How to Manage Insurance When Selling Your Company
Many of our local baby-boomer entrepreneurs have built great businesses and are now at or approaching the stage in their careers where they want to transition their company through an acquisition or an internal perpetuation. This is an exciting time and a pay-off for many years of work and leadership! Making sure that insurance is handled correctly is VERY important because the seller of a company is not intending to put their financial future in jeopardy. Let’s discuss some key items to consider.
Many transitions of a company will be executed in an “Asset only” purchase. That is great- but what does it mean? The component that is missing in the transaction is liabilities. The new entity is not intending to take on any liabilities created by the company being purchased. Many of the components of liability are effectively managed with a continuation of insurance products that should already be in place. (A side note to those companies positioning themselves for sale is to confirm the correct policies are in place as this is something that the purchasing company will consider in their due diligence…)
Here are some examples of coverage areas that should be considered:
- Claims Made policies
- Occurrence policies that have an ongoing exposure that need coverage
Examples of Claims Made policies may include coverage for Professional Services, harassment and discrimination, data compromise and policies to protect the management decisions of a board of directors. Claims made policies are different because one of the triggers for insurance to kick in is a claim being reported. It is possible that a claim is made to the selling company after the sale has happened. For example- let’s say a CPA firm has coverage which protects against harassment and discrimination. Prior to that company selling, they terminate an employee from the firm. After the sale of the company, that employee brings suit against the now sold company claiming to be let go based on discrimination of a protected class. To defend and then cover any damages, the firm in question would need to have “Tail Coverage” in place which extends the coverage of a “Claims Made” policy such as this one.
An equally probable example would be a claim against a firm that provides a service like an Architect or Engineer. In this case, that service is covered under Professional Liability which is also typically written on a claims made basis. Again, tail coverage would provide an extended coverage for any claim made against this policy. It is important to determine the length of tail coverage that a firm would need to purchase. For example, an architect may need a longer tail of coverage than a firm that provides short term business consulting to smaller companies. A CPA firm should consider a tail that equals the statute of limitation for the IRS- that just makes good sense!
If you are a business owner looking to sell and you don’t have a claims made policy; don’t celebrate just yet! Many contractors or manufacturers can have a liability policy written on an ‘Occurrence basis’. That work or product can have a liability that will last beyond any sale of a company. Again, the purchasing company is typically not intending to pick up this liability. This gap in coverage can be filled effectively with a discontinued operations coverage that does just that – covers the operations that are discontinued. It is highly recommended that an entity making an asset-only sale of their company carry this coverage.
So if you are one of those successful business owners who is looking to sell your company, CONGRATULATIONS! Make sure to bring your insurance professional into that discussion early so you do not unintentionally put your retirement years at risk!
Tony Johnson is an Accredited Advisor in Insurance specializing in risk management to the business community and can be reached at Davidson & Associates Insurance, 360-514-9550 or Tony [at] Davidsoninsurance [dot] com