As vaccines roll out and COVID-related restrictions are lifted across the country, it’s time to look at the impact the pandemic has had on the use of Representations & Warranty (R&W) insurance to cover M&A deals… and what to expect in the near term.
R&W insurance, of course, transfers all the indemnity risk to a third-party – the insurer. If there are any breaches of reps and warranties post-closing, the policyholder, usually the Buyer, simply files a claim and gets paid damages.
The use of this specialized type of coverage had been steadily growing and becoming more widespread pre-pandemic. Even lower middle market deals were being covered.
Just as M&A deal-making contracted, there was a reduction in the number of R&W policies being written in the first three quarters of 2020. But by the fourth quarter, it had rebounded and even surpassed 2019 levels. That trend continued into the first quarter of 2021.
In fact, according to the BMS Group’s Private Equity, M&A and Tax 2021 Report:
“As the initial challenges of operating amidst a lockdown were managed, deal volume rebounded strongly in Q3 and Q4 was the busiest quarter ever in the M&A insurance market. As we go to press, early indications are that M&A activity has levelled up somewhat but nonetheless we expect 2021 to be a record year for M&A insurance.”
Thanks to a rush to get back to deal-making, as well as the previous pre-pandemic growth, I expect a rising trend to continue as more dealmakers – both Buyers and Sellers – realize the value of this coverage. I forecast that this rebound will continue into 2022.
That doesn’t mean there won’t be key changes.
First thing to mention – especially if you have been hesitant to use R&W insurance – you should know that it’s well established and popular.
The BMS Group report highlighted that:
Key Trends in R&W Insurance to Watch
The pandemic is going to impact how R&W policies are written, cost, and other factors. But some of this would have happened anyway – without COVID – simply due to the increasing popularity of this coverage.
The COVID Impact Is Limited
While it’s still early to make a final judgement, it appears COVID hasn’t had a catastrophic impact on the R&W market.
As it states in the BMS Group report: “Despite the increase in claims frequency and severity, premium pricing has remained relatively low whereas it has hardened across other lines of insurance.”
Going forward, COVID will have zero impact because it’s “known.” R&W insurance covers the unknown. Underwriters won’t necessarily issue blanket exclusions for COVID-related issues, but they will take it into consideration.
Limits on the Rise
Another trend to watch for: Expect buyers of R&W insurance policies to buy more limits. In the last couple of years, Buyers have been securing policies at 5% to 10% of transaction value, which is largely to just cover the escrow. Problem is if you have a $100M deal and a $10M policy, what happens if you have an $18M loss?
The eight million over the R&W policy is uninsured.
As a result, Buyers are seeking to transfer more risk. So, look for them to buy more Policy limits, or select “hybrid” Excess Policy Limits only or Fundamental Reps (the cost of which are a fraction of the R&W pricing). Because there’s no remedy for anything uninsured, as the Seller is off the hook.
In the event there is a breach, and the amount of loss is significantly higher than the amount covered by R&W insurance, Buyers are beginning to make claims of fraud or misrepresentation against the Seller… because they know the Seller has a D&O policy.
If there is a loss that exceeds the R&W policy, Buyers are looking to recoup some costs through the Seller’s D&O policy. So it’s no surprise there has been an increase in fraud lawsuits.
D&O policies don’t pay for fraud. However, that exclusion only happens if fraud has been proven in court. The defendant has to admit they knew of fraud in court, or there must be a final judicial finding that fraud existed.
Up until then, the insurance company pays defense costs. If they settle, which is often the most cost-effective option, the insurance company pays the settlement. As part of the settlement, Sellers don’t have to admit fraud was committed.
This is why Sellers are being required to secure a D&O tail policy (if they don’t already have D&O in place) – Buyers should insist on it – and why they also need a R&W policy.
Costs Are Going Up
As more R&W policies are purchased, the cost will go up.
The rate will go from high 2% to mid 3%. And it’s already beginning to happen. On a minimum premium deal like I do, it’s already at 3%. A $5M policy is $150,000 to $175,000. But on a $20M limit policy it’s going to be at $600,000 whereas last year it was closer to $500,000.
There was a serious contraction of M&A activity in 2020 and the early part of 2021 – no surprise there. PE firms were holding back – not willing to commit their money. Plus, it’s a natural result of meetings moving online, workplaces going virtual, and the like. Many industries slowed down over the last year and lost productivity.
But now, PE firms, who’ve been sitting on all this cash for a year or more, are ready to start deal-making again. They – and their investors – are looking to start adding value to their portfolios again and rebuilding their balance sheets.
Since PE firms are so committed to R&W insurance, there was a natural dip in policies being written that mirrored the drop in M&A activity. But R&W has returned.
Special purpose acquisition companies (SPACs) will also have a hand in this growth in R&W policies being written in the next year or more. There are more than 400 SPACs that must complete an acquisition by 2023 – at the farthest out. That’s deadline pressure.
SPACs mostly target middle market companies – those $100M or more. As these so-called “blank check companies” start doing deals again, expect to see a spike in R&W policies written.
The one purpose of a SPAC is to acquire or merge with an existing company – it makes going public easier, quicker, and cheaper than a traditional IPO. And R&W coverage is perfect for these deals because even in the best of times, SPAC founders face tremendous pressure to get deals done within a two-year window. Because R&W insurance hedges risk for both Buyer and Seller it facilitates fast mergers and acquisitions.
Insurers Scramble for Qualified Underwriters
A natural side effect of the increasing use of R&W insurance over the last few years is that insurers are seriously understaffed with experienced Underwriters compared to demand for their services.
There are only so many Underwriters out there with the “know how” to underwrite M&A transactions. And as more insurance companies have entered the growing market, we’ve actually seen them “poach” underwriting teams from other insurers.
Pressure on Underwriters
R&W insurance is a complex line of coverage. Even if Underwriters outsource due diligence to an outside law firm, they are seriously stretched for time due to the sheer volume of policies being requested.
Many policies are being delayed – even declined – due to an insurer’s lack of bandwidth.
What does this mean for Buyers and Sellers?
