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Preparation as a competitive advantage: taking control before launch
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The insurance market has developed significantly to the point where many issues and risks that would previously be potentially contentious points of negotiation, may now be addressed and ringfenced through creative and novel insurance solutions. These matters that may now be pro-actively managed include scope of warranties, mechanics to provide the buyer assurance of recoverability in the event of warranty / indemnity claims, and material identified tax, litigation and other contingent risks. Pro-active management involves identification and assessment of risks / issues, and strong preparation may help reap rewards in the form of increased deal certainty and early resolution of issues that might otherwise been negotiated later in the process.
The strongest sale processes do not necessarily have fewer issues. They identify them earlier, decide how they will be managed and give bidders a clear framework for assessing the transaction.
For sellers, this creates an opportunity. Rather than leaving decisions around transaction risk until a preferred bidder has been selected, some sellers choose to address them before launch — while competitive tension remains and they retain greater control over the process.
The objective is not to eliminate risk. It is to reduce avoidable uncertainty and allow bidders to compete on the value of the business rather than on different assumptions about how transaction risks will ultimately be allocated.
From business readiness to transaction readiness
A high-quality business does not necessarily guarantee a smooth transaction.
Sale processes rarely lose momentum because of a single issue. More often, bidders identify a series of matters, including tax exposures, contractual gaps, regulatory uncertainties, historical liabilities or diligence limitations that need to be resolved as negotiations progress.
Traditionally, many of these issues are left until after a preferred bidder has been selected. By that stage, competitive tension has reduced and negotiating leverage may have begun to shift towards the buyer. Each unresolved issue can become another point for negotiation, potentially resulting in additional indemnities, escrows, purchase price adjustments or delays.
An alternative approach involves bringing those decisions forward.
Before launching a process, sellers can identify the material transaction risks and decide whether each should be:
- resolved before bidders enter the process;
- retained by the seller;
- transferred, including through insurance where appropriate; or
- reflected in the transaction structure or commercial terms.
This does not mean every issue needs to disappear before launch. Sophisticated buyers do not necessarily expect a risk-free business. What often matters is that the seller understands the issues, has determined how they will be managed and can present bidders with a credible solution.
Before launch, execution issues remain commercial decisions. Once exclusivity begins, they increasingly become negotiation points.
- Xianwei Lee, Head of M&A, Asia
Establishing the warranty framework before launch
Warranty protection is one area where this approach may have a meaningful impact on execution.
Traditionally, Warranty and Indemnity (W&I) insurance has often been treated primarily as a buyer workstream. Following selection of the preferred bidder, the buyer appoints its broker, approaches insurers, conducts underwriting and negotiates coverage alongside the Share Purchase Agreement (SPA), disclosure and financing workstreams.
This can mean bidders enter the process with different assumptions about warranty protection, while important questions around insurability, coverage, diligence requirements and pricing remain unresolved.
A seller-led W&I process is one approach that brings some or all of that work forward.
Depending on the transaction, the seller and its advisers can approach the W&I market ahead of the auction to potentially establish indicative pricing and coverage, identify potential insurer concerns and diligence requirements, and determine the proposed insurance structure. The successful bidder can then take forward a process that has already been prepared rather than starting from scratch.
The commercial rationale is straightforward. The seller makes the preparatory investment once, while all bidders benefit from greater visibility over the proposed warranty framework.
This can be particularly valuable in a competitive auction, where establishing a common insurance framework may make bids easier to compare, reduce differing assumptions about post-completion recourse and remove an execution-critical workstream from an already compressed exclusivity period.
Sophisticated sellers are changing when transaction risk decisions are made, not necessarily how those risks are ultimately allocated.
Soft Flip or Hard Flip?
The appropriate level of preparation will depend on the transaction and the degree of execution certainty the seller wishes to establish before launch.
Soft Flip
A Soft Flip typically involves approaching the W&I market ahead of the auction and establishing an indicative insurance framework, including likely pricing, coverage and key underwriting considerations. The successful bidder then takes forward the placement, completes underwriting and finalises the policy after entering exclusivity. This provides bidders with early visibility on the likely availability and cost of W&I insurance, while requiring a relatively modest upfront investment from the seller.
Hard Flip
A Hard Flip takes the process further. The seller selects an insurer and advances the underwriting process before bid selection, typically involving insurer review of the transaction documents and due diligence materials, together with at least part of the underwriting Q&A process.
There are two potential principal benefits to doing so.
First, advancing underwriting before bid selection may make the W&I process more efficient once it is flipped to the successful bidder. Rather than commencing underwriting from the beginning during an already compressed exclusivity period, the bidder inherits an advanced placement and can focus on completing the remaining underwriting steps.
Second, the process may give bidders greater visibility on the coverage that is likely to be available and, importantly, any additional or top-up due diligence that may be required to support that coverage. Potential diligence gaps can therefore be identified earlier, giving the seller or successful bidder an opportunity to address them before they become a late-stage coverage issue.
The trade-off is cost. A Hard Flip will typically involve an underwriting fee for the insurer's sell-side underwriting work, which will need to be borne by either the seller or the successful bidder depending on how the process is structured. The seller would therefore weigh that cost against the potential benefits of greater coverage visibility and a more advanced underwriting process at the point the transaction is flipped.
