Insights

  • Must-Have Insurance For Your Next Add-On Deal
    POSTED 10.13.20 Insurance

    If you’re involved in lower middle market M&A deals, you should know that Representations and Warranty (R&W) insurance is now available to cover transactions as low as $10M, offering tremendous benefits to both Buyers and Sellers.

    This isn’t common knowledge in M&A circles, even though it’s been more than two years since insurers started entertaining sub-$100M transactions.

    The pandemic has disrupted the normal route that this sort of news gets out: M&A conferences, where insurance companies share details on product development and product changes.

    If I wasn’t sharing this with you now, chances are, you wouldn’t know about it.

    That’s why I’m compelled to share that R&W policies created for lower middle market deals are available, and, although costs are rising because of the immense number of deals seeking this coverage, they are cheap – costing $225,000 to $240,000 for a $5M Limit R&W policy.

    This makes R&W coverage perfect for add-ons, which have been an increasing focus of PE firms in order to add value to existing portfolio companies.

    According to a recent report from Axial, the online platform that connects Buyers and Sellers, “Add-on acquisition activity in the United States has experienced a steady, near linear growth since the early 2000s.”

    Axial reports that 90% of acquirers are looking for add-ons right now—it’s a very robust market.

    Also noted in the report: add-ons represented 43.2% of buyout activity in 2002 and that had risen to 71.7% by 2020.

    Add-ons are often a smaller investment with potential for greater returns.

    The benefits to Sellers in an add-on deal are:

    • Greater value as part of a larger company
    • Cost synergies add to the bottom line
    • Access to larger customer base
    • Enhanced purchasing power and financial leverage

    Overall, this type of deal allows Sellers to strengthen a “weakness” keeping them from the next level. And the outlook for add-ons keeps getting better and better because Buyers in these deals are focusing on blending company cultures more than ever before. Add-ons are being done more “thoughtfully,” with conscious attention brought to successful integration—it’s not just “buy and forget.”

    The greatest benefit of an add-on is that it’s a “second bite at the apple.” Sellers retain a portion of the new entity, giving them potential for additional money when the new entity is eventually sold.

    For example, the owner of a $20M company agrees to sell for $15M cash and roll-over $5M (25%) in shares of the new firm. Later, when the new firm is sold for $100M, that 25% is now worth $25M, 5-times the original $5M roll-over figure and $5M more than the value of the original company.

    There’s a catch. Add-ons are smaller and less experienced in M&A than their counter parties.  Once a LOI is signed, Buyers with huge leverage can exert great pressure in negotiations, which creates tremendous stress on the Seller.

    The acquired company might feel cornered and bullied into agreeing to take a lot of risk and liability away from the Buyer – like take on a sizable escrow. Traditionally, the Seller could be at risk of losing 10% to 30% of proceeds if there is a serious breach. And they have to swallow the fact that they’ll only get a portion of their money at closing.

    Sellers have to wait a year or more – and the money sitting in escrow can be exhausted in the event of a breach that the Seller had no control over.

    That’s where Rep and Warranty comes in.

    Removing Risk With R&W Insurance

    One way to remove some of the contentious issues in a deal is through R&W, which enables Sellers and Buyers to transfer their M&A risk to an insurance company. This specialized type of insurance is helping add-ons be successful.

    Until recently, this powerful tool was not available to smaller (sub-$50M deals) due to cost and target companies not having thorough financial documents or Buyers developing key diligence reports.

    As detailed in my previous piece “Moore’s Law Comes to R&W Insurance” greater competition among M&A insurance companies has driven down premium levels and simplified prior eligibility criteria. To read the Moore’s Law piece, go to: https://www.rubiconins.com/moores-law-comes-to-rw-insurance/

    Insurers no longer require audited financials (a deal-breaker for lower middle market companies). Thanks to low costs, R&W is the ideal fit for sub-$100M acquisitions – especially add-ons. However, as I mentioned, due to increased competition in the last several months costs for these policies are going up.

    Currently, a $5M policy will cost $225,000 to $240,000.

    Another caveat: While deals as low as $10M are eligible for R&W insurance… not all insurers are offering coverage at this level. Due to a surge in M&A activity, the big national insurance brokers don’t have the staff available to handle all the applications coming their way. So, they’re focusing on deals with a transaction value of $200M+.

    If your deal falls under that threshold, you should be looking at a smaller firm that focuses on that level of deal—R&W coverage is still out there if you want it, you just have to look a little harder.

    (Also, keep in mind that Transaction Liability Private Enterprise (TLPE) insurance is available for deals with a Transaction Value of $250,000 to $10M.)

    Having this coverage in place makes for a much healthier environment post-closing, where you didn’t have to grind down the target company in negotiations. These are the folks joining your team, and if they come limping in, you can bet they won’t be as enthused to make the merger work.

    In the tech community, Buyers are especially reluctant to penalize their newest partners by using up escrow funds. So they have a dilemma. Do they eat the loss… or risk demoralizing their new partners? With a R&W insurance policy in place, that dilemma is gone.

