Prevalence of tech deals in the M&A space

Sean Hinton : Underwriting Counsel

Sean Hinton

Underwriting Counsel

2020 has certainly been an interesting year in the M&A market.  Analysts and industry experts anticipated potentially slower growth of deal activity from 2019 levels given multiple underlying uncertainties:  the impact of global economies, strained U.S. trade relations with China and the U.S. presidential election.  Then, COVID-19 hit, leading to a very underwhelming second quarter and speculation that deal volumes would remain depressed for the duration of the pandemic.  However, despite all the headwinds, the M&A market had come roaring back by Q3, not experiencing the noticeable lull typical of the lead-up to a U.S. presidential election or any noticeable slowdown overall on account of COVID-191.

While global M&A deal value during the first three quarters of this year reached just $1.86 trillion (USD), a decline of 28% as compared with the same period in 2019, the decline was concentrated in the first half of the year.  Global M&A activity began to recover noticeably in the 3rd Q; Mergermarket’s Global & Regional M&A Report, Q1-Q3, 2020 reported that 3rd Q deal values “more than doubled to $891 billion (USD) from the $372 billion (USD) in the 2nd Q.”  Technology, Media and Telecom (TMT) has fared better than other sectors, even though April and May 2020 represented the lowest number of tech M&A deals since 1st Q 2009 during the Great Recession.  TMT was one of the “busier sectors in 2Q20 globally.  In the 3rd Q, the sector emerged as the most active for deals with 760 deals totaling $301.2 billion,” according to data from Mergermarket2.

August M&A activity signaled a turning point, bringing an unexpected increase in deal volumes, primarily within the mid- to larger-size markets, and TMT rebounded even more remarkably.  “Six of the largest ten deals announced globally during August involved tech sector targets,” reported MarketWatch3.  Nine of those top ten deals were valued at $5 billion or more, the largest number for the month of August since 1999, led by the technology and healthcare sectors.  [MarketWatch also reported that deal] values in the technology sector totaled $69.3 billion (USD) for the month, representing 27% of all global M&A activity in August 20204.

Particularly in light of the COVID-19 pandemic, the TMT sector has become more attractive, bolstered by the movement toward digitalization, remote working and e-commerce.  Liberty GTS’s Representations & Warranties Insurance (RWI) submissions and deal flow reflect these broader M&A market trends.  While Liberty GTS’s second quarter submissions in the Americas were generally down quarter-over-quarter across all industry sectors, submissions for targets in the technology sector decreased at approximately half the rate of submissions overall.  In the third quarter of this year, tech submissions rose by approximately a third compared with the same period in 2019, and the increase in tech submissions in the third quarter outpaced that of submissions generally as global M&A activity rallied5.

A RWI policy protects a buyer from financial loss related to an unknown risk arising out of a breach of representation or warranty set forth in the purchase agreement and can provide certainty to buyers and sellers, especially during such uncertain times. Enterprise software and services, “cloud services,” are not necessarily hard assets that can be easily assessed by traditional legal and actuarial standards.   RWI coverage for technology transactions requires a distinct underwriting analysis and greater scrutiny during the due diligence process.

Intellectual capital imbedded in sophisticated technology companies and systems presents unique challenges for post-closing deal success.  For such targets, the most valuable corporate asset is often the people: the key teams of disruptors and innovators driving a company’s value proposition.  In evaluating the risk in a tech merger or acquisition, diligence on this “softer” and less tangible intellectual capital has become an essential component of RWI underwriting.  Buyers want to keep the key creators (and their know-how) in place post-acquisition.  Buy-side diligence, and therefore RWI underwriting, must focus on areas beyond the “classic” IP diligence, including the terms of employee contracts, the existence of any legacy non-disclosure or non-compete agreements, the adequacy of physical and electronic information security protections and other less-obvious hurdles that may impact the value of the acquisition post-closing.

The global team of underwriters at Liberty GTS has the breadth and depth of experience in the TMT sector to effectively and efficiently analyze the risks associated with tech acquisitions on tight deal timelines. As M&A activity within the tech space continues to grow, Liberty GTS is committed to remaining a trusted partner for both strategic and financial buyers entering or expanding their presence in the sector and continually evolving our approach to underwriting, according to the unique characteristics of each transaction.

  1. Global M&A shrugs off Covid-19 crisis with massive bounce in third-quarter dealmaking by B. Edwards (October 5, 2020): https://www.globallegalpost.com/big-stories/global-ma-shrugs-off-covid-19-crisis-with-massive-bounce-in-third-quarter-dealmaking-48355468/
  2. Mergermarket Global & Regional M&A Report 1Q-3Q20: https://www.mergermarket.com/info/3q20-global-ma-report-financial-league-tables
  3. Surge in megadeals points to M&A recovery as tech sector dominates by L. Saigol (September 2, 2020) https://www.marketwatch.com/story/surge-in-megadeals-points-to-ma-recovery-as-tech-sector-dominates-2020-09-01
  4. Mergermarket Global & Regional M&A Report 1Q-3Q20: https://www.mergermarket.com/info/3q20-global-ma-report-financial-league-tables
  5. Based on Liberty Mutual internal data, 2020

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.

