\When a company is evaluating the possibility of acquiring another business, senior management (with the support of financial and legal advisors, and other consultants) should undertake a thorough due diligence review of the company to be acquired in order to identify and address potential risks and issues of concern.
The benefits of a thorough due diligence process and resolving risks up front include:
- Increasing the likelihood of a timely, successful process
- Obtaining more accurate and reliable information
- Identifying and documenting adjustments with positive financial impact
- Strengthening negotiating position on risks at the beginning of the transaction
- Preparing the management team for likely questions to be raised by board members, investors, and others
A careful review of the business to be acquired should include:
- Predictability of future revenues; market conditions and trends; any issues with key customers
- Financial records and results, including detail accounting records, systems and budgets
- Infrastructure and operations – supply chain/raw materials, products, hazards, and technology
- Environmental and regulatory compliance
- Employee policies and agreements; healthcare issues and workers compensation issues
- Contracts – review for risk transfer provisions that may have promised indemnification or conferred additional insured status on the seller’s suppliers, customers, or past or present corporate affiliates.
- Current risk management/insurance program
The risk management program should not be given short shrift. There is nothing worse than a company acquiring another company and not understanding and appreciating the liabilities and risks associated with the acquired company. To maximize value and minimize risk, it is important to protect against liability exposure, so the planned due diligence should include:
- Insurance – organizing in a database all historic insurance policies, applications, schedules of insurance, claims data, insured and uninsured liabilities, corporate history, and a summary of losses by line of insurance. The insurance program should be reviewed to determine: (1) that there are no gaps in coverage; (2) that there are adequate limits; (3) that there are no notices of cancellation; (4) whether the policies are ‘claims made’ or ‘occurrence based’: (5) whether there are high deductible, fronted policies, or retrospective premium programs; (6) if there are exhausted policy limits; (7) if there are any open or pending notices of claims to insurance carriers; (8) if any of the policies require an extended reporting period; (10) if there are any weak insurance carriers on the historic insurance program; and (11) if there are any “change-in-control” provisions in the insurance policies that either restrict coverage or eliminate coverage with a change in ownership.
- Environmental and pollution liability – ensuring that all information regarding Phase I, EPA inspections, past use of property and disposal activity documentation is available.
- Property appraisals – gathering documentation for all property to be transferred
- Overall risks – identifying risks and establishing that those risks have been adequately addressed and covered; consider reps & warranties insurance for matters of concern to a buyer.
- Locating, reviewing and organizing corporate records - the articles of incorporation, by-laws, corporate minute books, and stock transfer records
A virtual data room can expedite closing by making the due diligence documents easily available on-line and provide appropriate security and monitoring capabilities.
A business acquisition can be a stressful and time-consuming endeavor. Acquiring companies are often only concerned about the current insurance program with the company to be acquired and don’t take the time to get a complete risk management picture. A thorough review of the risk management program as part of the due diligence process can save companies time and money later.
1. Parts of this article were taken from a previous article that was co-written with Russ Warren of Edgepoint Capital.
2. The parties should discuss whether the buyer is going to have rights to the seller’s insurance policies. Depending on the type of transaction contemplated between the buyer and seller (asset or stock purchase) and the jurisdictions involved, if the buyer is to have rights to the policies, the parties should discuss the best way to obtain an assignment of the policies and specifically address this issue in the Agreement.