    You want people to hit the ground running. How?

    Make sure they get as much money as they can with as little risk as possible. If you are the Buyer, the R&W policy is zero cost to you. And it can be applied directly to the purchase price which Sellers will eagerly accept.

    You want these transactions happening fast. You want to integrate the new group into your team in a positive way to ensure a successful transaction. What better way than this tool – Representations & Warranty insurance.

    It has withstood the test of time. It’s worked for the big deals, and now it also works for the lower middle market deals.

    What To Watch Out For

    As the R&W insurance market has matured, different insurance companies now favor different M&A profiles. Some prefer larger risks over $200M. Some prefer lower middle market – $50M or less. So when selecting a broker, make sure you work with one who is focused on your market segment.

    You could go to a “brand name” institutional broker for your lower middle market deal. They are not bad people, but they are focused on their bigger deals. They don’t have the bandwidth to handle the smaller transactions. If they have two or three billion-dollar deals going, they can’t handle a dozen $20M deals at the same time.

    Another wrinkle is that, due to lower priced R&W coverage, some brokers will add in extra fees to supplement revenue and maintain profitability per deal.

    I’m a broker with hands-on experience with the Representations and Warranty insurance product, specializing in insuring lower middle market deals.

    To learn more about the protection R&W coverage offers, I invite you to contact me, Patrick Stroth, at pstroth@rubiconins.com.

    Article Updated: September 01, 2021

  • The Lowdown on “Naked Tail” D&O Insurance
    POSTED 1.7.20 Insurance

    In insurance parlance, if you insure a particular exposure, you’re covered. If not, you’re bare. If you’re looking for a policy that covers something that’s never been covered before, you’re… naked.

    That’s the situation many privately held, small and middle market companies find themselves in when they seek to sell their business.

    The Buyer asks them to secure Directors and Officers Liability insurance (D&O), specifically a “tail” policy to make sure there’s a source of insurance coverage in case the Seller is held liable for any wrongful acts against an employee or others – things like human resources issues or fraud – committed before the closing date.

    Essentially, the Buyer doesn’t want to find out six months after the closing date that there is some sexual harassment lawsuit or anti-trust complaint against the former owners.

    As the new owner, the Buyer doesn’t want to be on the hook for incidents that happened before they purchased the target, so they require Tail coverage that extends the target’s D&O Liability, Employment Practices Liability, and Fiduciary Liability coverage for up to six years from closing.

    Tail policies provide virtually the same protection as a traditional D&O policy that has a Tail Endorsement. On the acquisition date, the Tail kicks in and covers lawsuits brought against the directors and officers of the target company. This covers any allegations that they committed a wrongful act prior to the acquisition, all the way back to the incorporation date.

    This sort of coverage is standard in the M&A world. I’ve been working in this space for years. As I mentioned in a previous article, when Representations and Warranty insurance is not a fit for a deal, Naked Tail coverage is one of three alternatives.

    (To put it in to perspective, the cost of D&O Tail coverage is about $20K to $50K. That’s a fraction of the cost of a R&W policy. And the deductible on a Tail policy is $25K to $50K, which is also a fraction of what it is for R&W.)

    There are literally thousands of privately held companies in the $30M to $50M range that have never held D&O insurance and now need it to satisfy the terms of their acquisition. Today, this can be done quickly, easily, and broadly.

    For example, a small business, run by husband and wife for 20 years. They never felt the need for D&O coverage and had gone the whole 20 years without any sort of legal claim against them. But, when they were ready to sell and enjoy a well-deserved retirement, they were forced to scramble and find coverage because the Buyer required a D&O Tail. Since the couple had never carried D&O previously, their options for finding suitable coverage were limited. That is until now.

    Insurance companies didn’t look at these Naked Tails favorably in the past. Generally, they wanted to see three to four years of successful coverage under a regular D&O policy (and wanted three to four years of premiums).

    What happened to people who didn’t previously have a policy and are about to sell or merge? The insurers would provide scaled down policies with multiple exclusions at rates that were substantially surcharged.

    Things have changed. Now, insurers understand that the risk of anything that the Seller didn’t know about blowing up post-closing is very small. And they are willing to offer these Naked Tail policies for even small transaction size deals.

    Today, Underwriters need only a statement from the Seller warranting that, as of the closing date, they know of no fact, event or circumstance that would give rise to a claim. Such warrants are hardly problematic because the Seller is already making these warrants to the Buyer on a much broader scale.  Therefore, the Naked Tail is a relatively low risk for Underwriters.

    Three Reasons You Need a Naked Tail Policy

    There are a couple of reasons you need a D&O Tail policy when you’re going through any M&A deal, besides the fact that it is contractually required. (For those who’ve never had D&O insurance and don’t see why you need it now, pay close attention.)