You can’t expect Underwriters to turnaround a policy to cover your deal in a week or even a couple of weeks. Insurtech has not reached the R&W world yet. Although it was possible in the past, waiting until the week before closing to begin the R&W process is as prudent as waiting until April 14th to call your CPA for tax assistance.
If you’re interested in having this coverage for your deal, you need to start the Underwriting process at least four weeks out so there are no surprises. Don’t come in last minute and expect miracles. Underwriters are people too.
You can’t push them to the brink without losing relationships. A good Underwriter wants to be your partner; they want to do it right and be as timely as possible. So, start the process sooner rather than later.
A note of caution: Some insurers advertise faster processing, but they are prone to delays. Best case scenario – you’ll find an insurer to cover your deal on schedule but at exorbitant costs (2-3X the normal underwriting fee) that result in extra expense.
What Underwriters Are Watching For
The ideal situation for an Underwriter is to put as few limitations as possible on deal. Their objective is to have as few exclusions as possible because exclusions create friction. But they still need a sustainable product. They must protect the insurance company they work for.
As a result, we’ll see Underwriters exercising more caution on wide open worded Reps. For example, if there is a Rep with the following wording “will continue to be” or “will continue” – which means post-closing – the Underwriter will read that out as if the wording doesn’t exist.
In this market dynamic, Underwriters are also watching out for the definition of “damages”. They don’t want to explicitly cover multiplied or consequential damages, which are very problematic.
But they have been known to strike a balance with policyholders. If, in the agreement the definition of damages is “silent” with regard to multiplied or consequential damages, the proposed policy will match the agreement with the intent that while the policy is not specifically covering consequential or multiplied damages, such damages are not specifically excluded either. This enables the parties to consider such damages in the event of a claim.
It’s essential for the insurance broker to make clear with the Underwriter that silent doesn’t mean excluded. In other words, if it’s not there it doesn’t mean it’s excluded, it means it’s agreed.
Where to Go From Here
As with many things, COVID has had an impact on M&A and the specialized type of insurance that covers these deals: Representations and Warranty. Yet, I expect the true value of this coverage to shine through, and for its popularity and widespread use to not just continue, but to grow and expand.
Here’s how they put it in the BMS Group report:
“We remain optimistic about the outlook for M&A insurance and expect it to continue to play a vital role in M&A, especially given how ingrained it has become in the deal process and the part it plays in unlocking both capital and negotiations which have reached an impasse on M&A transactions.”
In light of these trends, I wanted to offer you a free download of some best practices to consider going forward when it comes to incorporating Representations and Warranty insurance in your next M&A transaction.
If you have a deal coming up or one closing between now and the end of the year, and are open to having a conversation on how R&W can work for your particular deal, you can contact me Patrick Stroth, at email@example.com.
On this week’s episode of M&A Masters, we speak with special guest, Laura Simms. Laura handles Business Development at Strait Capital, a fund solutions provider offering a full range of financial solutions to hedge funds, private equity, family offices, and alternative asset managers. From their Dallas headquarters, Strait delivers fund administration, middle office operations, CFO suite services, and regulatory compliance services just to name a few.
“We really view ourselves as a partner to our clients,” says Laura. “We want to feel like an extension of their team. You know that we’re just a couple offices down, so we’ve really earned the reputation for being the trusted partner of choice for private investment advisors and managers who are seeking that quality, personalized service provided by a team of experienced professionals. Our mission has always been to protect investors and reduce risk in the global financial system.”
We chat more about Strait Capital, as well as:
Patrick Stroth: Hello there, I’m Patrick Stroth. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here, that’s a clean exit for owners, founders and their investors. Today I’m joined by Laura Simms, who handles business development at Strait. Strait is a fund solutions provider offering a full range of financial solutions to hedge funds, private equity, family offices and alternative asset managers.
From their Dallas headquarters, Strait delivers fund administration, middle office operations, CFO suite services and regulatory compliance services just to name a few. And in this era where more private equity and other organizations are looking to add to outsourcing, Strait comes at a time that’s no better than right no. So I’m very happy to have Laura join me here. Laura, welcome to the podcast. Thank you for joining me.
Laura Simms: Patrick, thanks for the opportunity.
Patrick: So before we get into Strait, let’s set the table. Tell us about yourself personally. How did you get to this point in your career?
Laura: Sure, absolutely. Well, born and raised first-generation Texan, although my family’s roots are from Hawaii, and both the west and east coast. And it was a privilege of mine to complete my undergraduate degree from the University of Texas in Austin. So after that time during the Great Recession, I moved to the Midwest to pursue some nonprofit work. Next, I spent a handful of years as an operator of a small business. I then transitioned my career into the investment management space and ran investor relations for a private multifamily office.
When my husband was deployed to the Middle East with the Army National Guard, we then made the decision to return to Texas. And that time around 2017, I joined Strait and was really attracted by their entrepreneurial culture, their audacious growth goals and just the ability to use my operational and client experience to advise prospective clients there. So when I joined, we were about 26 professionals and now we are a team of around 60.
So I’ve enjoyed my time there, the opportunity to run business development efforts. And what I really value is our partnership approach. So, that we provide for our clients and have found such great satisfaction in working in the middle market space with fund managers, advising them and really helping them through that fun launch process as well as working with established managers and helping them convert to our offering, which is extremely high quality and high touch.
When I’m not working, I pursue interests in health, wellness and fitness, as well as really enjoy volunteering in my community, which I now do through the junior league in the Dallas Museum of Art. And in the future, my husband and I plan to start a foundation to address areas of mental health, caring for veterans and assisting those who are in need.
Patrick: When you originally joined Strait, you said you went from 26 to 60. How long has that period been? How long have you been with Strait?
Laura: So I joined the firm in 2017. So about two and a half years.
Patrick: That’s a lot of growth.
Laura: That is. Absolutely. It’s been great to be a part of for sure.
Patrick: That’s impressive. Well, let’s talk about Strait. And, you could tell a lot about a company and their core and their founder’s vision. A lot of times it’s something as simple as the name. How, you know, tell us about Strait. What it is that they’re doing with the middle market, but start with the name and paint a picture for us.
