Warranty and indemnity insurance for private equity transactions can be challenging to obtain outside certain jurisdictions in Africa, but there may be ways to increase its availability.
While warranty and indemnity (W&I) insurance has become more readily available in South Africa, it can be challenging to source in some other African jurisdictions if the risk profile of the country and the transaction itself does not meet insurers’ requirements.
It's unfortunate because W&I insurance is a useful tool in private equity transactions. It enables the risk of acquiring a business (protectable by warranties and indemnities) to be transferred from a buyer and/or seller to an insurer, thereby facilitating transactions and reducing deal execution risk - at a premium, of course. A W&I insurance policy covers the loss arising from breaches of warranties or claims under the tax indemnity, unexpected events, defence costs or gross-up costs. W&I insurance therefore allows for the deal parties to negotiate a balanced set of warranties, on an expedited timeframe.
As Kudzani Pickup, the Chef Investment officer of Africa Lighthouse Capital, a leading private equity (PE) firm in Botswana investing in Africa, says:
“PE in Africa does not have access to standard financial support structures, such as W&I insurance, credit guarantees for commercial deals, limited partner guarantees, general partner specific insurance etc. In an environment where PE is new, these financial structures are most needed to support greater confidence in PE – by sellers, financiers, investors, and others. The absence of W&I insurance means that sellers either have to leave money in escrow or agree to a lower price. If in the case the seller is a PE firm, this is a drag on IRR. If the seller is not an institution, they may find it difficult to leave proceeds in escrow for a completed transaction. This can affect deal progression, either slowing it down or killing the deal so late in the process.”
Kudzani makes a good point: PE transactions are relatively new on the continent, so often the size and make-up of the PE transactions do not align with transactions for which insurers would typically provide cover. There are two key reasons for this:
- First: the minimum size deal for W&I insurers is USD 10 million (about ZAR 150 million), where on average 20% of the value will be insured. For smaller deals, the costs of this insurance can be prohibitive, ranging from 1.1%-1.7% (of the policy limit) in South Africa to 1.7%-3% elsewhere in Africa (depending on the jurisdiction). Numerous PE transactions on the continent are thus excluded based on the size of the transaction and pricing of the premium; and
- Second: W&I insurers prefer certain sectors and jurisdictions. Due to its regulated nature, mining is a sector that W&I insurers may steer clear of (although some W&I insurance packages cover mining transactions). In South Africa, transactions in the financial services sector are relatively easy to insure. Outside of South Africa, however, the sector is considered more unpredictable and high risk.
It's also worth noting that, the availability of W&I insurance also seems to depend on the appetite of the insurer at a point in time. At present with the current M&A boom in the markets, insurers are busy, and this seems to have diminished their appetite for insuring transactions on the continent outside South Africa. Certain African jurisdictions considered high-risk are somewhat excluded from W&I insurance cover. There are specific issues related to tax indemnities and the predictability of the tax authorities in some jurisdictions.
Simla Ramdayal, director of Mergers & Acquisitions, FINEX at Willis Towers Watson (a leading global advisory, broking and solutions company), says:
"Some of the deals that the firm has worked on in the past two years were in sectors such as telecommunications, renewable energy, retail, mining, financial services, vehicle fleet management, ICT, banking and agriculture. These deals were on the continent and in countries including South Africa, Nigeria, Mauritius, Kenya, Namibia, Ghana, Malawi, Zambia and Tanzania.
Not surprisingly, insurers have expressed a preference in insuring transactions where the target has a strong South African presence – where the risk is mainly centred around South Africa. In addition to having certain jurisdictions being preferred, certain jurisdictions such as the DRC, Chad and Zimbabwe do not seem attractive for W&I insurers."
W&I insurers consider the political and economic stability of a jurisdiction, leading to your seemingly outright exclusions. This is why it is surprising that a few transactions in Botswana have recently not been considered insurable, although Botswana is considered a relatively politically and economically stable jurisdiction.
The main guideline that there is on W&I insurance is the deal size. For the rest, the approach is on a case-by-case basis. This can create uncertainty and make it difficult for advisors to provide any real guidance to clients as to whether their deals are likely to qualify for W&I insurance.
For insurers there is a great opportunity in Africa. The latest edition of
Clyde & Co’s Insurance Growth Report 2020 showed that M&A insurance transactions grew faster in the Middle East and Africa in 2020 than anywhere else, by 166.7% (although off a low base).
What is clear from the above though, is that this is the tip of the iceberg, there are many more deals on the continent where W&I insurance is needed.
In terms of tackling some of the key issues at play which may address concerns by the insurers and the dealmakers:
- W&I insurers look for a full due diligence, which can be done by the seller but must be confirmed by the buyer independently. The quality of the diligence is key, and insurers prefer the due diligence to have been done by a professional firm such as a legal adviser. If the due diligence was done internally, it is still acceptable, but it must be documented to the same level as an external due diligence to achieve the same level of cover. Insurers will not cover aspects of a business on which a due diligence investigation was not conducted, or below the materiality threshold of a due diligence.
- W&I Insurance covers only the warranties set out and identified in the sale and purchase agreement (SPA). Accordingly, the SPA is reviewed by insurers, and this review should be accommodated in the transaction process, and at an early stage to allow for any structuring issues to be solved appropriately, and sooner rather than later.
- Engage insurers upfront, so that they can gain an understanding of the jurisdiction/s involved, and to ensure that are able to position a transaction for an easy assessment by the insurers. The easier it is for the insurer to assess at these busy times, the better. "You want insurers to measure profit, price and take some of the deal risks. This reduces overall cost of transactions and friction between transacting parties" (Kudzani) and for insurers to do this, they must understand the business they are taking the risk of, and transactors can greatly assist in this. Through this engagement and resultant understanding, it is the hope that insurers will be in a position to provide more firm general guidelines."
The rise of W&I insurance on the continent is welcome and can only serve to increase the possibilities and ensure that Africa maintains its growth trajectory. As Kudzani also noted: "conceptually, the markets are more efficient when risks are in the hands of those who are best able to handle them and investors can focus on investment."
This article was first published in DealMakers Africa Q3 2021 issue.