Tax Liability Insurance – A strategic tool during unsettling times

Christopher Waddington : Senior Tax Underwriter

Christopher Waddington

Senior Tax Underwriter

Tax liability insurance is a strategic tool utilized to transfer responsibility for tax contingencies from the insured to the insurer, whether in the context of a mergers and acquisitions transaction or otherwise.  Cover can provide certainty to buyers and sellers during transactions by transferring financial risk from potential material tax exposures to the insurer, thus allowing the parties to move forward with greater confidence.

Tax liability insurance can offer comfort to address various transactional issues:

  • Providing peace of mind to a company/individual that they will not be exposed to a historical tax position;
  • Removing a contentious tax issue from the negotiating table on an acquisition;
  • Improving a bidder’s offer by not requiring protection for a potential issue in the target company;
  • Allowing the release of funds from escrow; and
  • Enabling investment funds to return proceeds to investors.

However, these are unprecedented times, giving rise to particular challenges for both taxpayers and tax authorities worldwide.   Below are some specific scenarios where tax liability insurance can offer a potential solution to address tax risk in the current climate of market uncertainty:

Alternative to tax rulings:

In many jurisdictions, the process to obtain a binding tax ruling from the tax authority is currently protracted.  Tax insurance can provide a viable alternative for obtaining certainty where seeking a binding ruling may not be possible within the deal timetable.

Group restructuring and reorganisations:

Many groups may be under distress due to a reduction in trading activity and revenue.  As a result they may look to, or be required to, implement a restructuring (e.g. in preparation for a spin-off of unprofitable or non-core business), debt-for-equity swaps or debt waivers.  Such actions could potentially trigger significant tax consequences, such as capital gains taxes, transfer taxes and corporation taxes. For example, there may be uncertainty in the application of tax neutral reorganisation rules or debt waiver rules that potentially can create unexpected risk exposures.

Insolvency and administration:

Many expect the current climate may give rise to an increase in company liquidations and administrations of distressed businesses. Tax insurance can provide liquidators with a level of comfort in relation to a potential identified tax liability prior to releasing funds to investors/creditors.  It can also be used as a tool in the context of a pre-packaged administration, where the buyer typically has no recourse for an identified tax liability of the acquired target.

Significant, unanticipated government public spending has been essential to support business sustainability during the global pandemic, for example through furlough payments, business loans/grants and unemployment and social security payments.  Subsequently, tax authorities may be forced to adopt a more aggressive approach going forward to shore up government finances and redress national debt. If this does happen, tax liability insurance could play an increasingly important role in offering certainty for insureds in relation to managing tax risk going forward.

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.

Warranty & Indemnity Insurance – Strategic tool to help protect relationships post-closing

Geoffrey Lee : Australia and New Zealand Manager

Geoffrey Lee

Australia and New Zealand Manager

Warranty and Indemnity or Representations and Warranties (W&I) insurance is a strategic tool utilized in merger and acquisition transactions to transfer risk of financial loss for seller warranty breaches in a sale agreement to an insurer.

W&I has a number of well-known benefits for both buyers and sellers but the focus for this post is on highlighting where W&I could add significant value over uninsured deals in protecting ongoing business relationships between parties post-closing of a transaction. This is an area that is often overlooked but a crucial component of deal success.

In the event of a warranty breach, a buyer must consider the commercial realities of bringing a contentious action against the seller regardless of a claim’s legitimacy.  In many cases there is significant risk, particularly for public proceedings, that such an action could damage goodwill with management and employees or jeopardise existing relationships with established customers and suppliers of the business.  Particularly in the Asia context, saving ‘face’ and the concept of guanxi, where one relies heavily on social connections and networks, are fundamental values which permeate business relations and cannot be ignored post-closing of a transaction.  With a buy-side W&I policy, the insurer stands as a neutral and credit worthy third party to handle any potential warranty claims confidentially with the buyer.

Some common deal scenarios which W&I can help to address post-closing include:

Partial acquisitions

When a buyer acquires less than 100% of the business there will always be the need to manage on-going relationships between the new acquirer and existing vendors.  A warranty claim raises the potential for contentious disputes amongst the parties that could disrupt the post-integration process at a time when fostering goodwill with new business stakeholders should be a priority.

Founder divestments

Where founder led businesses are sold with existing obligations to work within the business post-completion, the drivers for its continued success are intrinsically linked to those providing the warranties under the sale agreement. Claims against the founder or management shareholders who are crucial to the business could be severely detrimental to the operation of the acquired business and its key customer and supplier relationships.

