No business owner would launch an acquisition campaign without assembling a solid team of advisors to sweat the details, starting with competent legal and accounting help.
If you don't include your insurance broker or risk manager among your advisors, however, you could make a big mistake.
Your own experience tells you that few businesses go very long without incurring an insured loss--say, a workers' compensation claim or the threat of a lawsuit over commercial auto liability. If your business handles hazardous materials or manufactures consumer items, you could hit the big time with a pollution claim or a product liability lawsuit.
The same threats, of course, face any business you might acquire, and you don't want one to blindside you; a big claim could sink your business altogether.
The solution? Get someone on your acquisition team who can assess these risks so you can factor them into your decision to go ahead with the acquisition, and at what price. Put another way, find an insurance broker or a consulting risk manager who knows what "due diligence" means in mergers and acquisitions.
Among other things, you must assess these risks:
* Pollution liability. If your target business manufactures, uses, transports, stores or disposes of hazardous materials of any kind, watch out for pollution liability. Federal and state law may hold you liable for the costs of a cleanup associated with current or past operations--even, for example, for the cost of cleaning up a disposal site that fully complied with the law years ago. To get a handle on any possible pollution liability, you may want to call in a consultant specializing in environmental risk assessments to look over the operations of your target company.
* Workers' compensation. Workers' comp claims often come with long "tails"--insurance-speak for long-term costs. For that matter, claims tend to rise at a target company as employees worry about their job security. Either way, workers' comp can hit you with unexpected costs, not to mention lost production time.
* Successor liability. If your target company manufactures consumer goods, take a good look at any hazards faced by its customers. As a rule, the courts hold successor companies--yours, if you merge or consolidate the operations of the target company into your own--strictly liable for the acts of predecessor companies, without regard to negligence.
* Directors and officers liability. If the shareholders of your target company--say, the members of an extended family--don't like your purchase price, they may sue on grounds that the target company's directors and officers protected their own interests, not those of shareholders. For that matter, your own shareholders may sue for the same reason.
You can handle these risks if you understand them, and the first step is to analyze your target company's operations in detail. The second is to study all liability policies currently in force at your target company, as well as those going back as many years as possible.
Among other things, you need to know how much insurance your target company carried covering what risks, and with what deductibles and exclusions. Of special importance is whether your target company carried "claims-made" or "occurrence" liability coverage.
Claims-made policies cover claims only if made while the policy is in force, no matter when the incident occurred from which a claim arises. For example, a claims-made general liability policy in force this year covers all claims arising this year--even those stemming from incidents occurring last year.
An occurrence policy, by contrast, covers claims only if arising from incidents occurring while the policy is in force, no matter when the claim is made. Put another way, an occurrence policy in force last year covers all incidents occurring last year--even if a claim comes in this year.
The distinction here is simple: A claims-made policy focuses on the timing of the claim, an occurrence policy on the timing of the event that gives rise to the claim.
But don't be misled. Other things being equal, occurrence policies offer broader coverage than claims-made policies, many of which exclude coverage for events occurring before a certain date in the past--the retroactive date.
It follows that if your target company carries occurrence liability insurance as a matter of practice, you take on less risk in buying the company. If it carries only claims-made liability coverage, on the other hand, you take on more risk.
Last but not least, you must also study any self-insurance programs covering such risks as workers' comp or commercial auto liability, making sure that the target company has ample reserves to cover claims. And where any commercial insurer no longer exists--for example, because it merged with another company--you need to know the financial strength of the successor company.
Your study of these matters will give the one thing vital to any merger or acquisition: a clear sense of the risks you take on in carrying out your transaction. Once your risks become clear, you can decide which to shoulder yourself, which to ask your target company to take on, and which to pass on to an insurer.
"What you want, I think, is to know the potential impact on your ability to make a profit after you do your deal," says Thomas E. Malone, whose Torrance insurance brokerage, Malone & McCulley, does a good deal of mergers and acquisitions work.
"If your broker tells you that you've got a potentially big pollution liability, you've got to factor that into your negotiations. You may want to discount the purchase price, or maybe set up an escrow account and assign liability between buyer and seller for a period of time, or share the costs of insuring against a claim.
"You can negotiate the value of any hazard into your deal. You just have to know what the hazard is, and what impact it may have on your business, so you can decide which risks to assume yourself and which to transfer to an insurance company."
Freelance writer Juan Hovey can be reached at (805) 492-7909 or via e-mail at email@example.com.