Is there a Market for Deferred Consideration Insurance?


BVCAIS Perspective


Nathan Sewell


CEO, BVCA Insurance Services nsewell@bvca.co.uk


Deferred Consideration Insurance (DCI) covers the risk that a seller of a business does not receive some or all payments due to them, where such payments have been deferred beyond the original sale date. Payments are usually of a pre-agreed amount, being part of the original consideration due to the Seller.


The degree of risk varies greatly, depending on a number of factors.


Nathan has been involved in the risk and insurance sector since 1989. With a long-term focus on the investment community he has worked at board level for both multinational and smaller independent companies and has established two specialist insurance businesses since 2007.


Nathan began his career as an underwriter before moving to global broker Aon Limited where he was responsible for the establishment of the London Market’s first M&A transactional liability team.


In 2002 Nathan moved to Willis to become the International Practice Leader of the Willis M&A team.


Nathan’s technical expertise incorporates most insurance classes from general placements to products specifically tailored for the private equity and venture capital arena.


a. Amount of consideration deferred. Typically between 20% and 50% (sometimes more).


b. Time period of deferral. Typically between 1 and 3 years but occasionally 5+.


c. Quality of counter-party on which payments are secured. This may be on the future cash flow of the target company or of an acquiring parent company.


It is these factors that would influence whether a Seller would seek some extra form of protection.


When is it used?


DCI has been used historically in a wide range of transaction types. It is more commonly seen in private company transactions where equity is not available or the cost of debt is prohibitive.


What are the advantages? Aside from the obvious use where a transaction would not otherwise be completed, there are some other distinct benefits:


n Increased sale price. This is derived from the cost efficiency of DCI as it is less expensive than the alternative solutions. It also may come from an attractive interest rate or coupon on the deferred element or if the target company is profitable and cash-flow positive.


n Simplified transaction process. By deferring part of the consideration, it may be that several layers of alternative debt/equity may not be required, thus reducing the number of parties involved. Parties may have differing agendas in terms of future direction of the business and/or exit plans.


n Creation of working capital. By deferring payments that may otherwise have been made by taking on more expensive debt, cash can be preserved for growing the business during the period of deferral.


Background and history – Is there a market? DCI has been a feature of the insurance market for a number of years. Between 1996 and around 2008, there were several insurers in this sector and a number of deals successfully insured. Having said that, for those involved in the M&A insurance/ transaction risks arena, there were always many more enquiries than deals done and the associated hit-rate was very low. During this time the availability of debt fluctuated but in the main banks were very happy to lend significant sums of money to PE/VC backed businesses and those PE/VC backers had a keen appetite for acquisitions.


These factors would make DCI less attractive generally, particularly as some insurers would also insist on some kind of equity participation.


Underwriting and policy features Underwriting focuses mainly on historical and financial performance of the target company (assuming the DC element is secured on the target) and includes the following areas of assessment:


n 3 to 5 year trading history. How has the company performed? What are the trading trends?


n Proposed funding and forward-looking plans (3 to 5 years). Are the plans sustainable and funded?


n Industry sector trends. Is it a trade or business operating in a growth area? Any unusual risk factors associated with the industry i.e. regulatory, technology or political?


38 Author Viewpoint


Risk and Insurance in Private Equity and M&A 2012/13


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28  |  Page 29  |  Page 30  |  Page 31  |  Page 32  |  Page 33  |  Page 34  |  Page 35  |  Page 36  |  Page 37  |  Page 38  |  Page 39  |  Page 40  |  Page 41  |  Page 42  |  Page 43  |  Page 44  |  Page 45  |  Page 46  |  Page 47  |  Page 48  |  Page 49  |  Page 50  |  Page 51  |  Page 52  |  Page 53  |  Page 54  |  Page 55  |  Page 56  |  Page 57  |  Page 58  |  Page 59  |  Page 60  |  Page 61  |  Page 62  |  Page 63  |  Page 64  |  Page 65  |  Page 66  |  Page 67  |  Page 68  |  Page 69  |  Page 70  |  Page 71  |  Page 72  |  Page 73  |  Page 74  |  Page 75  |  Page 76