Due Diligence Areas of Importance Cybersecurity: TThe technology sector remains active due to demand for innovative solutions and AI advancements, specifically with the new administration’s joint venture with OpenAi early in their term. Multi- factor authentication (MFA) and the placement of an internal Chief Information Security Officer (CISO) are favorable. We have access to tools that can assess the external cybersecurity of targets to better protect your organization. Further, buyers should have their advisors review first-party vs. third-party liability along with the security and controls of third-party vendors and partners to avoid collateral damages from any breach along a seller’s supply chain. Benefits & AI Resources: Healthcare costs continue to rise with medical and prescription claims trend increasing exponentially. For lower middle market add-on acquisitions, claims data is often unavailable for employers with under 100 employees enrolled on the health plan. Essentially, a buyer may blindly inherit the claims risk that comes with a target. AI tools can be used to assess a population’s claims data. By obtaining a single census during due diligence, we are able to understand the health risk of the population which influences our post-closing integration plan and decision making. Employee benefits compliance will remain a key focus during due diligence. The ‘red flags’ typically involve compliance with the Patient Protection and Affordable Care Act (PPACA) and ERISA. Future fines for noncompliance are expected. Representations & Warranties Considerations Representations and warranties insurance (RWI) rates continued to drop in 2024 due to the M&A slow down. Rates are expected to stabilize in 2025 as deal activity rebounds. Consequently, underwriter capacity will decrease and claims will start to trickle in. Additionally, underwriters are accommodating lower middle-market deals (sub $100M EV) to backfill their pipelines. Private Equity remains the leading user of RWI, utilizing it in the vast majority of their transactions. Strategic buyers are also beginning to use RWI more frequently, with 35 to 50% of strategic deals depending on various factors such as size and quality of due diligence. Price & Coverage RWI rates dropped in 2024 due to reduced deal activity and new carriers entering the market. The M&A market has seen a reduction in the number of deals utilizing RWI over the last twelve to eighteen months. As a result, insurers are competing over fewer deals and offering more attractive terms. Coverage amounts typically range between 10% to 20% of enterprise value (EV), with premiums between 2.4% to 3.0% of the coverage amount. For example, a $10 million limit may cost $240,000 to $300,000. Retention (similar to a deductible) amounts vary based on the size of the transaction, and range 0.5% to 1.0% of EV. Claims RWI claims increased in 2024, due in part to lowered retention levels, which results in the policy limit being triggered sooner, more transactions being insured and the severity of claims increasing. Breaches of representations related to inaccurate financial statements remain the most significant area of claims, with customer & contract representation issues on the rise. Other areas include compliance with laws, litigation, employee related matters, and IP & IT matters
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