Laura: Yeah, absolutely. So Strait, so the definition of Strait is a narrow passage of water which connects to larger bodies of water. So Strait was founded to be just that. We are that passage that connects an industry-leading team of experts with our clients in order to provide best in class services.
So for us, it was imperative to establish this culture of true partnership that’s grounded in ethical business practices, which really starts with our team and then extends to our clients. So our goal, we like to say, is to be the one service provider that’s on the asset side of our clients’ balance sheets. And so we do this by investing in the best technology, hiring exceptional talent and anticipating our clients’ needs and building those trusted relationships.
Patrick: Now, one thing about investing in technology and, we’re seeing that in spades right now, is, as companies have had to adjust to work remotely, if you’ve got weaknesses, either, you know, just simple connectivity or other issues like that, then you can’t hide from those. You could push those under the rug for a while when everybody’s all in a team in house, but once you diversify out, that gets real tough. Now, in addition to, you know, that technological advantage, okay, what else does Strait bring to the table?
Laura: Yeah, absolutely. So, you know, what you’re probably gonna hear me say a lot during our conversation is partner. So we really view ourselves as a partner to our clients. We want to feel like an extension of their team. You know that we’re just a couple offices down, or, you know, a few floors down. So we’ve really earned the reputation for being the trusted partner of choice for private investment advisors and managers who are seeking that quality personalized service provided by just a team of really experienced professionals.
So, Strait, we provide integrated middle and back-office platforms, which for our clients translates into reduced costs and really a flawless efficiency of deliverables that their investors can trust. So, Strait, we’re rooted in our values and we’re a partner for our clients, really our team and extending out to the community. So our mission has always been to protect investors and reduce risk in the global financial system.
So for us, accuracy is king and we’re so proud to say that we have not had a restatement in our firm’s 14 and a half year history. We also provide an exceptional user experience through our process-driven partnership approach, as we talked about before, advanced technology and really our team of industry experts. We hire people that are extremely driven, have that achiever mentality.
Our team of professionals is comprised of CPAs or those pursuing their CPAs. At the staff level, all of our folks either have their accounting degree or their finance degree and at the leadership, we bring in folks with, you know, extensive experience in the fund administration field or who’ve worked internally at a private equity or hedge fund before. You know, our manager Stacey Relton has really done a phenomenal job at creating this type of culture at our firm.
Hiring the right people is so important for straight that no one person comes into the firm without being interviewed by Stacey. So what she looks for are these intangibles, ensuring that their values align with ours, which are ethics above all else, owning the business, pursuing mastery, relationships matter and giving back. So, you know, we feel like if we hire the right people, give them a great work-life balance, our people are going to take care of our clients.
So additionally, our institutional platform FIS Investran is the gold standard and private equity accounting and investor reporting. So we offer this technology, our boutique level of service, white-glove approach to all of our clients, from the emerging manager to the established global investment firm. So no matter your size, we’re going to take care of you. We’re going to give you all the bells and whistles of the big shop but with that really boutique service.
Patrick: I think, I’m not as familiar with this just in the logistics of this. The smaller private equity firms, are, if they don’t have in-house accounting, they’re going out to a CPA firm that, you know, obviously, the bigger firms are going to cost a lot more. They run the risk of going to a regional or local CPA firm that may not have all the capabilities and all the knowledge, right?
Laura: Yeah, that’s absolutely right. You know, you may have a team of bookkeepers, obviously not at the CPA firms. But with us, you get that fund expertise because fund accounting is very niche. And so our team does it every day, right? So we’re experienced with the fund accounting, with the investor reporting.
And because we’ve made the steep investments in this, you know, gold standard in technology, it just helps out our clients because we can slice and dice and provide reporting customized to how they want. And then their investors, especially on the institutional side, are very familiar with Investran ready. So they’re comfortable with the platform. They’re comfortable with investor portal. And we’re passing this technology to every one of our clients, no matter your size.
Patrick: Something that you’ve said multiple times, now I want to underline this because this is not a small deal. This is a big deal. You talk about the importance of partnership. And there’s a real strong sense with this. And it’s something that I think a lot of us, we’re all service providers in this world right now in one capacity or another. But what separates a, you know, a service provider from what we want to be as a partner, is where you look to your clients and say, Hey, you know, you’re not just a source of revenue for us. We are partners together. We have our interests don’t just overlap, they’re integral.
And we have every interest in you reaching your goals and succeeding. And if we are, you know, tied in directly with your success and we’re joined at the hip, that’s a deep, deep commitment. Let’s go a step further on this. And I’m not certain, but I would think that because of what you’re doing, you’re almost in a fiduciary capacity, where, you know, you are, you owe a duty of care to your clients. And so I think where, you know, it’s the ethics that you underline and it’s not enough just to go ahead and have a good committed version of that and be, have a desire. You have to execute.
And so what you’re doing is you’re setting this up so you can execute with technology and not have, you know, the bugs are other systems that are problematic, and that you can move forward with them. It also sounds to me like you’re also set where you will help firms that, you know, need to outsource because they just don’t have the capacity, they don’t have the talent,t they don’t have that. But as they start growing, well, you can scale with them. Why bring those services in-house if they’re working beautifully, seamlessly? And then, because you can grow with them, that’s the case?
Patrick: Okay. The other thing that I noticed is going to be an issue coming up is going to be talent, and how, you know, if you’re trying to set up and have the internal accounting systems, the internal compliance controls and so forth. Where are you going to find those people and how are you going to vet them? And how do you know that they are going to be, you know, as committed and able to execute? They don’t have to do that. They just go right to you.
Laura: That’s absolutely correct.
Patrick: So although I’m sorry, I hope I didn’t rain on your parade and steal all your thunder but why don’t you give me some examples of, you know, where you’ve delivered, you know, for your clients. Give us a case or two of, you know, what you do?
Laura: Sure. Well, and Patrick, you kind of even touched on that. So, you know, we have a lot of success stories within our firm and among our clients. And one I’ll highlight is a client that launched their fund in 2013 from the DFW Metroplex and when they decided to outsource, Strait was their fund admin, and that was back in 2015. So when we onboard them, we created an institutional platform from day one, allowing them to really focus on growing their assets, building their track record.