Large corporate divestments

In today’s economic climate, many transactions are undertaken to streamline businesses by divesting or spinning-off non-core assets.  Large corporate groups often require complex transitional service arrangements whereby buyers and sellers continue working together post-closing.  A warranty claim could sour this relationship and significantly impair the acquired business during this important transition period.

Joint ventures or mergers

Parties in a joint venture or merger seek to combine existing businesses to achieve a shared goal. In this situation a bespoke W&I solution can be structured so that both parties’ liabilities under the warranties in the merger agreement can be insured. This frees the combined management to focus their attention on the future success of the venture.

Warranty breaches in an uninsured transaction can put significant strain on relations where post-closing obligations between parties exist.  Accordingly, M&A participants should consider the value of W&I insurance as a risk mitigation tool in these common deal scenarios above. Beyond offering secure financial recourse for a buyer, a W&I policy may help provide additional peace of mind that important relationships can continue to be maintained well beyond the parties signing on the dotted line.

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.

Representations & Warranties Insurance Offers Certainty in Uncertain Times

Jonah Goldberg : Underwriting Counsel

Jonah Goldberg

Underwriting Counsel

Representations and Warranties Insurance (RWI) can provide certainty to buyers and sellers during uncertain times.  RWI is an adaptable product that can alleviate risk and provide strategic advantages for dealmakers as they navigate opportunities during the COVID-19 pandemic.  Liberty Global Transaction Solutions (GTS) is taking a proactive, commercial approach by underwriting transactions during the COVID-19 pandemic on a case-by-case basis, rather than applying blanket COVID-19 exclusions in all RWI policies.

RWI protects a buyer from financial loss related to an unknown risk arising out of a breach of a representation or warranty set forth in the purchase agreement.  The financial strength of the insurance carrier writing the RWI policy is paramount, as the financial loss of an unknown risk transfers from the parties to the transaction to the insurer’s balance sheet.  RWI can bridge the gap between the respective parties on risk allocation, thereby bolstering buyer and seller confidence in the terms of the transaction.

“We do believe that most businesses are impacted by COVID-19 in some way,” stated Brittani Marszalek, underwriting counsel at Liberty GTS, at a recent webinar sponsored by the Association for Corporate Growth.  During a period of extended economic uncertainty, deal dynamics and parties’ negotiating leverage are likely to change. Long settled clauses in purchase agreements (for example, the definition of Material Adverse Effect (MAE), absence of changes representations and material contract and customer/supplier representations) are now being carefully negotiated as parties consider the impact that the COVID-19 pandemic might have on these provisions, and how the associated risks should be allocated between buyers and sellers. We also expect that the mergers and acquisitions (M&A) market will generally start to become more buyer friendly as a result of the COVID-19 pandemic after a sustained period of a seller friendly market prior to the outbreak.  Some buyers may see opportunities to acquire businesses at discounted prices and there is likely to be increased activity in distressed M&A.  RWI will be a useful tool in the context of such transactions by providing buyers a source of recovery where one might not otherwise be available and potentially increasing the value of the distressed assets.

While we expect the M&A market may start to become more buyer friendly, RWI will continue to be a useful tool for sellers in M&A transactions as RWI can reduce or even eliminate the traditional need for the seller to establish an escrow account or purchase price holdback at the time of the sale to cover post-closing indemnification matters.  Depending on the length of the escrow period, sale proceeds could be tied up for years.  RWI, therefore, is attractive to sellers as it can facilitate a “clean exit,” allowing them to leverage their capital for other investment opportunities and/or to pay out investors.  According to a study by SRS Aquion Inc., of signed private deals between 2016-2018, with an RWI policy in place, the median size of indemnification escrows “averaged just 2.4% of the deal’s purchase prices… as compared to deals without such insurance averaged 11.4% of the purchase price” as reported by The Wall Street Journal.1

Liberty GTS’ ongoing commitment to the M&A market is robust and unwavering during these uncertain times.  Our approach is providing assurance to clients that insurance solutions will be driven by sound research, disciplined underwriting decisions and flexibility to customize RWI coverage designed to address the distinct characteristics of each transaction.

  1. Wall Street Journal, “May 5, 2020: Rep and Warranty Insurers Confront Coronavirus Risk”; https://www.wsj.com/articles/rep-and-warranty-insurers-confront-coronavirus-risk-11588633766 

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.

How could the downturn in the U.S. oil and gas industry impact M&A activity?

Angela Wu : Underwriting Counsel

Angela Wu

Underwriting Counsel

The oil and gas industry took another plunge in April 2020.  The underlying mood of the National Association of Production and Exploration North American Prospect Expo (NAPE), the industry’s largest upstream oil and gas congregation held in February 2020 in Houston, Texas, reflected a hunkering-down mentality in preparation for an impending downturn.  And, that was before the COVID-19 pandemic ravaged global economies.

