The most common reasons companies proceed with M&A transactions are detailed below.
1. Diversification
Companies engage in M&A transactions when they wish to increase their product and service offerings without hiring new staff. For example, XYZ is in the textile sector but solely produces doctor’s kits. Another textile manufacturer, ABC, produces casual wear, such as jeans, jackets, and t-shirts. In this situation, XYZ may acquire the latter to expand its offerings.
2. Tax Benefits
Assume you have a successful business that generates considerable taxable income. You can buy another company of the same or different sort that has enough potential but has suffered a substantial loss owing to certain unforeseen circumstances. In this instance, both companies’ net income/loss will be clubbed, and the losses can be carried forward to the next fiscal year.
3. Cross Selling
Companies can use their and the company they have acquired's existing client base to cross-sell the products to each other’s consumer base. This helps to improve not only sales figures but also their reach.
4. Eliminate Competition
Many firms engage in mergers and acquisitions to eliminate competition and build market monopolies.
D&O insurance is designed to safeguard a company’s top management from legal fees or personal losses if they are sued for company-related activities while participating in mergers and acquisitions.
There are three main types of coverage under this policy. These are —
- Side A: This covers the directors and officers when the company cannot or will not indemnify them. Indemnify means to reimburse or compensate someone for a loss or damage.
- Side B: This policy applies to organisations that have an indemnification clause for top management.
- Side C: This policy covers both the organisation and its management when they are sued simultaneously.
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D&O insurance comes in handy in the following situations.
1. Mismanagement Pre- or Post-Acquisition
Assume Firm A decides to purchase Company B. Following the acquisition, A seeks to undertake due diligence on B and discovers that B’s managers have engaged in fraudulent activities and misrepresented different facts and statistics in order to complete the acquisition transactions and rescue their company from financial damage. In this instance, Firm A has the right to sue Company B and seek damages or compensation from its former managers and directors for the loss they caused to the firm and its shareholders.
Also, if the directors appointed to operate Company B after the acquisition caused a loss to the company’s suppliers, employees, customers, or creditors, they may face legal action.
The D&O insurance will assist the former and new management in dealing with the liabilities resulting from such a circumstance.
2. Resisting Takeover
Sometimes, one firm attempts to buy another (target company) without the consent of the target firm's Board of Directors. This scenario is known as a hostile takeover. However, suppose the target firm's directors oppose the transaction. In that case, the acquirer may sue them, arguing that the directors purposefully dispute the purchase, which is not in the best interests of the company being acquired.
Another scenario could be that the director authorises the takeover, but the acquired company’s shareholders claim that the settlement amount was insufficient.
In all cases, D&O insurance would help to cover the financial losses experienced while defending claims.
3. Cross Selling
A Merger or Acquisition is a time-consuming procedure that requires extensive paperwork and an in-depth risk evaluation of the firm to be purchased. During the procedures, both companies maintain the material confidential for many reasons.
Assume ABC is a home appliance firm pursuing an acquisition transaction. The company keeps the information confidential because it believes that if the news gets out, its customers will stop buying its products for fear of having problems with after-sales service. Alternatively, the company will proceed with stock clearance and clear its defective products as it doesn’t worry about its reputation anymore, which is unlikely to happen.
However, companies risk facing legal action if the information becomes public, particularly from investors and shareholders. The rationale is that acquisitions and mergers can influence share values in either direction and if shareholders are not informed, they may suffer significant losses.
D&O insurance can help deal with such kinds of legal suits as well.
Corporate actions, such as mergers and acquisitions, substantially impact the company and shareholders. Although these transactions are intended to improve the company’s growth and reach while diversifying its services, their risks must not be underestimated. D&O insurance helps senior management and organisations deal with lawsuits that may arise during or after an acquisition or merger transaction.