M&A in the construction sector

11 January 2017

The UK construction sector experienced significant challenges throughout a turbulent 2016. Government spending cuts and the withdrawal of private sector investment plans following the referendum vote prompted construction output to slip by 1.1% from July to September according to the Office for National Statistics, seeing the biggest quarterly fall for four years. Despite the strong headwinds, the number of merger and acquisition (M&A) deals ended up on 2015 levels, but combined values were down, reflecting the smaller nature of transactions (in many cases consolidation deals or carve-outs of non-core businesses). What 2017 has in store is still an unknown in the industry, but for those embarking on transactions, allocation of risk and balance sheet protection will be absolutely vital.

Over the last three to four years the insurance market has seen a boom in the use of all types of M&A insurance, but none more so than the emergence of warranty and indemnity (W&I) insurance. These policies can now bring effective and tangible benefits to parties seeking to buy or sell a business. 

These specialist one-off policies are used to mitigate deal risks but, more importantly, they are now highly flexible and have numerous strategic applications that can help deal planning, aid in negotiations and even improve the overall outcome and purchase price achieved. 

It is this use of policies as strategic tools that has driven the huge growth of this sector of the insurance market in recent years. The expansion in the US has been most prolific. Insurance capacity (the policy limit available per deal) now stands well above USD 1 billion – at least 100% higher than five years ago. This means that even mega deals can benefit from such transactions. 

Strategic uses - why use these policies? 

  • Seller clean exit – sellers agree a deal with minimal or nil liability in the sale agreement offering to pay for or contribute to a buyer insurance policy in lieu of a traditional warranty cap 
  • Seller covenant strength – buyers negotiate and secure protection from the seller for breaches of the terms of the sale agreement but the long term financial strength or even existence of the warranting party is in question
  • Management rolling over – buyers prefer to claim for breaches of terms of the sale agreement from an insurer rather than their “new” management team which has been acquired in the deal.

From a technical perspective, policies last up to seven years, premiums are one-off and give protection against liabilities stemming from the deal that fall into two baskets; unknown risks or known risks. 

  • Unknown risks: W&I insurance is the most widely used solution and is designed to cater for the unexpected loss suffered post completion stemming from a breach of the warranties (statements about the target business) given by the seller in the sale agreement
  • Known risks: where a specific matter has been identified and scoped during a buyer’s due diligence process, insurance can be used to take that long term potential liability off the table. These policies are frequently used to cover tax liabilities. If the problem is big enough, insurance can make the difference between a successfully closed deal and one that falls through. 

Those who employ M&A insurance to the greatest effect no longer think solely about risk transfer. Rather, the highly flexible concepts are taken into account at the planning stage and throughout the marketing and sale process. The key question is “how might we use insurance capital to facilitate our negotiation and improve the eventual outcome of our deal?” In a very real sense, the costs of an M&A insurance policy can be recovered many times over through the improvements achieved within the construction deal or in the negotiation. 

The focus is on a bespoke policy, reflecting the fact that each deal is different. In fact, M&A insurance is not sector specific and private equity and other institutional investors have understood the benefits for some time. These days, well advised corporates with an eye on strategic growth and additional balance sheet protection also frequently consider their use and application. JLT Specialty's M&A team predicts that more and more construction deals will be insured in 2017 and beyond as emphasis is placed on ring-fencing liabilities and reducing the risk of M&A transactions. 

For further information, please contact Felix Sloman, Associate, M&A team on +44 20 7558 3893 or email felix_sloman@jltgroup.com