Snapshot
- Both credit insurance and surety bonds can be used as alternatives to purchaser collateral (e.g. cash escrow or letters of credit) for deferred payments due in connection with transactions.
- When utilised, these can improve working capital, support negotiation of purchase terms, provide peace of mind to a seller and transfer purchaser credit risk.
As businesses look for growth in the current volatile economic environment, capitalising on new and innovative credit solutions can help M&A transactions by supporting deal-making, creating value and enhancing operational efficiencies post-closing.
What credit solutions are available?
A seller can use a trade credit insurance policy to provide protection against non-payment of a future consideration payment. This type of policy can be purchased on a disclosed or a non-disclosed basis.
Alternatively, a surety bond can be issued by an insurer on behalf of a buyer to guarantee their payment obligations. Surety bonds are similar in form to bank guarantees and are issued by S&P rated financial institutions who have the same legal obligations to make payments as do banks. However, crucial to the buyer, they do not require a charge over assets or cash collateral, so do not tie up working capital.
With a surety bond there is no requirement for the seller to be involved in the negotiation, so it can be pre-agreed between a buyer and an insurer to enhance a bid. In this respect there are parallels to a buy-side warranty and indemnity insurance policy where again the policy can be placed on the buy-side independent of the seller actively assisting in placing the product.
Surety Bonds and Replacements of Guarantees
Surety bonds can also be used to replace parent company guarantees covering legacy performance obligations of a target that is being acquired. This is advantageous for a seller as it no longer needs to keep in place a guarantee that relates to business activities that are being divested. A surety bond can also be used to replace existing bank guarantees on more desirable terms. As such, facilities are often a lower cost to bank guarantees and issued on an unsecured basis.
Case Study: Deferred Consideration Surety Bond
Aon supported Warburg Pincus on its USD 700M acquisition of Leumi Card by arranging and placing a landmark surety bond solution to support the deferred consideration payments agreed in the transaction.
Context
Warburg Pincus agreed to acquire Leumi Card from Bank Leumi and Azrieli Group for USD 700M. The deal’s commercial terms included the payment of consideration to the sellers by Warburg Pincus in three instalments: at completion and on the first and second anniversary of completion.
Given the deferred consideration structure, Warburg Pincus sought to optimise the cost of capital Bank Leumi was required to hold, for regulatory capital reasons, against the post-completion credit risk of Warburg Pincus for the deferred consideration period.
Solution
An insurance (surety bond) solution enhanced Warburg Pincus’ proposal by arbitraging a lower cost of insurance versus bank capital and accentuating the capital relief available to Bank Leumi given the highly rated insurer covenant (a combination of AA and A).
Aon structured a substantial deferred consideration bond from London with 6 surety providers, navigating the dynamics between the sureties’ commercial and legal requirements for issuing bonds and Warburg Pincus’ fund and deal structure.
Leumi Card’s sellers, as beneficiaries under the deferred consideration bond, are entitled to call it if the deferred consideration payments are not made on the first and second anniversary of completion.
Outcome
“Aon’s surety solution helped optimise our financial discussions with the Leumi Card sellers. The Aon team worked tirelessly to support us in understanding and addressing the sureties’ requirements within the context of the deal and guided us through the placement process to deliver a tremendous outcome for us.”
Max Fowinkel, Managing Director, Warburg Pincus