While rolling up sleeves and getting stuck into due diligence may not be the most glamorous part of a transaction, we all know that it’s critical in allowing buyers to understand the true position of a target across all areas of the business.
A thorough due diligence process doesn’t just allow you to unearth issues that could cause headaches down the line, it also significantly bolsters the strength of your W&I policy.
Speaking in broad terms, exclusions in W&I policies arise in two areas – the first are known issues, and of course these have to be considered on their merits as a part of the process. The second type, which can be more prevalent than you’d think, relate directly to DD and arise from topics simply falling outside the scope of diligence. As a buyer, this is well within your control.
Before going any further, let’s just clarify why these due diligence exclusions arise. No experienced W&I underwriter wants to fill your policy with exclusions. It reflects badly on them and no one leaves the process feeling rosy. It’s the underwriter’s job to work through the DD available and only pick out the points that are fair and necessary to specifically exclude.
That said, insurers can only cover warranties where there is supporting due diligence. In scenarios where there is either no (or very limited) diligence on a topic then their hands are tied and they have to exclude it from cover – otherwise they’d be going in with their eyes closed.
“A thorough DD process doesn’t only allow you to unearth issues that could cause headaches down line, it also significantly bolsters the strength of your W&I policy.”
Now as with anything, there is a balance to be reached. No reasonable underwriter would expect parties acting in a commercial fashion to dramatically increase their due diligence scope simply to allow for a robust W&I policy. But where insurers are within their rights to raise the issue is where an approach leaves material parts of the business without review – and as with anything this creates a commercial call for the buyer.
An example is a cross-border deal where the buyer decides that reviewing the Tax position in certain jurisdictions isn’t required. From a commercial perspective that may be reasonable, but it’s almost certainly going to lead you to a position where Tax matters in those countries is outside of insurance cover. The question then arises: what is the minimum reasonable amount of diligence you can perform that is cost effective, that will also satisfy an underwriter? In answering that, you should have the best of both worlds.
Ideally, the best time to make these decisions is when you’re preparing your due diligence scope at the outset, and we can certainly be there to help. Indeed, we’ve built the Wiispa Risk Wrapper to guide those conversations – we want to clarify the best approach for you. There is no black and white answer to everything but using our experience we will be able to guide you to a reasonable position on due diligence when the scope is first being considered.
Where you can really affect the position, though, is your over-arching approach to due diligence. If you’re willing to embrace it and ensure as many bases are covered as possible, it will pay significant dividends – and your W&I policy will be all the stronger for it.