, as is M&A activity in this space. We talk about that, as well as…

    • The many layers of technology integrated into drones… and how that creates opportunity for other companies
    • The growing list of unexpected industries that can benefit from drones
    • More than pictures and video – the ways drones collect data you’ve never heard about
    • Where the FAA and other government agencies stand on drones – and how it’s changing
    • And more

    Listen now…

    Mentioned in This Episode: www.hoganlovells.com

    Episode Transcript:

    Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters where I speak with the leading experts in merges and acquisitions. We’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today, I’m joined by Gretchen West, senior director at the Law Firm Hogan Lovells in Silicon Valley. Years before the commercial drone industry was taking off, no pun intended, Gretchen was already at the forefront of the Unmanned Systems Industry advocating on behalf of the global community to reduce the barriers to enable operations and use. Now, Gretchen has been a key speaker and authority on all things drone for the past couple years and was recently featured at most current Silicon Valley M&A forum. Gretchen, welcome to M&A Masters and thanks for joining me today.

    Gretchen West: Thanks for having me, Patrick.

    Patrick Stroth: Now, the reason why I asked to come along today and talk to our audience is, when we think about drones, I want to go back and compare it to the evolution of the airline industry, which didn’t exist until 1914. That’s actually 11 years after the Wright brothers had their first flight ever. We compared it with the drone industry which didn’t really come to our public attention until 2001. That’s when we knew about military drones. It took more than 10 years later. The next time the public really heard about drones is when Jeff Bezos was featured on 60 Minutes talking about using drones for delivery. That was done in 2013. It just seems like yesterday. The reason why you were featured on the recent Silicon Valley forum and the purpose of our conversation is to highlight just how in the blue an industry we take for granted today just didn’t exist not very long ago and in a very short period of time became a wide part of everybody’s daily lives just like the airline industry.

    If you’re an entrepreneur out there, how can you take advantage of a trend that you see it coming? Because there are a lot of opportunities out there for things that didn’t exist beforehand. We look at the drone situation here and that’s just our latest example of something from nothing. Before we get into talking about all things drone with Gretchen, Gretchen, why don’t you give our listeners a little bit of context and tell us how you got to this point of your career and with drones in particular?

    Gretchen West: Sure. Well, I’ve been working in the drone and unmanned system space for about 15 years. Back when I first started, I was working for a non-profit, which my experience is in non-profit management, I worked for an association that focused on air, ground and maritime vehicles that were unmanned and so remotely piloted or autonomously piloted. Back then, it was really all military. Quite honestly, this technology dates back to the Vietnam war. Some would even say World War II. A lot of this technology was developed decades ago. It obviously evolved over the years into more sophisticated military equipment, but like you said, Jeff Bezos put us on the map from a commercial perspective but even a lot of the commercial applications were developing a few years before that. I really focused my work now.

    You said that this is a newer industry. There’s lots of challenges. My work is really focused on helping enable this technology because I’ve seen a lot of the benefits, the commercial drone technology can bring to the public and to various industries. The work that I focused on is really reducing those barriers so that we can see more meaningful expansion of this industry because there’s mostly a lot more benefits to all these different various companies and industries.

    Patrick Stroth: You mentioned barriers. I can imagine they’re the logical barriers of technology coming in, but there are other barriers out there. Why don’t you talk about those?

    Gretchen West: Well, I think anyone that’s involved with technology understands that policy does not match the pace of technological development. It’s certainly the case where we’re talking about commercial drones. The FAA is the regulatory authority that manages our air space. This is a new entrance into our air space. Obviously, we’ve been flying on commercial aircraft for years and general aviation has been around for decades, but this is a new entrance. It is much smaller. In the future, they will be flown autonomously. For the FAA, to create rules around the brand new type of vehicle, it’s then very challenging. The rules that are on the books already really relate to commercial aviation. It doesn’t make sense to have the same rules for a commercial airline to be implied on a very small five-pound drone. Over the last 10 years, actually, longer than that, we’ve been trying to work with the government agencies to help them understand what this technology is.

    Where we are today, we still have a lot of regulatory hurdles, but the FAA and the other government agencies have come a very long way in helping enable this technology, but there’s still a lot of challenges around public perception, there’s challenges around privacy. There’s just a lot of different challenges, but they are all things that we can achieve if we work together as an industry and these are all things that we’re working very hard to overcome. With any other technology in an industry, the policy making doesn’t match the speed of technology. We’re seeing that very, very clearly in the commercial drone space.

