Insuring Against The Operational Risk Of M&A Transactions

Mergers and acquisitions (M&A) are transactions involving the ownership of companies or other organizations, which allow them to increase and reduce their size and change their competitive position, and are therefore an aspect of corporate strategy. In this article we review some of the reasons, the operational risks involved in these processes and also some of the mechanisms used to mitigate losses.

Reasons for mergers and acquisitions

  1. Economic

  • Cost reduction.
  • To obtain new resources and capabilities through the merger or acquisition of another company.
  • Replacing the management team: It is often the case that when management is replaced, there is a greater increase in value.
  • Obtaining tax incentives that can increase profits.

  1. Market power

  • May be the only way to enter an industry and/or country, due to high barriers to entry.
  • When mergers and acquisitions are horizontally integrated, the aim is to increase the market power of the resulting company and, consequently, reduce the level of competition in the industry.
  • And when they are vertically integrated, companies operating at different stages of the production cycle are integrated.

But what are some of the operational risks to be taken into account?

The potential is enormous; however, there are often miscalculations in relation to the scope of the operation, its implications, the new form of management or the level of integration required between one company and another.

  • Mergers and acquisitions sometimes give rise to problems related to possible hidden debts or contingencies in the financial, accounting, commercial, tax, etc. areas. In order to analyze these risks, the procedure known as due diligence or company purchase audit is used, which consists of an investigation of the different areas of the business to be acquired in order to know it in greater depth and determine whether the price and conditions agreed upon are the correct ones.
  • Clash between the different cultures of the companies. When we talk about large companies with experience in a market, probably over the years each one has implemented a particular company culture and leadership model. The cultures of the two companies should be aligned as much as possible. Here it is important to harmonize and make clear the type of leadership to be implemented.
  • Loss of employees. Layoffs can be one of the main problems of a merger or acquisition. It is essential to identify the areas that may generate complications before carrying out the operation and to carry out a harmonization of collective bargaining agreement conditions. In addition to calculating how many employees will be lost during this transition and, in particular, how talent will be impacted.

What alternatives are used to mitigate damages in the M&A process?

The risk in M&A transactions is usually mitigated through declarations and warranties insurance policies, better known as Rep and Warranty Insurance, which have been gaining competitiveness in the market. Their main benefit is the possibility of reassigning the risk of non-compliance with the representations and warranties clauses to a third party known as the insurer. This type of policy can be taken out by both parties.

Another type of policy that can help secure investment capital in a competitive market is Fidelity Bond, which covers any direct loss that the employee causes to the insured directly or in concert with others in the performance of his employment by theft, embezzlement, forgery, misappropriation, fraudulent misappropriation, willful misuse or other fraudulent or malicious act or acts.

Also among the alternatives to mitigate risks is D&O insurance. Nowadays, no manager assumes responsibilities in a company or organization if he/she is not guaranteed access to this insurance and for this reason it is one of the negotiation mechanisms used in the process of mergers and acquisitions, and which allows retaining talent, since its function is to cover founded or unfounded claims received by individuals for their decisions in the management and governance of the company, or as a consequence of the negligent actions of any of its employees, and which cause financial damages to third parties.

Interesting Related Article: “Mergers And Acquisition Laws Raise More Confusion