And now, this firm has made over 100 transactions, manage is over 3.7 billion in committed capital. This client is very well known in the industry. Not only do they provide Strait as a referral, you know, to their peers launching a new fund looking for a service provider because they’re so satisfied that the work that we’ve done for them, but when I’m out in the market, you know, talking to prospective clients, part of our process is providing references, client references.
Whenever I mentioned this client, that’s always, you know, super positive remarks on behalf of this prospective client and really just increases our level of expertise in their eyes because of, you know, the success with this client. So that’s one. And then, you know, that was a new kind of fund launch that we worked with.
We also work with a lot of conversions. You know, someone who they’ve been in business for a while or they are unhappy with their level of service. You know, we talked about the middle market. Patrick, you and I have talked about it before how it’s just a market that is overlooked and often in our space, they’re paying really high fees but not giving the service that they need and desire. So we’ll see a lot of those folks come over to Strait. And we’ve, you know, from large clients to small clients, we have the ability to process large amounts of data and kind of do that operational cleanup, you know, in the middle market. I personally love working with these folks.
There’s that entrepreneurial spirit. People are rolling up their sleeves and just going after it. Maybe they’re a deal guy, maybe they’re, you know, entrepreneur doing private equity firm independent sponsorship, but they haven’t really been focused on the accounting, the operation side when we could come in, do the operational cleanup, reduce those pain points that they are experiencing, bringing them up to speed on industry standards, which then elevates their investor experience and really sets them up for, you know, future growth. \
We’ll take time to help them understand the accounting side, help them understand the operational requirements and compliance requirements as a fund. So that’s kind of part of that, you know, partnership approach where we really go above and beyond. If someone has a question, we have the relationship where, you know, they just call someone on our team and they can ask the question. We’ll consult, we’ll advise and help them through, you know, issues that they’re experiencing.
Patrick: What’s the biggest, and this is completely unscripted or anything, but what’s the biggest problem that your clients have? Is it going to be on the accounting side, a compliance issue, tax? Is there anything that really grabs it? I can imagine personally, I can’t stand accounting, okay? I respect it. I know it’s necessary. You know, and I rightly have that outsourced. But I can imagine if there’s any discomfort for entrepreneurs.
Laura: Right. You know, I mean, I would say because we service so many different types of funds, we’re agnostic to size and strategy. The problems and the challenges can be different for each. You know, we can speak to the regulatory issues. If you are a registered fund, you have to abide by, you know, everything the SEC puts out. And that gives a lot of, you know, executives, heartburn, right? Am I doing everything right?
Am I following the law to a tee? So what our team has done is we have a compliance division. Our head of compliance, we relocated him from Bloomberg, he was a compliance officer there, and he built out our full compliance program. So those regulatory challenges that people face, especially as, you know, regulations change and update such as this year, we saw a lot of changes regarding Cayman, privacy law, their AML regulations, Sema.
And our team did a lot of diligence getting our clients up to speed to that and aligning them where they needed to. So, you know, there’s definitely those pain points in the compliance area. You mentioned the accounting. You know, maybe we’re nerds and we enjoy the accounting, but we definitely take that, you know, off of the plate for our clients. But really pain points can come on the compliance side making sure that you are doing, you know, everything right and correct.
Patrick: As a matter of fact, just Bloomberg issued a report where it’s concerned with mergers and acquisitions for companies that have either been getting the PPP loan for paycheck protection, or the employee retention tax credit. And if we’ve got companies on, you know, doing one or the other when they combine, then what happens? And even the government doesn’t know yet because they’re still waiting for guidance. And so, you’ve got this thing that’s constantly moving and you’ve got to keep your fingers on the pulse.
Laura: That’s right. And even if a client isn’t engaged with Strait for compliance, they have access to all of our experts. So we’re keeping our clients up to speed on all of these new regulations issues coming out, like you mentioned, regard to PPE. And so our team is keeping everyone abreast of what’s going on and making sure that, you know, people are in line with what’s coming out.
Patrick: We’ve got a lot of listeners, both on the entrepreneurial side and in the private equity space and so forth. Define first, give me a description of your ideal client. Who can Strait best serve?
Laura: Right. So what’s great about Strait is, you know, for us the accounting is the accounting, so that allows us to be agnostic to size and strategy. And because we’ve invested in the top shelf technology, our systems have the ability to process, you know, most every asset class out there. However, in terms of AUM, our ideal would probably be funds with committed capital of 100 million up to multi-billion.
However, we do work with smaller funds such as VC, which typically launches maybe around 50 million. Some examples of strategies we service on the private equity side are buyout, mezzanine, growth capital, distressed, oil and gas, minerals, real estate venture, hybrid kind of funds. So we really do most everything. You know, this isn’t an exhaustive list. As you shared at the beginning, we also service hedge funds, family offices. We work with independent sponsors.
Patrick: Gotcha. Within, in terms of geography, regional, nationwide, what’s your reach?
Laura: Great question. So, you know, we are headquartered here in Dallas and have a fair amount of clients in Texas, however, our client reaches nationwide. So we have a fair share of AUA assets under administration in the northeast and really sprinkled throughout the US.
Patrick: I focus on the rocky mountain area and in the Midwest. There just seems to be a lot of flight of capital and organizations and just talent getting away from the higher tax states into those quality of life sections of the country.
Laura: Right. Patrick, what’s really interesting is just this week, I talked to maybe three prospects out of Colorado. I don’t know if it was a coincidence, but yeah, new launches in Colorado. I guess one of them is vacationing there but
Patrick: Well yeah, that’s where, that made Montana they’ll go look at those places over there. So we will see. But it’s an issue being based in Silicon Valley how much talent and abilities we’re, you know, going down south into southern California and now they’re actually moving east into eastern Nevada and then into Utah and Colorado. So we could see quite a bit more out of there. And that’s going to be, I think that’s just because thanks to technology and a lot of other things that facilitates it.
Laura: That’s right.
Patrick: Yeah. The, as an issue and I look at this just being an insurance guy, okay? Does the subject of insurance as part of the overall with compliance or whatever, is it played at Strait or what do you observe on that, if anything?