    1. If you are getting purchased, this is major liquidity event. You become a deep-pocketed individual overnight. There’s nothing like some press release touting the $20M sale of your company to bring people out of the woodwork who are motivated to take some legal action. Could be past competitors (like a company hoping to be purchased but you were selected instead). Also, former employees who quit before the transaction happened and who now feel they want part of the payday. You need to be protected against such situations.
    2. D&O insurance will cover your costs. The cost of litigation is only going in one direction as time passes – up, especially as states, California foremost among them, pass court costs on to litigants. You’ll also have to pay defense costs and settlement costs. If you have a Tail policy, the insurer covers those costs. The more limits, the more protection, the more dry powder you have. You want to preserve your nest egg.
    3. If you don’t have R&W coverage, you have no protection from Buyers alleging you committed fraud or misrepresentation when you affirmed you knew of no potential breaches of the Reps in the Purchase and Sale Agreement. In these cases, they usually want to keep your escrow, and even clawback more funds to pay for the financial damages – up to 100% of the purchase price. That’s not good.

    D&O Tail coverage doesn’t cover fraudulent behavior, but it will give you money to defend yourself against allegations of fraud. An allegation is not proof. But if you want to keep your escrow, you must defend yourself in court, no matter how frivolous the claims. Without D&O coverage, you’ll pay your own legal costs.

    D&O Tail coverage doesn’t cover fraudulent behavior, but it will give you money to defend yourself against allegations of fraud. An allegation is not proof. But if you want to keep your escrow, you must defend yourself in court, no matter how frivolous the claims. Without D&O coverage, you’ll pay your own legal costs.

    How to Get Your D&O Tail Policy

    As I mentioned, if you’re looking to sell your business, you’ll most likely be contractually obligated to take out a D&O Tail policy. There’s no getting out of it, so to speak. And with the legal and financial protection it offers, why wouldn’t you want a policy anyway.

    I would recommend not going to your regular commercial insurance broker, even one with experience in standard D&O insurance. A Naked Tail policy is a whole other animal.

    You need a broker experienced in insuring M&A transactions and Naked Tails in particular. It’s a slightly different skillset. And because this issue usually comes up close to closing, you want a pro who can get the paperwork processed in a day or two.

    I’ve worked in this world for years and would love to answer any of your questions about setting up a D&O Tail policy to your deal. It’s low cost and easy to do. 

    You can contact me, Patrick Stroth, at pstroth@rubiconins.com

  • Alternatives When Representations and Warranty Insurance Isn’t a Fit 
    POSTED 10.8.19 Insurance

    In the world of M&A, many companies, on both the buy-side and sell-side, have realized the tremendous benefits provided by Representations and Warranty insurance.

    The Buyer is able to recover any losses from a breach of the Seller reps without doing so at the expense of the Seller. The Buyer simply makes a claim with the insurer. Plus, the policy cost is either discounted significantly or is free because the Seller will gladly cover the premium.

    Sellers love it because they take home more at closing and the indemnification risk is transferred to a third party – the insurance company. A clean exit, and they have zero fear of future potential clawback if there is a breach.

    That being said, not everyone is willing to entertain using this insurance.

    This is especially true in the case of a corporate, strategic Buyer, in which one company buys another because of synergy of products… to expand to a new customer base or geographic region… or to acquire products they want.

    The thing is that strategic Buyers are often much larger than the acquisition target – often hundreds of times larger. In these cases, there is no incentive for the Buyer to get R&W insurance; the protection it provides them is negligible. This is the case even if the Seller is willing to cover the cost. The other issue: the Seller has no leverage here.

    So what’s a Seller to do?

    As a small Seller, you don’t have to enter into an M&A deal with no protection. There are alternatives if your Buyer isn’t interested in full R&W insurance.

    Rep and Warranty Lite

    For tech companies, the most sensitive reps are those dealing with technology, of course. If those reps are breached, it could be very expensive as they are critical to the value of the company.

    The target tech company could be confident that their IP is not infringing on anybody, but the Buyer no doubt still has a bit of worry.

    If the Buyer is not willing to consider full R&W insurance, a Seller could get a limited policy that just covers IP reps. These types of policies do rely on the Buyer’s due diligence. So the Underwriters still have to engage the Buyer to get their diligence on IP. But it’s not the full report, so it’s a relatively easy ask. And the cost is still on the low end, with a premium cost at 2% – 2.5% of policy limit (subject to $100K minimum premium), with 1% transaction value retention.

    The same sort of arrangement could be made for tax reps, as well.

    Seller’s R&W Insurance

    Although the vast, vast majority of R&W insurance is on the buy-side, it is possible for Sellers to get their own policy. This could be handy if the Buyer refuses to disclose any of their due diligence and the Seller is nervous about not having any protection from risk.

    To be frank, sell-side policies can be more challenging than those of the Buyer’s side. It essentially protects the Seller in the case of a third-party (which includes the Buyer) bringing action against them for a breach of their reps.

    For example, McDonald’s recently bought a small AI company – the technology will be used to speed up the drive-through ordering process. A huge company buying a small one.

    Hypothetically, let’s say the AI company had unknowingly breached another company’s IP. That other company will sue McDonald’s and the AI company. McDonald’s is fine – they have their own protection and legal team. But the founders of the AI company need protection because they no longer have insurance after the acquisition. A sell-side R&W policy can be a perfect option.

