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5 Ways to Kill a Private Equity Deal

Wednesday, August 30, 2023
5 Ways to Kill a Private Equity Deal

Being Private Equity is not for the faint of heart. It’s an industry driven by your firm’s reputation for fueling growth and achieving high returns. Successful investments require the aggressive use of debt and a focus on cash flow and margin. Deal killers are like landmines that you need to navigate for both financial and reputational success.

There’s nothing like losing millions on a deal because of issues that could have been prevented. The good news is when it comes to risk management strategies, there are many ways to pinpoint potential deal-killers and strategize accordingly, which will save you time and money on your next deal. Here are five pitfalls we have seen recently in private equity deals:

1. Forgetting to account for the cost of a tail policy

Tail policies are crucial for companies who are going through an acquisition, as they cover what would otherwise be a gap in coverage after the sale. Tail policies can literally save a business, and as a result, they come at a hefty cost – usually 200-300 percent of the policy premium. Buyers almost always request this of sellers, but sellers often don’t take the costs into account until it is too late in the process. This often leads to two scenarios: the buyer will allow the requirement to go unfulfilled and take on unnecessary risk, or pay for it themselves. This could become a major issue at close.The solution? Obtain tail pricing earlier in the process. Also, where possible, convince the go-forward carriers to take on prior acts exposure. This is becoming more common under certain circumstances – particularly if there is no prior claims history and if the management team will stay the same.

2. Inadequate protection from data breaches

It’s always difficult to recover from a data breach or similar cyber event – but it’s even worse when diligence uncovers that there was no cyber liability coverage in place. In cases like these, it’s often also revealed that there were inadequate cybersecurity controls, misrepresentation in the cyber liability application or both. Either of these factors could prevent coverage in the event of a post-close cyber claim – even if a tail policy is purchased.

You could ask the target’s cyber liability carrier for a written statement saying that they will provide coverage even though the application has misrepresentations, but they are unlikely willing to agree to this. We recommend completing a new application with full transparency for the go-forward carrier and have them honor all prior acts. Carriers are more willing to do this and it is the best way to ensure pre-close cyber exposure is covered in the future.

3. Weak analysis of the Worker’s Compensation Experience Modification Rate (EMR)

When you acquire another company, you are also acquiring that company’s EMR, which could result in a positive or negative impact. We cannot stress how important it is to conduct a thorough analysis at the beginning of diligence – especially if you are in an industry that requires a certain EMR, like construction or manufacturing. An in-depth examination can determine if the EMR is going to increase beyond contracted requirements, which could lead to losing contracts, decreasing the value of the target and/or strategic acquirer.

4. No review of selling company’s claims

Claims drive the cost of health insurance. One or two large claims can significantly impact total plan cost. If the acquiring doesn’t ask for or if there is not claims information available during the diligence review, a large change in health insurance plan spend can occur post-close – in fact, we recently reviewed a group’s policy that jumped by 200 percent, due to large claims that occurred before the renewal. It’s crucial to review contracts with as much detail as possible, so you’re fully aware of all of the risks you are taking on.

5. The target company’s benefits are much richer than the buyer’s

Unfortunately, this is a common scenario. The seller’s employees often become disgruntled after learning that the buyer’s benefits program is more sparse than what they’ve had in the past. Depending on how large the change is, this could turn into high turnover once the sale is finalized. The seller can improve employee satisfaction by being transparent throughout the acquisition process and keeping communication open with management. Having those candid conversations builds trust and has the potential to lead to compromises that will satisfy everyone.

Need Help With Your Next Private Equity Deal?

Are you prepared to deal with any of these roadblocks? Horton’s Mergers & Acquisitions team has worked on hundreds of deals and can provide an assessment for your deal on potential gaps. Reach out and and schedule a consultation to plan your next private equity deal.

Material posted on this website is for informational purposes only and does not constitute a legal opinion or medical advice. Contact your legal representative or medical professional for information specific to your legal or medical needs.