Neither approach is inherently preferable. A Soft Flip may be sufficient where the transaction is relatively straightforward, and the priority is to provide bidders with early visibility on pricing and likely coverage. A Hard Flip may be more appropriate where the transaction is complex, the timetable is compressed, potential diligence or coverage issues would benefit from being identified early, or the seller places greater value on execution certainty.
The appropriate approach ultimately depends on the auction timetable, buyer profile, complexity of the business, available due diligence and the seller's commercial objectives.
Deciding what to do with known risks
Known risks require a different approach.
W&I insurance is principally designed to address unknown breaches of warranty. Where a specific tax, litigation, regulatory, contractual or other exposure has already been identified, the question is not whether that risk exists, but how it should be dealt with.
Leaving a material known risk unresolved can make bids harder to compare. Different bidders may attribute different values to the same exposure, apply different discounts to their bids or assume different levels of contractual protection will be available.
If the issue remains unresolved when a preferred bidder enters exclusivity, it may then become a significant negotiation point. Depending on the risk, the outcome could be a purchase price adjustment, escrow, specific indemnity, conditionality or another negotiated solution.
Addressing known risks earlier could allow sellers to consider the available solutions while they retain greater control over the process. Some issues may be capable of remediation. Others may appropriately remain with the seller or be reflected in the transaction structure. In suitable cases, specialist insurance can provide another option.
Tax Liability insurance
Certain identified tax exposures, where supported by sufficiently robust technical analysis, may be capable of being ringfenced through Tax Liability insurance.
For example, where diligence identifies uncertainty regarding the tax treatment of a historic transaction or structure, different bidders may take different views on the potential exposure and how it should be reflected in their bids. They may also seek to address the issue through a specific indemnity, escrow or purchase price adjustment.
Where the risk is sufficiently ascertainable and insurable, a tax liability policy may instead transfer the financial consequences of an adverse tax authority determination to the insurance market.
Addressing the issue ahead of the auction can therefore provide bidders with a more consistent framework for assessing the exposure, rather than allowing different assumptions about the same tax risk to affect bid comparability or become a significant negotiation point during exclusivity.
Contingent Risk insurance
A similar approach may apply to certain identified contingent risks.
Depending on the circumstances and the availability of sufficient supporting analysis, litigation, contractual, regulatory or other contingent exposures may be capable of being insured.
An unresolved contingent exposure can otherwise create uncertainty for bidders around both the probability and potential quantum of loss. Different bidders may price that uncertainty differently or seek different levels of contractual protection.
Where the risk is insurable, Contingent Risk insurance may provide a defined mechanism for allocating its financial consequences, rather than leaving the parties to negotiate an open-ended indemnity, significant escrow or valuation adjustment.
Not every known risk will be insurable, and the appropriate solution will depend on the merits, facts and potential quantum of the exposure. The important point is not that every identified risk should be insured.
Rather, some sellers find value in identifying material known risks early and deciding how they are intended to be dealt with before bidders begin negotiating them.
A broader transaction risk strategy
Taken together, these strategies reflect a broader approach to transaction preparation.
Seller-led W&I, Tax Liability insurance and Contingent Risk insurance are not ends in themselves. They are tools that can form part of a broader transaction risk strategy.
Ahead of an auction, a seller has an opportunity to assess the transaction as a bidder would: What are the material risks? Which can be resolved? Which should be retained? Which can potentially be transferred? And which might need to be reflected in the transaction structure?
Making those decisions earlier may create greater optionality by:
- helping to identify diligence gaps early, allowing the seller or successful bidder to address them before they become late-stage coverage issues.
- identifying known risks that might otherwise be priced differently by competing bidders or emerge as significant negotiation points.
- helping to establish a more consistent warranty framework, giving bidders a common basis on which to assess the transaction.
In this sense, insurance is only one part of transaction preparation. Some sellers find that understanding potential execution issues early enough allows them to decide how they could be dealt with, rather than allowing those decisions to be dictated by the dynamics of exclusivity.
Conclusion
Good transaction preparation is not about eliminating every issue before a business is brought to market.
Rather, it involves identifying the issues that could affect execution and deciding how they will be managed while competitive tension remains and the seller retains greater control over the process.
For some transactions, that may mean establishing the W&I framework before launch. For others, it may mean resolving a diligence issue, obtaining additional technical analysis, restructuring a particular exposure or exploring specialist insurance for an identified tax or contingent risk.
The objective is the same: reduce avoidable uncertainty before exclusivity and allow buyers to compete on the value of the business rather than on different assumptions about how transaction risks will be managed.
The strongest sale processes do not necessarily have fewer issues. They decide how those issues will be managed before buyers begin negotiating them.
That is the competitive advantage.
Get in touch
Transaction preparation often involves managing risks early, before they become negotiation points. We work with private equity sponsors, corporates and their advisers across Asia to identify transaction risks early and develop tailored solutions that can help preserve competitive tension, reduce execution uncertainty and keep negotiations focused on value. If you would like to discuss how these strategies could support your next transaction, please get in touch with our team.
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