    Directors and Officers Liability Insurance

    Owners and founders can also rely on a Directors and Officers liability policy to protect them in case of allegations of misrepresentation, unfair dealing, or fraud. At the very least, the D&O policy can pay lawyer costs to protect the policyholder.

    In the vast majority of purchase and sale agreements there is a requirement that the target company have a D&O policy in place. Privately owned companies with a small number of shareholders/owners might think they don’t need this coverage because they don’t have outside shareholders. But this protection is key.

    Once the Buyer acquires a company, the board is their responsibility. They don’t want to take a risk on things done before they acquired the company. It’s best to have some other source of recovery like this on their end as well.

    A D&O liability policy will run you a tiny fraction of what R&W costs.

    D&O Tail Insurance

    For those companies that never carried D&O insurance in the past, there’s a solution.  Companies can purchase a D&O Tail policy that will provide virtually the same protection as a traditional D&O policy that has a Tail Endorsement.

    In the event there is a claim against any of the directors and officers, they will be protected from legal action for up to six years post-closing if there is a D&O “tail” policy.

    Even if they didn’t have insurance previously, on the acquisition date the tail kicks in and covers any lawsuits brought against the directors and officers at the target company. This covers any allegations they committed a wrongful act prior to the acquisition, all the way back to the incorporation date.

    Step by Step, Down the Line

    Let me wrap things up with a quick case study of a company that wanted R&W coverage in place… and a Buyer who wasn’t willing to deal… and what they did next.

    A small AI company was bought by one of its clients – one 1,000 times its size, roughly, and worth $20B. The total transaction value was $17M.

    The Buyer had no interest in R&W insurance, even when we offered a policy that covered the full $17M.

    The Seller was really concerned because the IP reps went from general reps to fundamental reps with a longer survival period. That’s a lot of risk out there for them for years down the road if another company claims IP infringement.

    We offered to insure just those IP reps, with a premium from $100K to $300K, which the Seller was ready to pay.

    All that was needed to write the policy was the Buyer’s due diligence report. But they didn’t want to disclose any confidential information.

    The last alternative we were able to offer the Seller was a D&O Liability Insurance policy. We got the thumbs up and did a $5M limit D&O policy for $50K.

    The company was acquired on July 1, 2019. Until July 1, 2025, any lawsuit filed against the company’s board of directors for allegations prior to the acquisition date will be covered.

    Of course, R&W insurance would have been preferable for the Seller. But this was the best option and does offer substantial protection.

    If you’re interested in exploring your options for protecting yourself post-closing with Representations and Warranty insurance or some other type of coverage, get in touch with me, Patrick Stroth, at pstroth@rubiconins.com.

  • Austin Leo | Insurance That Increases Sales
    POSTED 9.17.19 M&A Masters Podcast

    In the world of tech, a lot of companies, especially the smaller ones and startups, their financials are quite opaque. You never know on the surface if one is about to go under or go unicorn.

    Austin Leo, VP of USI Insurance Services, highlights a specialized type of insurance, once reserved for large manufacturers, that can help larger companies identify who to do business with… especially those with the least risk of going under before they pay their bills. 

    And that’s just one benefit.

    It’s a great example of insurance coverage that adds tangible monetary value… even when you don’t have a claim. Austin walks us through the many ways these policies help and how they work in real-world terms. 

    Tune in to find out…

    • A strategy to prepare for a gap in your accounts receivable
    • A “backdoor” way to get information on potential clients
    • How to increase sales with insurance
    • Why lenders love this insurance – and are ready to spread the love to you
    • And more

    Listen now…

    Mentioned in this episode:

    Transcript

    Patrick Stroth: Hello there, I’m Patrick Stroth. Welcome to M&A Masters, where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here: that’s a clean exit for owners, founders and their investors.

    For most people, insurance is something that you pay for, but you hope you’ll never use. Even when it works, people are still not happy because something bad has had to happen in order for you to put your policy to use. Now there are insurance products out there that provide tangible monetary value without the policyholder ever having to suffer a loss. Rep-and-warranty insurance for M&A transactions provides this very value-added capability, and that’s what inspired me to pivot our program here at Rubicon M&A insurance to focus on insuring M&A transactions.

    Today, I’ve asked Austin Leo of USI Insurance Services to join me to discuss another product out there called trade credit insurance. Like rep and warranty, trade credit provides significant financial benefits without ever having to incur a loss. That’s probably why private equity firms are now warming up to this and using it on more and more of their portfolio companies. But,  I’ll let Austin tell you how. Austin, thanks for joining me today. Welcome to the program.

    Austin Leo: Hey, Patrick, thanks for having me. appreciate you having me on. Glad to be here.

    Patrick Stroth: Well, let’s give everybody listening here some context. How did you get to this point in your career, where you’re a specialist in this very technical area of insurance?

