No, this is not clickbait. There really is such a thing as “naked tail” in M&A. And as a technology M&A advisor, I have had more than one occasion where a seller is in need of “naked” tail insurance.
In my previous blog, I discussed the differences between D&O tail insurance and reps and warranties insurance (RWI or R&W insurance). And while most people don’t need RWI, almost every seller will need D&O tail, especially if you proceed with a stock transaction.
In an asset transaction, you may need some form of tail if you are selling all your assets. But many times, since you are not canceling your current policies, you may not need tail insurance.
But in a stock transaction, you absolutely will need tail, especially if you are selling to a company that is backed by private equity (which, today, is about 90% of all of my transactions).
But what if you don’t have a policy in place and the buyer wants tail insurance for D&O?
If you don’t have a D&O policy, you are not alone. Most sellers I work with may have E&O, EPLI, and some have cyber security insurance. But if you have officers, you will likely need D&O insurance.
What Is D&O Insurance?
First, let’s understand what D&O insurance is.
Directors and Officers (D&O) Insurance protects the personal assets of company directors and officers if they are sued for alleged wrongful acts related to their roles. It covers legal defense costs, settlements, and financial losses arising from lawsuits.
In more detail, it usually covers the following:
- Defense costs: Legal fees, expert witness fees, and other expenses associated with defending against a lawsuit.
- Settlements: Payments made to resolve a lawsuit without a trial.
- Judgments: Money awarded to the plaintiff by a court.
- Fines and penalties: Financial penalties imposed by regulatory bodies.
- Coverage for wrongful acts: This includes allegations of breach of fiduciary duty, misrepresentation, negligence, and other similar claims.
- Personal assets: The insurance protects the personal assets of directors and officers if they are held liable for actions taken in their capacity as leaders of the company.
D&O insurance can help companies attract and retain qualified executives and board members by providing them with financial protection. This is key if you want to add board members.
Why Does a Buyer Ask for D&O Tail?
The buyer asks for a “tail” policy on D&O insurance to ensure coverage for any wrongful acts (like HR issues or fraud) committed by the seller before the sale. This protects the buyer from being liable for incidents, such as lawsuits or complaints, which happened before they acquired the company.
Tail coverage extends D&O, Employment Practices, and Fiduciary Liability for up to six years post-closing, and it kicks in on the acquisition date. It covers claims related to wrongful acts by the former directors and officers before the purchase. This is standard in M&A deals and a more affordable alternative to representations and warranties insurance.
As I mentioned earlier, most of my sellers never carried D&O insurance but need it to meet acquisition terms. For example, a couple running a business for 20 years without any claims may need to quickly secure a D&O tail policy when selling. Historically, I have dealt with the lack of D&O coverage by first having the seller ask their insurance company if they will provide a tail policy. Unfortunately, that answer is usually “no” because they have never had prior coverage. Next (and this is only if being acquired by a PE firm), we then ask the PE firm to provide their insurance company to issue a quote, which they usually will do because of their relationship with the PE firm.
Recently, however, I ran into an issue with an international buyer where the PE firm was located in Europe and they could not assist us in providing a D&O tail policy. So, we were a little perplexed as to what to do next…until we found this concept of naked tail.
What Is Naked Tail Insurance?
In insurance speak, if you insure a particular exposure, you’re covered. If not, you’re bare.
If you’re looking for a policy that covers something that’s never been covered before, you’re…naked. And that is the situation many of my IT service providers find themselves in when they are looking to sell.
In the past, insurers required several years of D&O coverage before offering tail policies, often charging high rates with exclusions for those without prior coverage. Today, some insurers recognize the low risk and now offer naked tail policies, even for small deals, as long as the seller warrants there are no known claims or issues before closing.
Will it cost more if you haven’t had D&O in the past? Maybe, but not a lot more and certainly worth the cost.
Thinking About Selling in the Next Few Years? Here Is What You Need to Do NOW:
- Look to see if you have the following policies: commercial, D&O, E&O, EPLI, and cyber
- Look to see if they are a “claims-made” or an “occurrence-based” policy. A claims-made policy only covers incidents that happen and are reported within the policy’s timeframe (unless a “tail” is purchased). An occurrence policy has lifetime coverage for the incidents that occur during a policy period, regardless of when the claim is reported. If you have an occurrence policy, you may not need tail. But that will depend on the type of transaction you are contemplating.
- Ask your broker now to give you the number of years they can issue a tail policy for on each one of your policies. Most buyers will want six years of tail policy, but many times you can negotiate that down to three. If they are only able to offer one year, explore if that can be changed by moving to a different policy.
- If your insurance company does not offer tail on one or any policies, find a new insurance company who does. The only scenario where you won’t need tail policies is if you know for sure you will only be contemplating an asset sale (because you are only selling part of your assets).
One Last Little Piece of Advice…
Many times, a buyer will only ask for D&O and/or E&O tail policies. If you carry any EPLI (Employment Practices Liability Insurance, which protects your business from lawsuits filed by employees alleging discrimination, harassment, wrongful termination, and other employment-related issues, covering legal costs, settlements, and judgments), I would highly recommend that you purchase a tail policy for your own piece of mind. First, you will be surprised how money changes people’s actions and what they deem to be “fair” or not. And secondly, you should never have to continually look over your shoulder post-sale worrying about a lawsuit from a former employee (because remember, these are no longer your employees post-sale) who may not be entirely happy with your sale. Just a little “CYA” advice, my friends.
And as always, remember: I am not an insurance broker, and I am not giving you professional insurance advice. I am just sharing some commonsense advice and what I have seen in my many transactions.
Reps and Warranties Insurance Versus Tail Insurance