Laura: Sure, yeah. Well, to be honest, we don’t deal much with compliance, excuse me, insurance issues on behalf of our clients. What we do see at our level is, DNO and ENO. We’ll process insurance payments on behalf of our clients because we should serve as the treasury function, but we’re not necessarily involved in insurance-related challenges our clients may face.
I will say though, during the pandemic, we’ve had a lot of look back to policies to see how COVID type events are covered. How our, you know, our space is so niching, I would love to hear your thoughts on how you think insurance and different related matters could benefit our clients.
Patrick: Yeah, I think that the area particularly with private equity being at, the sole function of private equity, or the big function is to you know, acquire companies add value to them and then secure an exit at a point well north of where they started from. And so mergers and acquisitions, those transactions have been insured traditionally, in the last several years by a product called rep and warranty insurance.
The biggest development in why we’re were reaching out, as Strait does to the middle market and the lower middle market, is that the threshold for eligibility for rep warranty insurance, which really accelerates the process of closing successfully and eliminates all or virtually eliminates the need for escrows. There’s no fear of clawback of proceeds post-closing, if there’s a breach. Just a backstop for both sellers and buyers. It’s an ideal tool that private equity has embraced.
Only though at the hundred million dollar transaction threshold and up. In the last 18 months, though, because of competition, because among insurance companies with the success of the product in terms of claims, there are a lot fewer claims made. not because they’re excluded, but just a lot fewer claims that are happening because the diligence is so good that, you know, is a very successful product financially.
And so the pricing and the costs have fallen along with the thresholds, now we’re able to see transactions that are 15 million to 30 million. I mean, these are, you know, add ons that can now be insured. Where, with an add on, perhaps it didn’t make sense to spend three, $400,000 in cost per rep warranty policy.
But if it’s under $200,000, all of a sudden that’s check the box. Particularly with buyers and sellers, a lot of times they negotiate and they share the cost of it anyway. So it’s a win-win. The more information we get out about that, we’re trying to do that largely because lower middle market, middle-market companies are getting overlooked. And if they default and go to the brand large institutional firms, who are great, we need somebody to ensure Disneyland, we need somebody to handle, you know, the billion-dollar Walmart acquisitions. You know, to them as an add on.
But for the smaller companies, they don’t get serviced well and they get overcharged with fees. Because the premiums are so low, the commission’s are equally low. So the large institutional insurance firms have to charge fees in addition. That’s a cost add you don’t need, particularly for the lower middle market. And, you know, it’s better to come in at that level. The other comment I’m going to do on my soapbox, particularly with directors and officers liability, is, and it’s something that you should look at, is with mergers and acquisitions, the target company has to purchase a DNO tail.
They have a policy that will last for three to 16 years after closing of the transaction just in case any wrongful acts pre-closing get brought in litigation against the former board. There are a lot of D&O policies on real Mainstreet standard carriers that are out there that will only give you a one year tail, maybe a two. That’s not gonna help if you need six. And so you need products or somebody that has the capability there. And that’s with, you know, that’s a very common thing.
A lot of times we find that you got sole owners of industrial companies never needed D&O policy because they were the only shareholder or they and their spouse for the shareholders. They didn’t need D&O. Now all of a sudden they come up to sell their company and they need it. So those are the types of things we really relish getting in because we want to be, as with you, the entrepreneurs, the folks that really created something out of nothing to have something so they can get a clean exit. And so that’s the area that we get in with the insurance. And it’s been just a great ride in the sector.
I focused in this sector starting in 2015 and it’s been an absolute joy. You know, I always ask about what you see for trends and so forth in and around private equity or M&A. As we record this, we’re at the I would call it the end of the beginning of COVID-19. We’re steadily reopening and there’s fits and starts no matter where you are. You’re in Texas so I know that maybe not everybody’s back at the office yet, even though you’re leaps and bounds ahead of California. But, you know, what do you see trend-wise either in light of COVID, not in light of COVID, but what do you see, you know, out there that you can share?
Laura: Sure, yeah, that’s a great question. I can certainly share what we see among our client base as well as, you know, what I’m just hearing in the market. So for one, force measure clauses and their effectiveness have been a big topic. Also valuation in terms of downside and illiquids, like oil and gas interests. Among our private equity clients, valuations, not surprising, have been hurt during the pandemic.
But as you know, for us at the fund level, you know, it’s a long-term investment and thankfully, everyone has been able to weather the storm. So we didn’t see much M&A activity happening. We did see activity though. We saw deals get done both on the acquisition and exit. However, these were deals that were already in motion pre-COVID. I was recently talking with one of our clients and he focuses, his firm focuses on the lower middle market in Texas and surrounding areas. And for them, deal flow, he said, has been surprisingly steady. Things did slow in March in April, but everything still remains on track for the year.
So they invest in a niche manufacturing healthcare services and business and industrial services. Key trends that we kind of see in the market, we touched on this at the beginning, and obviously, it’s what we do, but the demand for outsourcing and all, and additionally acceleration in adopting technology and then just an even greater focus on cybersecurity. So, demand for outsourcing has been on the rise in recent years. However, the move to remote working and the fallout from the pandemic has only accelerated this trend, right? So this surge in demand is not only expected in the fund admin space, but also areas such as HR and IT.
So why is this important to M&A? Well, outsourcing enables sponsors to focus on fundraising and supporting their portfolio companies, which is essentially, which excuse me, which is especially important for smaller firms with limited in-house resources. So investors more and more are desiring to partner with GPs that are able to focus mostly all of their time on investment decisions and leave the back-office operations to a team of experts like Strait. Digital collaboration, as most everyone has experienced during the pandemic, and as you and I are doing now, communication and document sharing tools are vital and extremely helpful.
This is especially true for GPs, LPs and other service providers during this time of quarantine. You know, GPS have been hosting investor presentations via video and have that critical need to sign things digitally. So these changes were already happening slowly in our industry, but because of the pandemic, we’ve been forced to move forward in this area. And I was reading a survey that private equity international put out and they said 50% of GPs intend to hold more online LP meetings once quote normal business life returns.