    Austin: Sure, so good question. Sometimes I asked myself that myself. So, you know, I started off my career actually working in PR, and then ended up at a company, they were a French company, that specialized in company information in the B2B sector and advertising your products in that sector to specialized clients. Ended up you know, you know, really like that part of the business, especially the information side of that. And, I ended up at an insurance firm by the name of Coface. Now, Coface is a French insurer (second-largest trade credit insurer in the world), and I started off there as an underwriter and soon found that insurance was fascinating to me. Especially the trade credit side of things, whereas you mentioned, you know, you don’t really need to find the value when a claim happens— you can do that much earlier. And we can talk about that. But anyway, ended up you know as an underwriter, a Coface. Then went to manage our global clients, and then went on to the broker sodas business with my own firm. And then, eventually joining USI. 

    Patrick: Well, as with a real diverse industry like insurance, there are products that can cover any number of different exposures. Why don’t we help the audience out here— what is exactly trade credit, and then who uses it, or who’s the traditional user of a trade credit insurance policy?

     

    What Is Trade Credit Insurance?

    Austin: Sure. So trade credit insurance helps companies identify their risks, it provides companies with information on their customers, the insurance side of it really covers a company who is selling on open account terms— open account credit terms to another company— it helps them mitigate that risk against non payment, slow payment, or bankruptcies and insolvency.

    So you’re selling to another company, for whatever reason, they don’t pay you or cannot pay you. That’s when credit insurance would kick in, and pay a claim on the non-payment side of it.

    Patrick: So they step in and pay your outstanding accounts receivables because the client disappears or is somehow unable to pay?

    Austin: That’s exactly right.

    Patrick: And the traditional policy was— I can think of these where you’ve got big ARs out there were large industrial manufacturers, textiles, commodity type things. That could be the typical client of this. But nowadays, are there other clients, particularly in the tech sector, where this could be used?

    Austin: Yeah, absolutely. And you’re right, Patrick. You know, a lot of companies that have used trade credit insurance are, you know, manufacturers, distributors, the commodity traders, but, you know, manufacturer or distributor of components. And that was kind of the traditional side of a user of trade, credit insurance. Use it for multiple things, you know, both for mitigation and enhancements, financing, and sales. But now we’re finding that in the tech sector, you know, a couple of things are happening, right? Tech companies tend to be a bit focused on sales, especially to companies they might not have a ton of information on, or are new to the industry.

    So that leaves you, you know, at risk to non-payment, or lack of information on your companies. And as I always say, you know, a sale isn’t a sale until it’s paid or collected, right? So, it’s great that you’re sales focused and offering open account turns to other companies, but until it’s paid, it’s not a sale. So, that’s where we find tech companies benefiting from the trade credit side of things, you know, the heavy AR stack on the book, the last thing you want is for multiple companies not paying you, customers not paying you. 

    And then I mentioned on the information side, you know. Newer companies, prospective clients… it’s tough to pull information. I mean, of course, you know, you can, you know, Dun & Bradstreet, CreditSafe is a provider of B2B company information. The insurance companies also have big databases filled with information, and they do their due diligence. I mean the last thing they want to do is, you know, pay a claim, right? They want to be profitable. So, the information that we find from the insurers tends to be better than some of the stuff we find from, you know, like the DMV. So, yeah, I think the benefit in the tech side is, you know, data information on your prospects, clients. And then, of course, you know, mitigating the risk of non-payment or insolvency from those clients.

    The other thing that we find is the financial benefit.

    How Does Trade Credit Work?

    Patrick: Before we get into the financial benefit, I just want to go back just on a really nice use case scenario. So you have… what the service that you can provide as your insurance product can provide background checks for prospective customers. So if you’re a tech firm, you’re about to sign a major contract with a potential customer, they could turn to their trade credit insurance and say, we want to sign up this company in South Korea as a client, they’re going to pay us X dollars… and we don’t have as much information. But, the insurance company with their resources, can find out whether or not that potential client in South Korea is a good or bad credit risk. Is that is that how that works?

    Austin: Yeah, that’s correct. So yes, you know, we want to sell to company A in China, you know, notoriously, it’s kind of known in China, that it’s tough to get financials. The insurers are able to do that along with banks. So yeah, you know, we expect to have, you know, 2 million open, you know, AR exposure at any given time… high AR exposure at any given time. What do you guys think? And then the trade credit insurance will come back and say, “well, you know, you know, either yes, will approve the 2 million and, and here’s why. Or we’ll do a partial approval of that.” And give you information on why, you know, maybe they’re late to pay other suppliers, and that’s in their database, maybe their financial conditions have worsened Or, you know, the last answer you want here is, is “no,” but it’s relevant, you know, information, right. 

    The last thing you want to do is try to turn bad credit into good credit. Never works out. We’ve seen it time after time. So, yes, the credit insurance information… or I’m sorry, the credit insurance companies are all members of the Berne Union, and they share information with one another.

    So you’re seeing the information that you know, the bank’s get…. the insurance gets, but you might necessarily not.

    Patrick: Wow, so then, not only are you protecting your client from from a perspective loss, but you’re just giving them that that background information so that they can make a better decision that’s got to improve, you know, they’re not necessarily I think, guaranteeing this AR is out there. But, they are really protecting those.

