Insurance adds fuel to heated M&A bid battles

By Simon Challis, European Insurance Correspondent

LONDON, May 18 (Reuters) - Insurance that frees sellers of firms from tying up lots of cash as guarantees in acquisition deals is increasingly being used by deal-hungry private equity firms to gain an advantage in bidding auctions for unlisted companies, industry executives say.

Cash-laden private equity firms have spent over $1,440 billion on more than 6,000 acquisitions since 2005, according to data by Dealogic, and the still white-hot pace of mergers and acquisitions has meant it is increasingly hard for buyers to extract any financial guarantees from sellers.

In the past vendors have put as much as 10 to 15 percent of the purchase price into an escrow account that can be drawn upon if unexpected problems surface after the deal is done.

This means sellers may not see millions of dollars from the deal for as long as seven years after it is done -- which is deeply unpopular with private equity firms, who are now as likely to be sellers as they are buyers of companies.

"It's either a poor or inefficient use of their capital or it's a contingency they can't really have if they want to wind up a fund and distribute cash (to investors)", said John McNally, vice president of the M&A insurance unit at AIG AIGN.N

As a result an increasing number of private equity sellers are turning to insurers to provide a solution that can reassure potential buyers -- and push up the bidding to allow them to extract the maximum return.

Teresa Jones, a director in Aon Corp's (AOC.N) professional risks unit, said, "(Sellers) know they're going to get a number of bidders out there and their aim is to get the best price and still get a clean exit."

McNally said sellers are using insurance in to attract higher bids. "They're saying, 'How about if we do give a large amount of recourse or indemnity caps behind warranties? But instead of us being on the hook, we'll use an insurance policy'."

Bidders too are increasingly using these insurance policies as a way to set their offers apart from those of their rivals.

"It's a seller's market at the moment. If you have a good business to sell you'll have lots of people ready to take it off you. Trying to differentiate yourself is really hard. We've seen some (bidders) use insurance to try to get rid of some of the liabilities that exist within a sale agreement," said Alastair Burns, head of of the private equity M&A unit at Marsh (MMC.N).

A bid with an insurance policy not only offers vendors a higher price, but also the freedom to walk away with most of the proceeds straight away with few strings atteched, said Burns.

INSURANCE HAS ADVANTAGES

Insurance offers a major advantage over escrow accounts in that the upfront premium involved in buying an insurance policy is a fraction of the amount that would need to be tied up in an escrow account, said Alistair Lester, the head of the M&A practice at broker Willis (WSH.N).

An insurance policy appears as an asset on the target's balance sheet and can offer buyers more protection than an escrow account -- often up to as much 25 percent of the enterprise value of the target firm -- and can be an easier way of reclaiming money than pursuing the vendor through the courts.