And then lastly, just with technology and cybersecurity. So, with these digital collaboration functions and a greater demand for data among LPs and GPs. This brings a greater need for focus on cybersecurity and data protection. If firms fail to manage their cybersecurity risks, they could face regulatory sanctions, reputational damage or liabilities to third parties which could really impact the value of an investment. And we all know cybersecurity has been a hot topic and it’s very much so a hot topic for investors and often asked in the DBQ ODD process. We field a lot of those questions when we’re on calls with prospective investors for our clients.
Patrick: I’m gonna put a shameless plug in for you. I’m sorry, I do apologize. But, you know, with cybersecurity, we’re noticing just the amount of capital being raised by firms in cybersecurity space, the number of acquisitions by strategics and private equity to bring in a cybersecurity company or cybersecurity talent to then augment the cybersecurity of a portfolio, okay? There’s another hedge to all of that.
And there’s an insurance policy called cyber liability that pays not only for the damages arising from a breach, and that’s just loss of confidential information getting out, but it’s going to pay the compliance fines and penalties that will follow a breach. It also has business interruption which is free from the COVID business interruption and a lot of other, you know, crime coverage from hacking, ransomware, that kind of stuff. It’s a great underlying product and the beautiful thing about it, it’s not expensive. And, you know, so as we see that important going, you got it really invest on that cyber infrastructure.
But this is the back, you know, just the hedge on that. I think, I completely agree because that’s, a number the acquisitions we’ve been seeing are tech companies specializing in cybersecurity. And, Laura, with all this going on, which is all fabulous, you know, so we’re turning lemons into lemonade here with what’s going on. How can our audience reach you to learn more about you and Strait and have a quick go for a conversation?
Laura: Yeah, absolutely. I would love to chat with anyone interested in Strait, our services. They could visit our website, straitcapital.com. That’s www.STRAITCAPITAL.com. And I’d be happy to take their email at firstname.lastname@example.org.
Patrick: Two M’s for Simms, just so you know.
Laura: Yes, that’s right. LAURA.SIMMS@STRAITCAPITAL.com.
Patrick: Well, Laura, thank you very much. It was an absolute pleasure speaking with you. I hope you had as much fun as I did today. And I really encourage you to check out more at Strait Capital.
Laura: Thanks, Patrick.
On this week’s episode of M&A Masters, we speak with Christie McFall, Business Development Director of Great Range Capital. Based in Mission Woods, Kansas, Great Range Capital brings a unique combination of institutional-grade experience and Midwestern values to middle market and lower-middle market firms in the Heartland.
“Our whole goal is to take a successful business that has a strong management team that is looking for some sort of succession plan, if it’s taking equity out of the business and slowing down, or just growing that business to the next level because they can’t. That’s one of the things that I find appealing from these businesses in the Midwest is you get to find somebody who’s talented, took an idea, and grew a successful company. But when they can say, I just don’t know how to get to the next level, and I need some help, those are the types of relationships we’re looking for,” says Christie.
We chat more about Christie’s career and Great Range Capital, as well as:
Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here, that’s a clean exit for owners, founders and their investors. Today I’m joined by Christine McFall, Business Development Director of Great Range Capital. Based in Mission Woods, Kansas, Great Range Capital brings a unique combination of institutional-grade experience and Midwestern values to middle market and lower-middle market firms in the heartland. Christie, thanks for joining me. Welcome to the program.
Christie McFall: Hi, thanks for having me. I’m excited to be here.
Patrick: Well, before we get into Great Range Capital which we’ll short to GRC, why don’t you tell us about you? What got you to this point in your career?
Christie: Yeah, so I’ve always done business development and marketing. And prior to the firm, I was at a company called UBM. It’s based out of London. You won’t find that name anymore because over the last three years it was bought and sold three times. I think it went from UBM to Informa to a company called NJH Associates. My role was when I was hired was to grow the company through M&A.
And I was able to do that. I bought a couple of data firms and a few media companies to round out my portfolio. But in the process, they were buying and selling my group at the same time. So although I learned a lot and enjoyed the process, I wanted to stop being on the receiving end of the acquisition and be on the buying side. I really enjoy the process and I enjoy, you know, meeting new people.
And that’s one of the biggest benefits of the role that I have is getting out into the marketplace and meeting business owners and influencers and deal brokers. And I like that a lot. I don’t necessarily love the integration part of being bought and sold, where you’re trying to figure out a new process, procedure, email capabilities, integrating your finances into a new business. So more of the operation side. I like being on the business development side.
Patrick: Lots of ironing out the wrinkles. GRC has a real pride where they’re strong in the heartland in the region. Briefly, though, for you personally, are you originally from the Kansas area?
Christie: I’m originally from Iowa, Des Moines, Iowa.
Patrick: Okay. As a Californian would say, same thing. But
Christie: Yeah. Close enough.
Patrick: So your travels have brought you around now. Now you’re here in Kansas. So tell us about Great Range Capital.
Christie: We’ve been around for 10 years. It was founded by two gentlemen, Ryan Sprott and Paul Maxwell. They grew up in Kansas. They went to KU. They’re brothers in long so they’ve known each other since they were teenagers. And after they graduated, they both went to the east coast to learn the business inside and out.
Worked for major firms, you know, did the billion-dollar deals. But along the way, they always knew in the back of their mind that they wanted to come back to the Midwest and felt strongly that the Midwest was underserved from a private equity standpoint as well. Yeah, a lot of people fly in, but not a lot of people actually live and work right here with the companies that are based here.
Patrick: Huge competitive advantage.
Christie: Very much so. And it’s really where we win. So our thesis is similar to others. We’re looking at lower-middle market companies, three to $15 million in EBITDA. Manufacturing is our sweet spot, but we’ll look at pretty much any company that doesn’t play an oil and gas or has some cyclicality to it. But the difference is we can sit down at a table and have that connection and that chemistry that a lot of folks who fly in for the day cannot have. We are, we drive there. You know, we only really look at businesses in the Midwest.
So typically, the seven states that touch Kansas. And then we’ll go outside those seven states, but they have to be in the Midwest for the portfolio company. Add-on opportunities we may look outside of that geography, but really tightly looking at the Midwest. We drive there, we’re there in a day, we didn’t fly in our private jets. We are raising our families here. We understand the emotional decision that this is for an owner rather than just a financial.
