Surety is a powerful tool for corporates, investors, and advisers to be aware of when considering an M&A transaction. Surety bonds can act as liquidity enhancers and deal enablers, unlocking vital working capital and providing the required security to win contracts and fulfil obligations.
A surety bond guarantees the contractual obligations (either performance or payment related) of the Principal (Corporate) for the benefit of the Beneficiary (Employer). It is not a contract of insurance but does provide financial protection to the Beneficiary against losses they may sustain as a result of the Principal breaching the Contract. A surety bond is a popular alternative to bank guarantees and letters of credit and can provide a solution which helps to free up a Corporates’ banking lines, enhancing working capital whilst also often providing material cost savings.
Surety Considerations for M&A transactions:
1. Legacy
Both the buyer and seller must understand the existing guarantee / bond portfolio.
The seller needs to understand what guarantees it is liable for and whether it can be released from these as part of the sale.
The buyer needs to understand the obligations for each guarantee being inherited, including how onerous they are, current contract status and any potential claims.
2. Future
The buyer will want to ensure efficient and accurate management of the existing guarantees and any future requirements.
Prior to transferring, existing (and potentially new) Sureties will need to be comfortable with the NewCo which will entail understanding areas such as what the business will look like from day one post-sale, the new group structure, transaction funding, levels of leverage/debt, availability of credit facilities and go-forwards strategy.
The seller may need to maintain some guarantees for remaining entities of their group post sale. In the same way that the sureties want to comfortable with the buyer’s NewCo, the sureties also want to be comfortable with the seller’s new group. In order to get the Sureties comfortable, they will need to understand areas such as what the new group structure is, how the balance sheet will be effected, how the cash generated from the sale will be used, levels of leverage/debt post sale, availability of credit facilities post sale and the groups future strategy.
Importantly, previous facility terms are not necessarily indicative of future surety support. To ensure continuous support for both existing and new facilities, effective presentation and discussions are required with the market.
The buyer’s view
A key factor for the transaction can be inheriting the existing guarantees into a new facility. This can only be done once a new security package and indemnity has been agreed with the sureties and at this point could the seller be released from their liability under their existing indemnity.
A transactional benefit of surety could be for the buyer to explore a deferred consideration bond. This type of bond allows for the buyer to defer a portion of the consideration due to the seller whilst still completing on the sale. This form of bond can enhance cashflow for the buyer whilst providing the seller with adequate security should the buyer default on any scheduled payment.
The seller’s view
The seller will want to ensure that they are fully released from each bond obligation that is related to a contract which is a part of the sale. This will include having the entities being sold released from the existing indemnities held by the Sureties. The ability to release the seller from these obligations and provide a ‘clean cut away’ can be crucial to allow the deal to get across the line.
Key advantages for using Surety for M&A transactions
Can be issued across the world (with some exemptions). Where surety is not the norm and the banks dominate the market, sureties can often issue bank-fronted solutions. In these cases, the bank will issue the guarantee, but the Surety will act as the Guarantor. The Beneficiary still receives a bank guarantee, but the corporate retains the benefits from using a Surety.
Flexibility with bond wordings, issuing conditional, adjudication and on-demand style forms.
Frees up a Corporate’s working capital, providing an alternative to using existing banking lines for guarantees.
Complement existing banking lines and enhance available bonding capacity.
Banks tend to have high capital requirements and often charge more. Surety can provide a cost-effective solution, where usually the only security required is via a Cross Company Guarantee (Indemnity) which ranks them as an unsecured creditor.
Lockton Surety and M&A transactions:
Effective management of existing surety programmes and ensuring appropriate ‘go forwards’ arrangements are in place should be an integral part and consideration for companies involved in M&A transactions. Lockton can help companies navigate through this process from an early stage and add value from the outset.
