Yesterday Price Waterhouse Cooper released its Q2 M&A report on the 721 deals worth $47.7 billion announced in that quarter, and there were a few surprises. Although deal volumes, as expected, declined 7% over Q1 and 14% over Q2 2011,
Use of M&A insurance on the rise
Forecasts of increased M&A activity, combined with a global economic climate where risk aversion is the name of the game, present an opportune moment for examining M&A insurance as a viable means of reducing risks in business transactions.
The most common type of transaction insurance is Representation and Warranties (R&W) insurance, which targets the net liabilities facing parties in M&A deals.
Intended to help smooth negotiations and closings, R&W insurance seeks a balance between buyers’ concerns for losses resulting from breaches of representations and warranties, and sellers’ interests in liability protection. As an alternative to traditional mechanisms of risk management (e.g., escrows, holdbacks, indemnities), R&W insurance addresses both buyer and seller concerns.
M&A trends look positive in 2012
Grant Thornton recently released its 20th annual International Business Report on M&A in which it suggests the market for M&A looks strong both globally and in Canada, as businesses look to invest cash resources built up over a period
Expense escrow funds are a good idea
Although expense escrow funds have become increasingly popular south of the border, they still remain relatively uncommon in Canada. An expense escrow account is a separate fund created to pay the legal fees or other expenses of the former shareholders that may arise in defending against claims post-closing. Expense escrows benefit sellers, shareholders and buyers as follows:
- Sellers – by discouraging buyers from bringing a weak or frivolous claim, with the aim of tying-up funds in escrow indefinitely, knowing that the former shareholders will not have the means to fight it;
- Large shareholders – by providing funds to represent the selling shareholders without forcing large shareholders to contribute more than their pro-rata portion of expenses; and
- Buyers – by providing access to funds in the event that the terms of the merger obligate the parties to split costs for items such as audits and arbitration.
Shareholder Representative Services (SRS), a United States based shareholder representative company, recommends a minimum escrow expense fund of $100,000, increasing depending on the size, complexity and earn-out potential of the transaction. According to the 2011 SRS M&A Deal Terms Study, available at the SRS website, the average size of an expense fund for deals with and without earn-out provisions was 0.51% and 0.4%, respectively, in 2011.