Listen, if it’s just a financial decision, meaning I want the highest multiple for my business, we’re probably not the partner. If you are looking, we want owner-operated businesses that are healthy and strong. Those folks usually stay involved at least for a time period and roll some equity in alongside of us to help grow the business. And we understand that that business is important to them. Their families usually work there. Lots of the people in the town or there. It’s a very big employer usually, so we are comfortable having conversations about how to maintain that business.
We aren’t coming in to put in 10 new executives, sweep out the management team and start anew. That isn’t, our, we aren’t operators. We don’t want to run the business. We want them to run their business. We might bring in somebody who can grow it from a strategic level, either a CFO or CEO, some board members, but we don’t want to run the business. We want them to do what they do best. So it’s a chemistry conversation and it takes years, a long time to earn the people’s trust. But that’s our differentiator, which really are, we understand where they’re coming from. We can speak their language.
Patrick: You guys have a commitment to the lower-middle market, middle market as a market segment, okay? Is that a choice? Or are you restricted just because that’s all that’s there in the Midwest?
Christie: Yeah, absolute choice. There are so many businesses, valuable businesses here in the Midwest, we choose to focus on the lower-middle market, middle market range. for a few reasons. Obviously, you know, we like to say that we can drive to your business within a day. We don’t fly in from the east coast.
We’re here in addition to Ryan and Paul being from KU, everyone else in the firm is from Kansas except for me, so they really went out on a limb hiring an Iowa girl. But we all are from here. We grew up here. We’ve all spent time either in Chicago, Milwaukee, Minnesota or Minneapolis, sorry. And East Coast, I was in LA myself. And we’ve all come back here to raise our families and focus on the businesses. So when we sit across the table from a business owner, you know, when we talk about shared values, we can say that honestly and mean it.
We’re a firm based in the Midwest, we drove to visit you today. You are listening to and talking to folks that understand the value of your business. We understand the value of the employment here to the town, to the folks that work here. And we understand that this is mostly an emotional decision and not just a financial decision. And we find that that sets us apart. You know, the businesses that we target are, you know, within three to $15 million of EBITA range. We believe, you know, most of these folks are owner-operators that want to stay involved or help the business grow in some way.
Maybe they just want to slow down and let somebody else come in and help them continue to grow that business. But it’s an emotional decision. And we focus on that size and that type of owner-operated business where we can sit down and have those relationship-driven conversations. That’s where we win and that size seems to be the most effective. We’re also wanting to be a majority owner first in on capital raise and so that seems to be the size where that’s really a typical arrangement.
Patrick: You said a couple of things that stood out to me. And it’s the power of having focus in a particular market and enjoying that market that you’re in. One of them was that personal aspect that you’re, you’ve got boots on the ground and it supports the philosophy that I share is that mergers and acquisitions are not the combination of Company A buying and Company B, it is one group of people choosing to work and combine forces with another group of people. And when you put those together in an ideal situation, the intent is that the whole is greater than the sum of its parts.
And so if people get together, cultures mix, interests mixing and align, it all works. And that’s usually the remedy for success. And so there are others out there, and I’m sure you’ve come across this where there are other competitors that are probably offering a lot more money than what you’d be offering but you just don’t have the fitness. One thing that’s just critical and you can’t overlook. I think the other thing is essential is that the lower-middle market is a lot bigger than people think it is.
And the crying shame out there and the reason why we wanted to talk to you today and introduce GRC out there was that the lower-middle market is large, but it’s really underserved. And I mean underserved in a big way because if you don’t have in house core dev or you haven’t gone through a lot of transactions and you’re a founder, you don’t know where to turn. And by default, they’re going to pick the brand names, large institutions and go in that direction to seek help. And, you know, they’re going to find out that they’re going to be overlooked because of their size.
They’re going to be underserved. They’re going to probably have somebody who’s condescending to them. And the large institutions, while they’re very large, they don’t have the bandwidth to handle the solutions or deliver an alternative to a smaller client. And so the lower-middle market company ends up getting some prepackaged solution. And so they’re not only overlooked and underserved, they exit poorer, I’ll put it politely, not as rich as they would otherwise if they partnered with a firm like GRC. So give us an example just of one of your deals where you guys added value, where that connection worked.
Christie: I mean, it’s hard to pick just one. I’ll highlight two. I, you know, all six of our portfolio companies are based in the Midwest. They were all owner-operated and relationship-driven deals. In Mountain Valley, Spring Water-based and Hot Springs Arkansas was owned by the JB Hunt family. All were relationship-driven.
Met with them still to this day we, you know, we own, we just sold that company I guess a year and a half ago. still connected to that group, still send them opportunities when we see, you know, add ons for them that might look good. Fair Bank Equipment in Wichita, Kansas is owned by the Rei family. Cody Wright is the President and CEO. He’s been with that business for 20 years plus. He’s the grandson of the founder. And I think he eats Thanksgiving dinner with our two founders as well.
I mean, these have become family members of ours talking about what we’re looking for from an owner-operator relationship. You know, it takes a few courses, you know, a few of these folks are looking to slow down. Well, they say they’re looking to slow down, they really do. They say they’d like to retire or slow down over the next three years. And the fact is, once we get in there, and the business starts to grow, half the time, they’re reinvigorated in the business and spend more time.
So apologies to their families who they told that they were finally going to go to that lake house or that beach house in Florida and slow down because that’s rarely the case. Usually, it invigorates them to get back in the game and somehow find the energy to keep going, which is impressive. And that’s the case with most of our businesses. What they’re really looking to do is maybe take that second bite at the apple, and that’s really what we offer, you know, from our perspective. I think you’ve mentioned exiting poorer than when you started or not as rich as when you, as you’d hoped you’d be.
Our whole goal is to take a successful business that has a great strong management team that is looking for some sort of succession plan, if it’s taking equity out of the business now, slowing down, like I mentioned, or just growing that business to the next level, because they can’t. You know, they’re very honest about that. And that’s one of the things that I find appealing from these businesses in the Midwest is you get, you find somebody who’s certainly talented, took an idea and grew a successful company.
