A Tale of Two Cities: A Seller’s Dream or a Buyer’s Nightmare?

According to headlines everywhere, the mergers and acquisitions (M&A) market is flourishing. Many firms are reporting that 2021 has proven to be a banner year for M&A activity, reaching historic levels in the first quarter with over $21.2 billion in deal value. These headlines, however, are overlooking the challenges that buyers are facing in this market, and the lasting effects of the pandemic on the private equity sector.

Mergers, Acquisitions, and the Pandemic

After an abrupt pause in the spring of 2020 due to COVID-19, M&A deals picked back up swiftly. By the end of 2020, we saw a three-year high with the total transaction volume reaching $168 billion, a 90% increase from the same period in 2019.

In this landscape, the M&A market has become a tale of two cities, impacting buyers and sellers vastly differently and heavily influencing business decisions. On one hand, this market has been the opportunity of a lifetime for buyers to capitalize on fire sale deals. On the other hand, more conservative private equity buyers are sitting on the sidelines, unsure of how to navigate this fast-paced and expensive market. And regardless of who’s buying, COVID-19 struck many companies hard, forcing them to sell earlier than anticipated. Buyers are feeling the burn of the market’s aggression, navigating steep costs and rising insurance needs. While sellers are receiving over-asking prices for their businesses, buyers are facing unprecedented requirements from underwriters.

With the incredibly high value on closing deals today, we’re seeing the hardest insurance market in over 40 years. Interested buyers are having to jump through hoops in order to secure coverage, hoops that didn’t exist a few years ago. Business leaders on both ends of M&A deals should pay close attention to evolving private equity insurance considerations.

Underwriters are Overwhelmed

For many years, M&A market prices decreased. After taking a hard look at pricing in 2020 and assessing the ongoing increase in loss ratios, underwriters promoted a reversal of the reserves and a market correction.

As a result of working leaner than ever before, underwriters are now choosing risks carefully, factoring exposures into what deals they will consider. The dynamic is shifting drastically - buyers must now produce more data, more information, and more due diligence than ever before in order to justify the price tags of M&A deals, most of which are closing far over initial asking price. For brokers to get deals done, they need to acquire data about organizations that had previously never been asked for by underwriters.

Representations and Warranties: A New Era

As was the case before the hard market, representations and warranties are a panacea for getting deals done. Reps and warranties protect against losses that occur because of the seller’s breach of its representations in the acquisition agreement. With myriad transaction types occurring, reps and warranties has expanded into litigation and buyouts, tax and opinion insurance, credit collateral, and an overall merge between the finance and insurance industries. Even brokers are breaking into reps and warranties.

While reps and warranties are expanding, underwriting is closing in. Learning from their experiences in risk versus reward, underwriters have become more sophisticated in terms of what deals they’re willing to review, causing them to decline deals more often than before.

As the COVID-19 pandemic’s impact lingers, the future of the M&A market is uncertain. This tale of two cities is likely to persist and the market will continue to harden. As businesses look for a partner in closing deals, it is essential to identify a firm with a longstanding and experienced history in the market. Risk Strategies’ Private Equity team can provide an unmatched level of experience and service during a truly unique time.

Want to learn more?

Connect with the Risk Strategies Private Equity team at privateequity@risk-strategies.com.

Email me directly at nkrauter@krautergroup.com.