The oil and gas industry largely consists of four major sectors: Upstream, Midstream, Downstream and Services, the last of which provides products and services that support aspects of operations for the other sectors.  As a result of advances in extraction technology and increased production, the domestic oil and gas industry has experienced significant growth nationwide.  As the industry boomed, investment opportunities in every segment of the energy sector abounded and interest from private equity firms increased dramatically.  Smaller energy-focused private equity companies also grew as need for private capital expanded.  At the start of 2020, the oil and gas industry represented 8% of GDP in the United States, supporting 10.3 million jobs, according to the American Petroleum Institute.1

Private equity investments, in general terms, focus on shorter term horizons, as opposed to strategically orchestrated transactions, which acquire businesses with the goals of consolidation and operational efficiencies.  As private equity firm investment in the oil and gas sector expanded, so too did the use of Representations and Warranties (R&W) insurance to protect against transactional risks in mergers and acquisitions.

R&W insurance is a tactical tool utilized in merger and acquisition transactions to transfer risk of financial loss for a breach of seller warranties provided in a purchase agreement to an insurance company’s balance sheet.  The insurance coverage can greatly reduce or replace the traditional need for the seller to set aside a large amount of money in escrow at the time of sale in order to cover post-closing indemnification needs.  Depending on the length of the escrow period, this may tie up capital for years.  R&W insurance is therefore attractive to private equity sellers as it can facilitate a clean exit, allowing the firm to leverage its capital for other investment ventures and/or pay out to investors as soon as possible.

What role will private equity now play amid the industry’s currently rapid downturn and how can R&W insurance play a pivotal role in offering transactional assurance?  As of Q1 2020, the industry saw oil prices trending at just below $50.00 per barrel.  Today, oil prices have sunk to some of their lowest levels in history as a result of 1) the Saudi-Russia price dispute; and 2) the far-reaching effects of COVID-19.  In March 2020, a price dispute erupted between Saudi Arabia, OPEC’s most influential member, and Russia, when the two countries failed to reach an agreement on supply cutbacks. Then, as both countries increased crude production dramatically, the ensuing supply glut caused oil prices to fall dramatically. At the same time, despite historically low oil prices, the world-wide COVID-19 outbreak stifled demand with airplanes grounded, people following stay-at-home guidance in every state, and economic activity generally subdued.  The combined effect of the dramatic increase in supply and the drop in demand caused WTI prices to close at a historic negative $37 per barrel on April 20, 2020.2 While this last plunge was the result of the characteristics of futures contracts and oil has since returned to positive territory, oil prices remain low. A recent Bank of America report projects that “demand will plunge by an average of 9.2 million barrels per day in 2020, more than double the originally projected 4.4 daily billion drop.”3  As of May 2020, the S&P 500 Energy Sector Fund (XLE) was trading down over 50% from a year earlier, as reported on the NYSE.

Oil and gas companies facing near-term debt maturities have likely either gone into bankruptcy or have hired restructuring advisors in advance.  Should oil prices not improve, thus restricting cash flows, a wave of restructurings and foreclosures could be expected.  Major lenders, such as JPMorgan Chase & Co., Wells Fargo & Co. and others, are reported to be setting up independent companies with management and operators in order to own and operate oil and gas assets after foreclosure.  If lenders decide to sell assets for pennies on the dollar instead of operate them, this environment would provide an invaluable opportunity for private equity and other investors with access to capital.  Such players will likely shift their focus to investing and acquiring distressed and deeply discounted assets.  In a distressed acquisition scenario, along with the traditional benefits received from R&W insurance, R&W insurance can, subject to terms, conditions and regulation: (1) backstop indemnities to increase the appeal of distressed assets, (2) remove the need to hold funds in escrow, which allows sellers to liquidate quickly; and (3) ease concerns regarding collection of funds from sellers that can be difficult or costly to pursue.

Carriers offering R&W insurance will be poised to respond with sound, disciplined underwriting standards designed to help offer protection and increase buyer confidence for unexpected transactional risks during the oil and gas industry’s projected systemic shift.

 

  1. American Petroleum Institute, “Energy Works Data”; www.api.org
  2. Forbes, “April 20: WTI At -$37, Brent At $26! What Happened? What Comes Next? The Stories That Will Be Told…”; https://www.forbes.com/sites/thebakersinstitute/2020/04/21/april-20-wti-at37-brent-at-26-what-happened-what-comes-next-the-stories-that-will-be-told/#16ec3e414d4b
  3. Bank of America Report, referenced by CNN, “April 13: Cheap oil isn’t going away, even after record production cuts”; https://lite.cnn.com/en/article/h_555e5ccb331690ff269b7f342cb6346c

This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.