    Patrick Stroth: I get a sense when we talk about some of the regulatory considerations and how it’s trying to keep pace. There are a lot of examples where, particularly with the FDA and other regulatory bodies that the regulators work very hard to slow down approval. That’s the opposite, at least, from what we read in periodicals when we’re talking about regulatory issues and autonomous cars. Do you get a sense, the FDA and the Feds are doing what they can to accelerate or facilitate? Are they working with the industry to try to come up with some good rules?

    Gretchen West: They are and they have been for many years. I think, sometimes, the FAA gets a bad rep because they are moving slowly, but their whole mission is to protect the safety of the air space. No one wants to be flying on a commercial airplane and have an incursion with a commercial drone. I think we’ve all seen enough new stories about how drones have been flying around airports. That’s the number one priority of the FAA. I think we all agree that something we all have vested interest in. It’s not deliberately a slow process, but some of it is just the way rules are written in the government, that it takes time to go through an inner agency process with so many different agencies weighing in. That said, the FAA has said repeatedly, so has the Department of Transportation, that they are very interested in working with industry. They’ve made a lot of great stride. Their congress has passed, now, two re-authorization bills that has language around unmanned aircraft systems to enable broader commercial operations.

    Now, it’s just a matter of getting the rules in place to really enable that. It takes time, but I think we all know that we’ve all seen some of the benefits of commercial drones as has the FAA. I think they all know enforcement is the very difficult challenge. Rules have to come at a place because people aren’t going to stop flying drones. They understand the value of them. The rules need to be in place. The FAA, I think, is moving as quickly as they can as an under-resourced agency, in my opinion.

    Patrick Stroth: Well, it is peril, I would say, with the autonomous driving because I had never seen regulators more excited than the concept of getting drivers off the road and so forth and doing everything they can on that. It’s encouraging to see that government is actually working with that. When we look at the public perception of this and a lot of people have what limited views they’ve seen on using drones for taking pictures or if they’ve seen them on TV shows being used in brighter ways. There’s a perception out there. I would also think with commercial airlines, it took a lot of bravery in the early days for somebody to actually think to get on an airplane and fly across the country. Now, there’s got to be some courage and some knowledge of uses for the drone beyond what people can think right off the top of their mind. You had just referenced the commercial benefits of drone usage. Give us a couple of examples on how they’re being deployed and what benefits they’re bringing to companies or to the public at large.

    Gretchen West: Sure. There are so many benefits. We could spend several hours on this call, on this podcast just talking about the various benefits, but just to highlight a few. There’s the benefit of saving money. For example, in the oil and gas industry, when a human have to inspect a flares deck, that flares deck has to be shut down, which can cost a company up to a million dollars a day. If you’re able to use a drone, you don’t have to shut down the flares deck. You can use a drone with various sensors to monitor and inspect that flares deck. That’s just one example. There’s other examples of how, for example, saving lives and improving safety.

    The cell tower industry, you have climbers that carry about 80 pounds of gear and they can climb up to or higher than 1,000 feet in the air. You don’t know what changes in weather there will be. There are climbers that die every year from climbing these towers. It’s a very dangerous job. Why not use a done? You could get it up to inspect the tower in about 20 minutes. If there’s a problem with the tower, then you send the climber up to repair whatever needs to be repaired, but otherwise, you just potentially saved some time and saved lives by doing that. There’s so many other industries that are using this technology. For example, in the construction world, they have to measure stockpiles. The way you do that is, you have a human walking around the pile of whatever it is measuring manually.

    Well, there’s technology out there now, a sensor that you can put on a drone and it can map that stockpile and give you those measurements in real-time. It’s a time-saving. It’s a cost-saving. It’s not replacing the human worker because there are other jobs that have to be done within all of these industries. The drone is more of a … it’s a tool to help. You mentioned Jeff Bezos in delivery and I think a lot of people nicker a little bit when they hear about delivery, but I think one of the most important aspects of drone delivery is in the humanitarian area. Lots of companies are developing technology where you can deliver blood from blood banks to hospitals or organs from hospital to hospital for organ transplant. There is this testing and there are actual trials going on overseas, outside the United States, where the regulatory environment might be a little bit easier where aid is being brought to people in need. There’s countries, third world countries, where drones have flown after natural disaster, delivering water or medicine or whatever it might be.

    I think some of those use cases really open up the door for delivery whether it’s consumer delivery, business to business delivery or humanitarian. I think being able to get something to you quickly especially after a natural disaster is incredibly important. I could go on and on about all the different benefits and all these different industries. You’ve got news gathering and mining and inspecting railroads, inspecting bridges, any kind of infrastructure, farmers using drones in their field to instead of walking a field to look for damage after a hailstorm or looking for areas of irrigation, maybe, or they can put a drone up in the air and have NDVI sensory imagery, all sorts of different types of mapping where they can immediately see what’s going on in their field.