    That’s got to make a company’s lenders really happy. I mean, you had just referenced me there is a financial benefit, I can imagine, you know, with their, with their lenders, companies, lenders would love if the company had this kind of protection.

    Austin: Yeah, and you bring up a good point, Patrick. So, yeah, the lenders, they love trade credit insurance. Especially when there is ABL: an asset-based lending facility in place. You know, companies… everybody thinks about their assets, right? You know, you have the people, you have your property, you have your inventory, all of those are insured, right?

    A lot of times companies don’t think about your receivables as an asset. And they are, and in some cases, they’re the largest asset a company has. So the lenders love it when the foreign receivables are insured with trade credit insurance because it allows them to include those into the borrowing base of an ABL. It also allows them and their credit folks in the bank to feel comfortable raising advance rates, which is really key. You know, you could have a company that has a facility that’s getting, you know, an 80% advanced rate on their assets. With trade credit insurance, the bank can bump that up to 85%-90%. 

    We’ve seen companies that have gotten, you know, 1 million-2 million, just an increase in working capital, just from having a trade credit insurance policy.

    Patrick: Wow. And so, in addition to mitigating risk on the one side, you’re now improving their accessibility to more cash. And that’s got to be just a great benefit that offsets any costs. And this can also be used in a couple of other things, not just for increasing your cash flow, but does it impact on other operational things like your sales? 

    Austin: Yes, yes, it does. So, you know, you could have you can have a group of customers, right?  Where your credit folks internally, within the organization say, “we’ve looked at the financials based on the information that we have, you know, credit report financials, we’re comfortable granting $2 million dollar limit for them in credit.” 

    Whereas you there could be a credit insurer saying, “you know, that’s great. You know, we have information, we can justify a $4 million limit, and would be willing to include that in a credit insurance policy and underwrite that and ensure that.”

    So, I mean, in essence, you know, you can go above and beyond what you might be comfortable doing internally, from a credit standpoint. And you’re just having a partnership with the credit insurance company, letting them take on that risk and really risk transferring that which in turn, you know, you can sell more to a customer… you’re obviously going to increase your sales, depending on how many times a year you do that, and what the open account terms are. So yeah, we’ve seen companies, I mean, in general— we have statistics on this, based on what the insurers provide— companies can increase their sales by 20%, just by using the trade credit piece.

    Benefits of Trade Credit Insurance

    Patrick: Okay, so that’s benefit three. Benefit one was protecting yourself with the information on prospective customers that you can get from the trade credit insurance company. Number two is improving terms from your lender, so they can get more cash flow probably improve their lending rate, and then you can increase sales. So all those are tangible, testable, you can do with evidence and so forth.

    So that really is something. Do you have any case studies or just use examples in the technology sector? I know, you’ve been writing some tech company lately, you share with us some examples of that?

    Austin: Sure. So, you know, we had a tech company that we’re working with, that had a private equity company go in, and partner with them, right. One of the things that were not making them look, so financially sound was the bad debt reserve that they had on their balance sheet.

    So, you know, tech company, as I mentioned, you know, tech companies can be so much focused on sales. So they, were, but to the wrong companies, right? So, piled on a ton of AR, which turned into bad debt, which, you know, when you have bad debt, you have to keep a bad debt reserve on your balance sheet, which negative negatively impacts working capital.

    So, what we did for them, is, we were able to use credit insurance as a way to take out that bad debt reserve, right? You can completely remove that from your balance sheet, transfer that risk to the insurer. In addition to that, they had, you know, two or three clients that were a concentration risk. So the three clients made up about 70% of their business. So what we did, and what the lender liked and in the private equity company, they liked that removing that risk of concentration, right? Because God forbid something happens to you know, one or two of those three big clients completely would put them out of business. So we’re able to transfer that risk. 

    And then from a financial standpoint, they were able to get additional working capital, from some of the foreign receivables and increase to their advanced rate on their ABL facility. So the working capital paid for the credit insurance policy times ten. And the main thing that, you know, we’re sitting down, we’re talking with the CFO, and he goes, you know, what I don’t want is to detract from sales, right? We’re a sales-focused organization, that is where we want to stay focused, we need to grow. So the tool that they really liked was, you know, using one of the large insurers for their database, and even before selling to a company, a new customer— they were able to go into the online portal of the insurer, putting the company’s name, where they’re located, and the credit limit needed, they would know before they even made the sale, if that would be eligible for trade credit insurance. Which gives them a competitive advantage, right? So you know, the information, the lending, and then removing the bad debt reserve off their balance sheet, completely changed this company. It was actually amazing to see what we’re able to do for them.

    Patrick: Yeah, the one thing is private equity firms are notorious when it comes to insurance, they really do not like spending any dollars on premiums unless there is some real value coming in. So, it’s a real validation for you to have private equities firms now becoming more active and really warming up to that. Have you seen a growing trend of that with private equity?

