M&A experts worldwide are using an insurance policy known as a Representation and Warranty (R&W) to transfer risk from the parties in a transaction to an insurance company. R&W policies are designed to, “step in the shoes” of a seller to pay indemnification claims made by the buyer for inaccuracies of the representations and warranties outlined in the purchase/sale agreement. Due to the low cost of R&W insurance, sellers are driving the demand for these policies rather than accept large, lengthy escrow or withhold terms. Buyers are discovering how R&W insurance can enhance their bid without having to raise their offer.
Limit Capacity – Up to $100M on a single policy. Excess capacity up to an additional $400M available as needed.
Retentions – commonly 1% to 3% of the purchase price. Reduces over time
Premium – 3% to 4.5% of the limits purchased (including taxes and fees). Minimum premium is $300,000
Underwriting Fee – From $25,000 to $35,000 in addition to the premium. Covers the cost of Insurer’s attorney’s fees and due diligence costs to review and manuscript a policy. Non-refundable.
Terms – designed to match the survival period. Post survival extensions available upon request.
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):
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.
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:
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.
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:
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…
Listen now…
Mentioned in This Episode: www.hoganlovells.com
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.
The typical insurance broker wants to serve all their clients’ needs, especially if it’s a large client that requires various types of insurance to cover its operations.
The motivation is to be there for the client, who you know well. And the extra commission doesn’t hurt either.
But although a broker may have the best intentions, if the insurance required is out of the broker’s area of expertise (and no broker is master of all), this practice is actually not good for clients. They’re just not going to get the best value out of their policy.
When it comes to Representations and Warranty (R&W) insurance, a highly specialized variety that covers M&A deals, this is definitely the case.
R&W insurance protects both Buyer and Seller if there is a financial loss resulting from a breach of the Seller’s representations that were outlined in a purchase-sale agreement.
If there is a breach, the insurer covers the losses because the coverage transfers the indemnity obligation from the Seller.
Buyers and Sellers entering into deals who are interested in one of these policies need a broker who specializes in R&W insurance and does it routinely. Not to mention that the broker must understand how M&A works.
In R&W insurance, it’s not what you know, it’s what you don’t know that will come back to bite you.
Here’s why: On the surface, the coverages from one R&W policy to another are very similar. It’s rare when R&W insurance policy verbiage diverges greatly and have material coverage missing, which often happens with other types of business insurance. Within various business insurance programs, many coverages considered “essential” by some are deemed “optional” by others and therefore omitted to save costs (i.e. Uninsured/Underinsured Motorists coverage).
The scope of coverage for an R&W policy is determined by two elements: The Seller’s reps and the degree to which the Buyer performed diligence on those reps.
The key difference between R&W policies comes from decisions Underwriters make as to what degree they’re willing to cover all or most of the Seller’s warranties. This decision is based on two elements: The Underwriters’ appetite for risk in a certain business sector and the amount of diligence performed by the Buyer. It’s essential for the insurance broker to determine to what extent each insurer is willing to cover the majority of warranties, and where there may be flexibility.
Unlike other instances when business insurance is considered, R&W is brought to bear in M&A transactions where 100’s of millions are at stake. That’s both exhilarating and terrifying for the parties. Often times, Buyers and Sellers haven’t used R&W before, so they have no idea what to expect from the process. They need a “steady hand” to guide them, manage their expectations and inform them as to what they can expect.
Brokers who lack experience in placing R&W will struggle to navigate the underwriting process. Ultimately, this can put their clients through unnecessary stress due to delays and “surprises” that an experienced player can anticipate and prepare for.
An example would be to prepare Buyers for the time and access Underwriters will need with the Buyer’s team to review the diligence performed and which outside parties participated. Brokers unfamiliar with R&W might fail to prepare their clients for this, which can result in a huge burden on the Buyer.
A broker’s relationships with Underwriters at different insurance companies is essential. Different insurers have different appetites for risk. A qualified broker, who are also experienced with M&A, knows who does what.
Some insurers are comfortable with healthcare deals and the added regulatory scrutiny they bring.
Some insurers are comfortable in the up-and-coming cannabis market. (Actually, there’s only one insurer in this market so far, but more will ultimately follow.)
Some insurers will cover certain deals but only with so many strings attached that the client won’t actually qualify, or the cost will be too high.
Insurance companies’ appetite for certain risks can change over time, and a savvy broker will keep track of these trends.
R&W policies cover complex business deals – and the Underwriters typically don’t know every industry well. That’s where the broker comes in to match the right Underwriter with experience – and interest – in a certain space for the deal.
A good broker/Underwriter relationship has other benefits.
First, a good broker sends information the Underwriters need without waiting for them to ask. That means coverage is obtained that much more quickly.
Just like anything in life, when you know someone, things just go smoother. This is particularly true on smaller deals, in which Underwriters have to deal with less due diligence provided by the Buyer.
Some insurers will penalize the Buyer for having less comprehensive due diligence. But a good broker can be a go-between and mediate in that case.
For example, say the financial statements were reviewed but not officially audited. The broker can explain why that was the case and why it’s okay. A trusted relationship makes it possible.
Typically, both Buyers and Sellers have their own brokers handling their respective insurance programs. When those brokers see the premium sizes (and the resulting commission) from R&W policies for big deals they say, “Sign me up.” They’re not qualified, but they’re certainly not leaving that money on the table and are willing to dabble if given the chance. This creates unnecessary friction between the parties as they argue on behalf of their “guy” or “gal”.
The best approach is to select an independent specialist who will only handle the R&W placement. There would be “zero conflict” with the incumbent brokers as R&W is a one-time deal that doesn’t touch any other policy.
That neutral broker will have a fiduciary responsibility to the Buyer (R&W policyholder) to provide the broadest level of protection, while committed to delivering a variety of options that are budget appropriate in the interests of the Seller (who often shares in the cost of R&W).
That’s why a neutral broker who knows R&W best practices and has the clients’ best interest at heart will get the ideal outcome for both sides.
There’s no shortcut for a broker who has experience and has had working relationships with Underwriters for years. With that comes mutual respect. If there are disagreements or contentious points, they are easier to work through.
In an M&A deal, Buyers and Sellers should not rely on a broker who does their other insurance to secure their R&W policy. Get a specialist.
A number of Underwriters have already “trained” me. I know the inside track. They know I’ll run the process the way they need to provide the best policy in a timely manner.
I’d be happy to discuss with you how Representations and Warranty insurance could benefit your next M&A deal, as well as the costs. Please contact me, Patrick Stroth, at pstroth@rubiconins.com or 415-806-2356.