    Public safety has been using this technology for a long time. They’re good for traffic monitoring from a security perspective, using a drone to monitor a facility such as a prison or pharmaceutical plant or a nuclear facility. There’s so many different great use cases where drones … Really, they’re a tool that can create efficiencies and they can reduce cost, and they can save money and save lives.

    Patrick Stroth: It’s whatever the limits of the imagination are. This isn’t just some funky little happy gadget. This is a real flexible, viable tool that’s going to be sustainable, I can imagine. Again, I keep going in the parallel to when they would think about the first airplanes where they were used. Before they’re carrying passengers, they’re carrying letters. They’re probably limited to about 30 or 40 pounds worth of letters that they could carry at a time. Now, you think about what FedEx delivers in a single day. I think that this is just amazing. Now, there’s going to need to be a couple of breakthroughs both on a regulatory and a developmental stage to really get this a little bit more mainstream. There were a couple areas that they may not be on the cusp of that, but what are the things that we should look out for that if these things changed or these thing gets solved regulatory or otherwise, then we’re going to see things open up wide.

    Gretchen West: Yeah. There’s a handful of really near-term pending things that are going to help. There’s obviously some other longer term challenges that we need to overcome, but last year, the FAA re-authorization bill was passed. I don’t remember how many pages, but there were pages of provisions for the FAA around integrating and enabling UAF technology, drone technology. DFA has now have their handful with all these task that they need to complete, but the first and probably most important thing that the industry needs to see now is remote identification. A couple years ago, the security agencies, DOJ, DHS and others were very concerned about the clueless, the careless and the criminal actors of flying, and how do you identify the difference between the three?

    You’re talking about a sports stadium where somebody is flying near a sports stadium or an airport where somebody is flying near an airport to Gatwick, for example. We’ve all read those new stories about drone flying around Gatwick and the millions of dollars that were lost because the airport had to shut down. Was that the person that was flying, which is just a kid that’s out flying with his dad just for fun as a hobbyist. Maybe, maybe not. Is it something that’s clueless that’s out there that doesn’t understand the rules or somebody that’s criminal? As of today, there’s not really a good way to identify any of the drones that are in the sky. Yes, there are some apps and some things that are baked into some of these drones, but it’s not a formal process.

    To be able to move forward with any of the other expanded operations that our industry needs to see, those remote ID, whatever remote ID is going to look like, whatever the rule is that the FAA comes up with, that has to happen first. That is a critical piece to satisfy the US security agencies and the FAA. That is the number one thing that we’re waiting for. Secondary to that is, I’ve mentioned expanded operations a few times. The law, now, permits commercial operations of drones, but it’s very limited. You cannot fly beyond visual line of sight of the drones. You have to have your eyes on the drone at all times. You can’t fly over people. You can’t fly at night. Now, some of these, you can get a special permission from the FAA to do, but it’s much harder. For a lot of the operations, the industries that I just mentioned, if you’re a real estate agent and you’re just flying over a house, you can stay within visual line of sight, not fly over people and not fly at night. You’re probably fine.

    If you want to monitor a big pipeline or a railroad, then you need to fly beyond visual line of sight. We’re waiting on some rules now to enable those expanded operations. One was just opened for comment which closed this past Monday and would be operating over people and operating over people in a moving vehicle. The way that the rule is crafted by the FAA, it’s going to hamper the commercial drone industry if it passes as it is. Not being able to operate a drone over a person and a moving vehicle is a non-starter for this industry and operate the restrictions around operating over people is, there needs to be more research and testing that’s done because it’s still very restrictive. Those are some rules that we’re waiting to see how they change in order to enable this community.

    I mentioned a security concern, that’s a big issue for the federal government, but it’s not just about remote identification. It’s also about this new industry that sprouted up. It’s called, Counter-drone Technology or Counter-UAS Technology. Think about a baseball stadium or a football stadium. They like to use drones to film practices and eventually, maybe even film games, but they don’t want drones flying into their stadium when there’s a map gathering, when there’s a game going on. A drone was just flown into Fenway Park the other day. This counter-drone technology, potentially, could help curve some of the careless, clueless criminal, but the authorities are very, very limited in the industry to use that technology. That’s something we really need to see develop with the FAA and with congress to figure out, how do we let more than just a few federal agencies utilize this technology, how do we allow private companies to be able to use it.

