The soaring valuations of tech companies and the high prices these firms demand from investors in M&A deals has created some concerns among the M&A insurers, who will potentially have to pay out substantially more in claims. While acquiring a tech company in the current market will likely command a far higher price for buyers, it is important to understand how a target valuation, cyber defences, data management and ownership impact how insurers view M&A deals in the tech sector.
2021 saw a record number of M&A deals of tech companies in the UK, with 603 deals being completed by private equity firms and venture capitalists in 2021, up from 470 in 2020, according to data from KPMG (opens a new window).
Appetite for tech deals soared throughout the pandemic, with many seeing the space, along with the healthcare sector, as industries which are “Covid-proof.”
As deal prices soar, reaching a record worth of $21 billion in 2021, insurers are keeping a close eye on the structure of target companies, wary that they may have to pay huge sums in warranty and indemnity (W&I) insurance claims if a deal turns sour.
What do insurers look at with W&I policies?
When considering an M&A deal, insurers will take into account a spectrum of factors, though with tech M&A deals in particular, insurers will be partially focused on three key components:
Valuation
The valuation of tech M&A has increased year-on-year since 2019. Data from M&A investment bank Icon notes (opens a new window) that deals in 2019 averaged (opens a new window) at an enterprise value (EV) to EBITDA multiples of 16.2X, compared to an EBITDA multiples of 23X by the end of 2021.
The soaring valuation of tech companies, buoyed by investors seeking refuge during the pandemic and increased interest from private equity and other buyers, has meant that insurers are in a position where they are liable to pay on a multiplied basis in the event of a warranty loss.
The risk of these inflated valuations means that some insurers may be wary of covering M&A transactions, possibly asking for damages to be capped under the W&I policy at a set multiple (normally around 15X Revenue or 16X Multiple)
Insurers are not shying away from M&A deals in tech or other sectors, though the high valuations that tech companies have commanded in recent years has meant insurance firms will need to be shown that the price being paid is fair and reasonable.
Data and IP ownership
Insurers will want clarity over how data is managed and protected by target companies, as well as ensuring any intellectual property used by the acquisition target is fully owned by them and protected.
Both data and IP technology pose similar risks which can cause unease for insurers. Breaches or mismanagement of data can invite regulatory fines and lawsuits from those effected, while disputes over IP ownership can also lead to long-running legal battles – costly for both companies and insurers.
Concerns over data and IP ownership are best dealt with thorough due diligence. Ensuring you have as much information available on how a target company is structured, its in-house IPs, and data management processes, will all help in mitigating insurer fears.
Cyber
Concerns over cyber threats are a priority for the majority of companies and insurers now. While financial tech companies are subject to regulations over cyber defences and other threats, the wider tech industry is not, meaning insurers will need to be appeased.
Again, due diligence is key in addressing insurer concerns. Demonstrating evidence of what defences a target company has in place, the training and education it provides its staff to protect against cyber attacks, and other measures such as two-step authentication being used to protect against attacks.
Keep in mind, while insurers for W&I policies will be interested in the cybersecurity of a company, this is not the same as having dedicated cyber insurance – which will be an entirely separate policy.
In summary
Tech M&A shows no signs of slowing at the moment, with Morgan Stanley’s outlook (opens a new window) being that the primary drivers that drove record activity in 2021 remain in place for 2022. However, the investment bank did note that headwinds in the sector such as supply chain issues, labour issues, and rising interest rates could see M&A impacted to a degree.
Mitigating the risk that insurers will be focused on in W&I insurance is not easy in such a bullish market, however, taking steps to address the measures in place of a target company’s cyber defences, and its data and IP ownership, will provide a stronger foundation for insurers to quantify the risk.
For more information on how to mitigate risks on tech transations, please contact your Lockton representative:
George Apperly, Vice President
E: george.apperly@lockton.com
T: +44 020 7933 2138