    Austin: Yeah, absolutely. I mean, you know, when private equities go in, and they invest in a company, they want to make sure that they’re getting the best return on their investment. Right. And they don’t want to spend any more money than needed. That’s for sure. So yeah, yep.

    You know, we’ve seen I mean, yeah, there’s a way for us to do a financial benefit review. Right? So, before you even get the trade credit insurance policy, there’s a questionnaire that we have, there are things that we like to review, to see if it would be, you know, cost-effective or cost-prohibitive to the, to both the company and then the PE firm.

    So yeah, we’re seeing private equity use tree credit insurance a lot more. You know, over in Europe, the trade credit insurance market is like 60% to 70% of companies use trade credit. Here in the US, it’s about 12% to 15%. So I think it’s just, you know, a lack of knowledge… a lack of people out there in the marketplace really educating people on trade credit. And we’re starting to see that come around. So, yeah, private equity firms are getting very keen on it. And understanding the benefits and utilizing the trade credit, you know, from the financial benefit, and from a risk mitigation benefit. For sure.

     

    Patrick: Well, it’s all it’s also nice, because even before they have to commit to securing a policy (there is an application process) but they can find out dollar-for-dollar, how much more they can make before the even have to get a policy, I think that’s a really nice element. We see the same thing and do it proposing terms of rep warranty where you can go ahead and get the terms of a deal set up and we can already kind of model “well, here are ways that you’re going to be able to exit the transaction with more cash than you would if there were no insurance.” I mean, and usually, the financial benefit is a multiple of whatever the cost is.

    So it’s as a lot of people say, once they learn about trade credit a little bit more just as with rep and warranty, the same to word description they just say it’s a no brainer. And that’s why I really think the more people that learn about this, and see how it’s being deployed is a real benefit. What’s the application process? What is there a minimum eligibility requirement? What’s the process? So if someone were to reach out to you, how would they get started?

    Austin: Sure. So no, there’s no minimum requirement for trade credit. There used to be. But as we’ve seen, you know, I was talking to a client of mine 10 years ago, there’s about, you know, maybe 10. In insurance companies who’d be willing twice, right trade credit. Now, there’s about 25, or 26, we can go to, which kind of, you know, change the market and added a ton of additional capacity into the marketplace and softened the market as well, which is good for prospective buyers.

    So no, listen, not a very labour-intensive application process. Basically, they want to understand, you know, who is your company? What do you guys do? Have you had losses in the past? Who are your customers? You know, one of the benefits from going through the application process is, as I mentioned, you have lots of markets to go to, you have lots of insurers who have big databases full of information. Basically, you get a free review of your top 20 customers, by multiple sources. So you could have five or six trade credit insurance companies saying, here’s what we think about all of your top 20 customers, here’s how we would risk rate them. And if we see any problems, here’s what we see. So it’s a nice kind of due diligence process, as well, as you know, looking into the product itself. So no, essentially, you know, you can reach out to me, we have our own application that all the insurers accept, and we’d be happy to guide you through the process and see if it’s something that’s right for the company.

    Patrick: How long does the process take?

    Austin: Generally, applications, you know, sitting down working on it, I’ve had clients fill it out within, you know, 20-30 minutes. I’ve had clients take months to get back to me, but I think it’s due to other priorities. But listen, you know, I think, you know, sitting down, it should take no longer than 20 minutes to maybe an hour if you have all the information necessary.

    Patrick: Well, the other issue is just how long does it take for the insurance carriers to processing? Assuming full submission, complete submissions out there to you go to the 20 markets for them? How long is it approximately… weeks? Days?

     

    Austin: No, it’s… you know, Patrick, it’s relatively quick. If we have a filled-in application, and we submitted to the market, we expect to have responses back from the insurers within a week to 12 days. So, you know, two weeks if you’ll all of the markets have quoted, and will sit down with people and talk about the pros and cons to each. 

    Patrick: Well, that’s that is it, there is no reason for someone not to reach out because just having the information will… even if it’s a no-go, that that information, I think, is a tremendous use to business owners out there and management firms and so forth. 

    Austin, these products are tailor-made for each and every particular client, there’s not a lot of heavy lifting, the cost is a fraction of what the benefits are. So there’s no reason why you shouldn’t be flooded with people reaching out. How can our audience get ahold of you so that they can see if this is a fit for them? 

    Austin: Sure, so you can feel free to contact me via LinkedIn, which is Austin Leo. You can reach out to me at Austin.Leo@USI.com or there’s always the phone which is 908-240-5145.

    Patrick: Excellent, Austin. Thank you very much for helping me bring in another value add that doesn’t require somebody suffering pain in order to get benefits. So thanks again.

    Austin: Patrick, thanks for having me on. I appreciate it, it was a pleasure.

     

  • When Insurtech Works… and When It Definitely Doesn’t
    POSTED 1.16.19 Insurance

    You’ve seen the commercials on TV.

    You visit a website and easily apply for insurance for your home or car, getting quotes from multiple companies at the same time. Some types of health insurance even work like this.

    The advantage of these online marketplaces is you don’t have to go through the time-consuming process of calling or visiting an agent to get your policy… who might even try to upsell you on other services. It can be a real chore.