    I think, remote idea is the most important, but the fourth one is called, The UTM, the Unmanned Aircraft Traffic Management system. It’s basically virtual highways in the skies for drones to fly. It’s like air traffic control for commercial aircraft but at low altitude and it’s all automated. Now, the FAA have been developing this for years with a couple hundred industry partners. I think we’re getting closer to see some implementation of the UTM, but this is what is going to help our industry have all this operation. It’s going to enable delivery. It’s going to enable beyond visual line of sight and operations over people. It will be this automated system that will help all of this. It’s meant to be designed in a way that if you’re flying from point A to point B, you get your coordinates. If a medevac flies into your route at some point in time, you’re automatically diverted. It’s meant to be this automated system that’s very safe. It’s really going to enable the technology and this industry to grow. We’re still waiting for that to be implemented.

    Patrick Stroth: Yeah. Not only do you not have pilots in the vehicle, but then it sounds like you’re not going to help people in the air traffic control system or the automated, which you’d have to do with the volume of vehicles out there under this UTM.

    Gretchen West: Exactly. The current air traffic control system that the FAA uses is one of the safest in the world for man deviation, but think about adding millions of aircraft to that system. It will be impossible for the FAA to be able to monitor all of that in addition to man deviation.

    Patrick Stroth: That’s amazing. The ID of all the different uses for the drone brings up the idea because for an M&A conversation we’re having today, drone is a very interesting topic and people might be thinking … Yeah, but how does that apply to us in M&A because we’re not necessarily in the aerospace industry or the flying industry? How is this going to be applicable? I just think that there are a variety of different technologies that drones are using right now. They open up opportunities for all kinds of innovators. You’re talking about the UTM and the counter-drone technology. You could probably flush that a little bit, but what are the types of technologies that are necessary for this industry to grow?

    Gretchen West: Well, I think when a lot of people think of drones, they just think of this little, small toy aircraft that’s flying around in the sky. Really, that’s the shell of it. There’s plenty of companies that are developing the hardware, but it’s really the brains in the drone that’s the most important thing. You’ve got the sensors. There’s a variety of different sensors depending on what your application is, whether it’s agriculture, construction, mining, whatever it might be. There’s mapping technology that’s being developed. Communications, infrastructure technology. The software that comes a navigation software to be able to automate how you get drones from point A to point B. I mentioned remote ID. There’s lots of different companies that are developing technologies to satisfy what remote ID might look like.

    Obviously talking about UTM, I mentioned there’s about 200 partners that are working with NASA and the FAA to develop this. A lot of it is software. It is multiple layers of software that are going into what this UTM structure will look like. We’re at step one through a program, now that several companies have developed an app where you can get notifications and authorizations to find certain air spaces, but that’s step one. There’s all these layers of software and technology that need to go into a UTM system. Insurance companies are automating drone insurance for how operators are able to obtain insurance. Again, counter-drone technology which is similar but different but a lot of different technologies that are being built into how counter-drone technology is going to work. Basically, it’s air space security is what counter-drone technology really is.

    There’s so many different areas within this commercial drone space where innovators can develop different software layers to fit into whatever these different applications are. They’re all very different. There’s so much opportunity. We see startups that are developing these types of technologies every day. There’s a lot of opportunity to get into this space and start helping craft what the feature of commercial drone integration is going to look like.

    Patrick Stroth: Well, I think, also, if there’s the creation, again, from nothing comes something, lots and lots of new applications and new developers on that. We got to figure down the road and again, that focus on us is looking how it applies to M&A is that there are going to be a lot of M&A opportunities. Give us, from your perspective, what you’re seeing on the M&A front within the drone sector.

    Gretchen West: Sure. I think we’re going to continue to see increased activity in M&A including in this year. Back 15 years ago or even 10 years ago when these commercial companies were just starting to get into the space, there weren’t that many companies and they were mostly startups. Now, you’re seeing big named companies like Amazon, Intel, IBM, Goggle, Cisco, AT&T, Verizon, Ford, Mercedes Benz and all these companies that you wouldn’t think of as being in the drone space. All of them are starting to develop something around commercial drone. Intel, for example, has acquired a couple companies to help with what their drone solution is going to be. Goggle has done the same. Verizon has done the same. They’ve acquired a company called, Skyward, which is going to help them be a player in the UTM space.

