Part 1: Insurance “need to know facts” when selling your restoration company.
Over the past few years, I have seen a lot of change within the restoration industry and an influx of businesses selling. Curious as to why, my perspective is that many baby boomers are at that point in their career.
With TPA’s continuing to pinch folks, as well as costs going up, margins have been decreasing. I have heard from many, “It’s not as good as it used to be.” Of course, no one likes change. With interest rates being near historical lows and a ton of private equity on the sideline, no wonder there has been so many mergers and acquisitions.
Stock Purchase vs Asset Purchase
If you do not have a solid succession plan or you are considering selling, there are several things that you need to make sure happen “insurance-wise” before a deal is made. First, you should have a good understanding of a stock purchase vs. an asset purchase. In a stock purchase, the buyer will continue the company with its corporate name and will assume all past liabilities going forward.
With an asset purchase, the buyer is purchasing the fixed assets (equipment, computers, vaults, etc.), as well as your territory, and often will hire your current staff.
For most restoration business that are over $10 million in sales, it is more often a stock purchase. Those who are TPA-heavy tend to be a stock purchase as well because all the contracts are tied to the corporate name. For companies under $10 million in sales, it is more common to see an asset purchase. This is not set in stone, however, as I have seen companies under $10 million still involved in stock sales.
Occurrence vs Claims-Made
There are two general types of liability insurance policy forms. If you are a savvy contractor, or your agent has already done a good job of explaining Occurrence vs. Claims-Made, then this will be a quick refresher for you. I am not talking about deductibles; I am talking about how your policy triggers if and when there is a claim.
An Occurrence policy protects you from any covered incident that occurs during the policy period, regardless of when a claim is filed. Occurrence will respond to claims that come in – even after the policy has been canceled – so long as the incident occurred during the period in which coverage was in force. In effect, an Occurrence policy offers permanent coverage for incidents that occur during the policy period. When it comes to limits, each year an Occurrence policy is in force represents a separate set of limits. Claims-Made, on the other hand, is very different. These policies provide coverage for claims only when both the alleged incident and the resulting claims are made while the policy is in force and after the retroactive date. Often, there is also a provision that the claim must be reported to the carrier during the policy period, or any extended reporting period. Claims-Made policies provide coverage so long as the insured continues to pay premiums for the initial policy and any subsequent renewals. Each succeeding year the policy is continuously renewed, the coverage period is extended. Once premiums stop, the coverage stops. Claims made to the insurance company after the coverage period ends will not be covered, even if the alleged damage occurred while the policy was in force.
With Claims-Made, you get one set of policy limits that transcend through all policy periods back to the retroactive date, where the policy limits in place when the policy is purchased remain the single set of limits available to protect the insured from all claims that could arise from service provided during the years the policy is continuously in force. Although your limits will replenish upon renewal, you are tied to one aggregate limit going back to the retroactive date. If you catch where I am going, you can see that Occurrence is often better than Claims-Made for many reasons. With Occurrence, a business owner can walk away, cancel their policies, and should not have to pay any additional premium.
What Do I Need to Do?
There are certain types of policies that are almost always sold Claims-Made: Professional Liability (Errors & Omissions), Directors & Officers (D&O), Employment Practices Liability (EPL), tough to place Product Liability, and various types of Pollution policies may be sold Claims-Made. Contractor Pollution Liability (CPL) can be either/or and the same can be said for mold. In fact, some carriers write CPL on Occurrence, but put the mold on Claims-Made. Since a mold claim has a higher likelihood than most other pollution claims, some carrier attempt to limit their exposure.
The process to wrap up a Claims-Made policy is fairly simple but can be costly depending on the exposures and past claims activity. Your agent needs to contact your current carriers and request an Extended Reporting Period (ERP), what many call a “Tail”. They may be offered for one year, two years, three years, or five years depending on your carrier. Be sure to read the Extended Reporting Period section at the end of any Claims-Made policy.
An underlying issue that most don’t mention though is the fact that the statute of limitations for construction defects is between seven and 10 years depending on your state. If you do not purchase a Tail, most carriers typically offer a free tail anywhere from 30 to 60 days, also known as a “Mini-Tail”. After this is up, an insurance carrier will deny any claim that comes in. Remember, with Claims-Made, it’s all about who you are with when the claim is made, not when the work is done. Once you stop purchasing a Claims-Made policy, there is no more coverage.
If you are the seller in an asset purchase, be sure that you purchase a Tail. We have seen an insured not purchase the Tail, then pay $300k out of pocket for an uncovered Professional Liability claim presented after the Mini- Tail. Whereas, if you are involved in a stock purchase, the new owners will have to cancel/rewrite the policies and the agent involved needs to be sure to match the Claims-Made retroactive dates. If the agent doesn’t get the carrier to honor the retroactive dates, then that new business owner could be left to defend themselves out of pocket if a claim is presented for work that was performed under the prior ownership.
Still, even if you are involved in a stock purchase, be sure to have your attorney review the indemnity section. There could be language that says you will need to indemnify and hold them harmless for any liability that comes up from work performed prior to the sale.
Don’t Wait Until the Last Minute
Don’t let your insurance be on the back burner if you are positioning yourself for a sale. Sure, there is a lot of private equity money out there, and your EBITDA might be in a great position, but be sure that you are talking with your agent before too much due diligence is done. I have heard of deals getting held up for 30+ days past when they were trying to close because of an insurance issue.
You likely have been protecting your company from a number of different risks for many years. If it’s time to sell, be sure to get all your insurance wrapped up in a timely manner, not the week prior to the sale. The last thing anyone wants is to sell a business that you worked so long building to then have an uncovered claim when you are trying to ride off into the sunset.
At the same time, as part of their due diligence, buyers should be looking to make sure that the insurance in place is appropriate by reviewing the policies, limits and if there are any onerous exclusions. As you can tell, it’s a lot more than just reviewing the financials.
Be on the lookout for Part 2, where I will discuss how having strong risk management and a culture of safety can make you even more marketable, and increase your valuation, before a sale.