When they can say, I just don’t know how to get to the next level and I need some help, those are the types of relationships we’re looking for. And that’s really, when we can bring some value, and aside from just the capital, we can bring in a next-level CEO or CFO or strategy person that can grow that business. And then three, four years, five down the line when we sell that business, again, which we have, Mountain Valley, Springwater and Heartland Landscaping we sold again and those owners get another, you know, bite of that apple.
They get another opportunity to financially benefit from the growth of their company. And that’s truly what it’s all about. We are not, you know, we’re not flying in for the day. We are here. We live here, we drove to visit you, we want to see you successful, we want to see your business grow. We all benefit from that. And it seems to be a win-win all the way around. We are connected to these folks. We deeply understand their business.
And I would say that over the last, you know, six weeks as we have turned inward as a community and as a business, we have focused solely on keeping that business healthy and the employees that are healthy and how to see everyone through this time. I’m not on the, you know, quote-unquote investment team side. I’m on the business development side. So while they have really turned inward to focus on those companies, I have strengthened my relationships, looking to network and grow our deal flow. And people are hungry for interaction and talking. So it’s been an interesting time on both sides of the coin there.
Patrick: With the number of deals that are going on with you, I’m curious as to what experience you guys have had with a product called rep and warranty insurance and whether or not that’s impacted you as it has. For those of you who don’t know, rep and warranty is an insurance policy that ensures the seller’s representation.
So in the event the seller reps are inaccurate or breached, despite the due diligence of the buyer, and the buyer suffers financially rather than the buyer pulling funds from an escrow or trying to carve back money from the seller, instead they have an insurance policy that will pay the buyer their loss. Buyer gets certainty of collection, seller gets A, no escrow or very tiny escrow, and they get a clean exit from the deal. And so I’m just, it’s been a very exciting growing product throughout M&A, largely on the mega-deals. I’m just curious what experience you’ve had.
Christie: Yeah, absolutely. I had a chance to talk to Ryan and Paul about this as well. And we’ve used it on our last two sales. We feel strongly that it’s great product. The cost is much more reasonable than it has been, you know, 10, maybe 15 years ago. So we expect to use it much more going forward. And we think the usage in general across private equity and M&A is going to just continue to increase. So we’re excited about it. It’s a really good product. Cost-effective and makes a whole lot of sense for us.
Patrick: Now, as we record this, we’re getting near the end, hopefully, the beginning of the phase of the reopening of America from COVID-19. Could you give us your best guess as to, or what trends do you see either globally, in the US or with GRC for M&A in the next six months to fall?
Christie: Sure. So I think there’s a couple of things. I think the biggest impact I see on it is truly on deal terms, specifically due diligence issues and the time it’s going to take to get a deal done. And what’s, and by no means were these deals ever quick. They take quite a few years, you know, weeks months. But I think that’s going to continue to take quite a bit of time as new modeling has to be done and things that we’ve never considered in the past are taken into consideration.
So that’s going to have an impact. I think that the way these transactions are developed and negotiated are going to change. This is a business where getting everybody in the room literally has been a big part of the process. And I’ve spoken about it today. The relationship-driven aspect of our business is sitting across the table from somebody and making a connection.
So that’s, we’re gonna have to do that different. That looks different. It’s technology, it’s how you and I are, are talking today. You know, the Zoom, the WebEx, the virtual meetings that, you know, not shaking hands when we can meet in person. There’s just going to be some changes that people will have to embrace. And so that looks different. From a Great Range perspective, we have a very focused investment thesis that we have followed for 10 years.
You know, we don’t forget our roots. We don’t forget that thesis, even if something looks really great but it happens to be based in California, it’s just not a part of our investment approach. So we’ve been lucky in deal flow and continuing to see nice deals. We have based all of our time in networking and relationship-driven, not only from a deal perspective on with the owners, but also with influencers and brokers. So we’re still seeing those opportunities because we’re honest and straightforward and we’ll tell you right away, this is for us, this isn’t for us. We won’t beat around the bush.
So we’ve been lucky to see deal flow continue. You know, and I think that’s because we have a tightly held thesis. You know, we’re only in those seven states. We only invest in the Midwest. We’re only looking at companies that are healthy, owner-operated. The size three to 15 million in EBITA. You know, those things are pretty tight and we’ve held true to that. So we continue to see some deals. So for us, it’s been okay. You know, we’re continuing to look at a few businesses we had under LOI prior to going into COVID-19.
And we hope to continue with those businesses and close those deals, you know, within the next 90 days. So, I think It depends. I think there’s some larger private equity groups, global groups, where deal flow has come to a halt. People have backed out of some deals that were, you know, newsworthy if you will. But we’re chugging right along in the Midwest and we hope to continue knew to deploy capital. There is money to invest, and we have it and we would like to continue to see those good deals.
Patrick: I think that discipline, plan your work, work your plan has served you guys well. And so you’re not immune from the environment out here but you’re definitely protected against that. That would make you just a strong, vigorous, active and a solid partner for owners and founders out there.
Christie: Absolutely. You know, we didn’t invest in distressed businesses before and that isn’t where we’re headed now. The industries we like to look at are, you know, manufacturing and distribution and business services and healthcare services. Those have been impacted certainly, but hopefully, will you know, rebound and stay strong, typically usually do. So that sets us up for a nice, hopefully, a nice future.
Patrick: Well, I don’t think there’s gonna be any shrinking in manufacturing in terms of new ventures. And if there’s any place for manufacturers, it can be in the middle of the country, just cost-wise. You know, so I think that bodes very, very well. Christie, how can our listeners find you?
Christie: Well, they can reach me a number of ways. So they could go to our website, which is greatrangecapital.com or they can email me at email@example.com. And my name is spelled CHRISTIE.mcfall MC F as in Frank, ALL, @greatrangecapital.com. Or the easiest way is probably my cell phone, which I don’t mind giving out. I’m in new business so I expect phone calls and I answer them even if I don’t know where the number’s coming from, strange. 913-952-3037
Patrick: So if you can’t find Christie, that is your fault. Christie, thanks very much. I recommend everybody take a look at Great Range Capital. And thank you again.
Christie: Thank you