    I think we’ll continue to see more companies interested in commercial drone technology. Some that you may not even think of today that will be interested in developing some drone program. Instead of going out and building your own hardware and software, which hardware is hard in a software, there’s a lot of companies out there that have been very, very successful in what they have been able to develop. I think we’ll see a lot of strategic M&A coming. Unfortunately, we’ve seen some companies that have failed in this space. I think we’ll continue to see that. I mentioned counter-drone technology. That’s a newer part of this industry. Two years ago, there were probably a dozen counter-drone technology companies. Now, there’s over 200. There’s over 200 systems that have been developed around counter-drone technology.

    It’s just not sustainable to have 200 types of technology out there in the counter-drone space. I think we’ll see a lot of consolidation in that space as well and probably, eventually, see more consolidation in UTM as we get closer to private industry being a supplier of this technology with the federal government and with the users of that air traffic management system. I think we’ll see more consolidation there to just build in all those layers under one company. I think that industry is very right for just an increase, a large increase in M&A activity. It’s been one of those industries for so long where it’s just … People are developing. There wasn’t a good roadmap from a regulatory perspective. Some people were developing technologies that may not fit.

    Now, we have a pretty clear roadmap. Even though it’s moving slowly and that has its own challenges, I think we are at a stage where the industry is becoming more mature and so we will be seeing a lot more M&A activity.

    Patrick Stroth: It’s early mature and it will continue to go. I think the biggest beneficiaries throughout all of this is going to be the public, the consumers, because we’ll get finer working finished products here that are both safe and reliable and less and less expensive to operate as time goes on. That’s why American business does as well as it does. Do you have any predictions for just what’s around the corner for the industry or any trends that you see coming that we should keep an eye out for?

    Gretchen West: Well, I think the counter-drone space is really interesting. Like I said before, there’s limited authority. A couple agencies within the federal government are allowed to actually use the technology, but there are things in play to create some new rules to allow for private companies to hopefully get approval to become a user of that technology. I think that’s very important. I mentioned before from a security standpoint using counter-drone technology around … anywhere there’s a map gathering or an amusement park or some critical infrastructure. I think counter-drone technology is an area that we’re going to see a lot more development and something to watch. I think the commercial drone industry as a whole and all these different amazing use cases that we can find benefit and save money, save lives, create efficiencies, I think … The industry is moving slowly because of the regulatory environment. I know sometimes that is a concern to investors. This is not an industry with quick returns at this stage, but we know that it’s coming. We’ve seen the value that this technology provides.

    I think if people just hold on a few more years, we will see more commercial operations and those returns will come back in. There will be a lot more M&A. A lot of startups, I know, were developing technologies simply to be acquired by a customer or strategic partner or something like that. I think this is coming. Even though there’s a lot of challenges, our team and the work we do are … We’re in Washington, D.C. all the time talking to the regulators and the federal government to help reduce these barriers. We’re going to get there. We are going to get there. I think it’s really important to keep an eye on this space from commercial operations of drones, to counter-drone technology. Even urban air mobility, the air taxi industry which is similar but different to commercial operations of drone, but all of these areas, I think, are fascinating areas and they are coming. It’s going to be a place where I think investors, investment thinkers really need to pay attention to.

    Patrick Stroth: Well, as you mentioned, we’re just scratching the surface of this topic. We didn’t even get in to talking about the types of investor’s funds, fund managers, opportunities and things like that. I think we’re going to leave that to our listeners that if they’ve got a particular question like that, I think they can direct that to you directly. Gretchen, how can people find you?

    Gretchen West: Well, they can find me via email at gretchen.west@hoganlovells.com. That’s H-O-G-A-N-L-O-V-E-L-L-S.com.

    Patrick Stroth: Thank you very much, Gretchen. Again, it’s a catchy topic, but it’s also right on point with what we want to do. Thank you, again, for joining us and have a good afternoon.

    Gretchen West: Thank you. You too.

     

  • Why the Right Broker Is Key When Working with R&W Insurance Underwriters
    POSTED 5.21.19 Insurance, M&A

    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.

    It’s All About Who You Know

    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.

    Getting the Deal Done

    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.

    The Value of “Neutrality”

    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.

    Where to Go from Here

    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 pstroth@rubiconins.com or 415-806-2356.

  • Private Equity and Tech Companies Face Stiff Competition From Unlikely Source for Tech Acquisitions
    POSTED 5.8.19 M&A

    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:

    • Creating a new framework for engaging customers
    • Increased focus on data on how they can leverage it to market more effectively to customers
    • Acquiring technology they don’t have
    • Evolving consumption and monetization models
    • Recognition that their existence is threatened if they don’t evolve
    • New channels/new distribution models
    • Recognition of the trend of disruption (if you can’t beat ‘em – buy ‘em)

    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