    I have no problem with this so-called “insurtech” when it’s used to secure these relatively simple types of “consumer” insurance faster and easier.

    When it comes to any sort of insurance product with the least bit of complexity, however, insurtech should be just a first step to give you a ballpark idea of what’s out there.

    And, you need an expert helping you in person when you go beyond this Step 1 to ensure you get the coverage you need.

    Take the popular online legal services website, LegalZoom. They make it super easy to set up articles of incorporation. But if you’re a startup looking to attract serious investors, doing so would lose you all credibility. And you couldn’t be certain your business was structured correctly.

    With insurance, you could potentially go “DIY” and try to do your own research to figure out which option is best for you as far as type of policy and level of coverage. But if something goes wrong down the line and you discover a certain risk isn’t covered, it’s all on you.

    You could sue the insurance company but… good luck there.

    What You Should Do Instead

    You need an expert who does this for a living and knows specialized types of insurance like Representations and Warranty (R&W), which covers M&A transactions, as well as Directors and Officers liability insurance, Cyber Security insurance, and more, inside and out.

    If you deal with a broker, you not only have an expert to answer questions. The broker is also accountable. By law, they have a fiduciary responsibility to look after your best interests. If they make a mistake, you have someone to go after.

    These brokers may not be available 24/7 like an online marketplace, but they have the specific information you need and the answers to your complicated questions, backed up by years of experience dealing with these issues every day. That peace of mind is priceless when so much money is on the line.

    And, speaking of money, the difference in what you’ll pay in fees for an online marketplace versus an in-person broker is not as much as you might think. A bargain compared to the millions of dollars that change hands in a typical M&A deal.

    When you use a broker, you get responsiveness and expert-level input to make sure you get the right policy.

    Let’s use an example from the auto insurance world.

    On-line auto policies provide Liability and coverage for physical damage to the car (Comprehensive/Collision coverage), which most buyers understand. To keep costs down, buyers only select the coverages they think they need at the lowest Limit possible to comply with the law.

    The danger, is these “optional” coverages purchased at levels solely dictated by price, can leave drivers seriously unprotected. 

    In the case of Uninsured motorists – a driver will be left paying his medical bills and those of his passengers if his car is struck by someone with little or no insurance (think drunk driver). 

    Worse is when young adults (the “m-word”) living in their parents’ home purchase a tiny amount of insurance thinking they have no net worth at risk. They later find a court will likely allow attorneys to pursue their parents’ home for compensation because of their residence – so the house is “fair game”.

    This is no problem when there is a savvy broker involved. They’ll ask the questions necessary to understand what’s at stake and they can provide complete explanations of coverage, so buyers can make an informed decision.

    When an Expert Makes the Difference

    When it comes to complex insurance like Directors and Officers liability and R&W, only where the needs are very simple can I say that insurtech is the way to secure a policy.

    The vast majority of situations and transactions are much too complex. In the case of R&W insurance, this coverage is intimately intertwined with an M&A deal and is a major component of the negotiations. Underwriters need quite a bit of information before they’re confident in writing your policy. That’s not something you can handle online.

    In these cases, you need someone on your team who can put together a “patchwork” of different coverages and policies so there are no gaps… and no overlapping that causes you to pay too much.

    The layman can’t read through the policies to figure that out on their own. This complexity is why brokers are licensed and regulated.

    If you’re looking at securing a specialized type of insurance like Representations and Warranty, Directors and Officers liability, or Cyber Security, bypass the online portals and talk with an expert.

    I’m happy to jump on the phone or answer your questions by email. You can reach me at (650) 931-2321 or pstroth@rubiconins.com.

  • Representations and Warranty Insurance Pricing Trends for 2018
    POSTED 7.25.18 M&A

    From a cost perspective, there’s never been a better time to deploy Representations and Warranty (R&W) insurance in M&A deals.

    Read More >

  • Nate McKitterick | The Insurance You Need for M&A Deals
    POSTED 7.18.18 M&A Masters Podcast

    In every M&A deal, the devil is in the details. Nate McKitterick explains the ins and outs of one of the biggest potential deal breaking issues – indemnification.

    Read More >

  • 6 Ways Buyers Benefit from Representations and Warranty Insurance in an M&A Deal
    POSTED 5.16.18 M&A

    If you’re the Buyer in a merger or acquisition, you can take one action at the start of the deal—at the offer stage—that will

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  • The Top 3 M&A Insurance Brokers in Silicon Valley – an Honest Comparison
    POSTED 4.18.18 M&A

    As global insurance and risk management professional service firms, Marsh & McLennan and Aon do great work and have solid reputations in the world of M&A insurance. Along with Rubicon M&A Insurance Services, LLC, they are the only companies offering this specialized type of insurance to companies in Silicon Valley.

    Read More >

  • Role of the Insurance Broker in Your M&A Deal
    POSTED 4.4.18 M&A

    At the end of the day, successful mergers and acquisitions are about bringing people together… coming to an agreement and moving forward to everybody’s satisfaction.

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