When buying or selling a business, understanding indemnification is crucial. Indemnification clauses in merger and acquisition (M&A) agreements help protect both parties from potential losses and liabilities. This article will explain the types of indemnification protections available to Buyers and Sellers and provide practical considerations for each side.
What is Indemnification?
Indemnification means reimbursing the other party for a loss suffered due to a third party’s claim. In M&A, it also covers first-party liabilities, such as breaches of promises or issues that arise before or after the deal closes.
Purpose of Indemnification
The main purpose of indemnification clauses is to transfer liability from the party that incurs the loss to the party whose actions caused it. This ensures that the responsible party bears the financial burden of any claims or losses.
How to Protect Myself as a Buyer:
Representations and Warranties Insurance (RWI): This insurance protects Buyers against losses from breaches of the Seller’s promises. It covers unknown risks and can make negotiations smoother. However, like any insurance, RWI has exceptions and limitations, and the Buyer may be responsible for paying all or part of the premium.
Holdbacks: A portion of the purchase price is held back in an escrow account or a similar holding mechanism for a specified period to cover any potential claims. This ensures that funds are available if indemnification is needed and offers additional security to Buyers.
Seller’s Note: This is similar to a holdback, but without using escrow or a third-party. The money is held by the Buyer and can be used to offset any claims against the Seller. This means that if the Buyer needs to make a claim, they can reduce the amount they owe the Seller in future payments. This method generally requires less upfront capital and provides another way for the Buyer to recover funds if needed.
Earnouts: Part of the purchase price depends on the business achieving certain performance targets after the deal closes. This aligns the interests of the Buyer and Seller and provides protection against overpaying.
How to Limit Exposure as a Seller:
Limiting Scope of Indemnification: Sellers should aim to limit their indemnification obligations to avoid excessive liability. This can include specifying time limits for types of claims or setting an overall time limit for all potential claims.
Preparing for Potential Liabilities: Sellers should address any known issues before the sale and disclose all relevant information to avoid future claims. Sellers must ensure that all information and promises included in their representations and warranties to the Buyer are accurate and fully up-to-date.
Negotiating Terms: Sellers should negotiate terms that minimize post-closing risks, such as including a lower cap and a larger deductible basket, as explained hereafter.
RWI for Sellers: Sellers can use RWI to protect themselves against claims from the Buyer. This insurance covers breaches of the Seller’s representations and warranties, reducing the financial impact of potential claims and providing peace of mind to the extent covered.
M&A Transactions’ Special Indemnification Provisions:
Escrow Agreements: This provisional agreement sets aside a portion of the sale proceeds in an escrow account until certain conditions are met to cover potential indemnification claims.
Indemnification Thresholds/Baskets: This provision establishes a minimum amount of losses that must be incurred before indemnification kicks in. Baskets can be “first dollar” or “tipping basket” (covering all losses once the threshold is met) or “deductible” (covering only losses above the threshold). A Buyer will prefer a tipping basket because all losses will be covered. A Seller will prefer deductible to limit the money claimed.
Indemnification Caps: An indemnification cap limits the Seller’s indemnification obligation to a certain dollar value, typically equal to the indemnification escrow. This is a Seller friendly provision that will be capped to at least the value of the purchase price.
Other Common Limitations:
Mitigation: Indemnified parties must take reasonable steps to mitigate any loss, including incurring costs only to the minimum extent necessary to remedy the breach.
Insurance: Payments by an indemnifying party are limited to the amount remaining after deducting any insurance proceeds or similar payments.
Tax Benefits: Payments are reduced by any tax benefits realized as a result of the loss.
Special/Consequential Damages: Indemnifying parties are not liable for punitive, incidental, consequential, special, or indirect damages, including loss of future revenue or income, loss of business reputation or opportunity, or loss of value.
Conclusion:
Indemnification is a key part of M&A transactions, providing essential protections for both parties. Clear and well-drafted indemnification clauses help ensure a smooth transaction and protect against unforeseen liabilities. To that end, it is important you consult with an experienced professional to assist you in drafting and negotiating these types of provisions in healthcare transactions.
Alfonso Zambrano, Shareholder – Brown & Fortunato, P.C. Alfonso Zambrano is a shareholder and director at Brown & Fortunato with a broad corporate practice emphasizing on mergers and acquisitions, corporate finance, business start-ups, real estate transactions and corporate governance. Alfonso has served as the principal legal advisor on numerous transactions in various industries to help clients achieve their goals and implement their business strategies. Alfonso is a member of the State Bar of Texas, the State Bar of New York, and the Amarillo Area Bar Association. He is also an active board member of the Amarillo Museum of Art, and the Harrington Regional Medical Center. He is currently serving as President of the Amarillo Local Government Corporation. In recognition of his community service, Alfonso received the Amarillo Chamber of Commerce Top 20 under 40 Award in 2019.
Michael Gawargi, Associate Attorney – Brown & Fortunato, P.C. Michael Gawargi is a member of Brown & Fortunato’s Corporate Group where his practice is focused on drafting and negotiating complex agreements, assisting in mergers and acquisitions, managing corporate governance issues, and guiding business entities through formation and strategic growth initiatives. Michael’s work is characterized by a detail-oriented approach to transactional matters and a commitment to delivering sound legal counsel. Michael is a proud alumnus of Texas A&M University, where he graduated magna cum laude with a Bachelor of Arts in Communication and a minor in Philosophy. He earned his Juris Doctorate from Southern Methodist University Dedman School of Law. During his time in law school, he was awarded scholarships recognizing his academic dedication and achievements.
FORT WORTH, Texas, Nov. 15, 2024 /PRNewswire/ -- VERTESS (https://vertess.com), a leading healthcare mergers and acquisitions (M&A) advisory firm, is pleased to announce that Momentum (https://momentumme.com/), a Maine behavioral health provider that offers shared living and other services to people with intellectual and developmental disabilities, has joined the Mosaic (http://www.mosaicinfo.org) family. Momentum is now part of Living Innovations (http://livinginnovations.com), a service of Mosaic. Together they have increased their reach to people with diverse needs in Maine, New Hampshire, Rhode Island, and Connecticut. The transaction was facilitated by the VERTESS team and Rachel Boynton.
Living Innovations offers community-based services to 950 people, including more than 500 individuals who participate in shared living. They also provide vocational services to 204 people. Momentum serves approximately 270 people through its shared living and other community-based programs. Living Innovations State Operations Director, Andy Taranko, shares, "Momentum is a trusted organization that has innovative programs like Nature Trek and a strong reputation for quality. It is a natural fit for the high-quality services Living Innovations provides across Maine." These two organizations will serve about 1,500 individuals through shared living, community support, and employment services.
Dennis Strout, founder and Executive Director of Momentum, noted that his decision to become part of Living Innovations was greatly influenced by his desire to ensure the services provided continued long into the future. He shares, "The Momentum workforce has helped people achieve incredible things, and Living Innovations brings new levels of support and resources, a welcome addition to provide long-term stability for the services."
"I enjoyed working with the professional teams at Momentum and Mosaic in support of their goals," stated David Coit, VERTESS Director of Finance and Valuation. "Having worked with Living Innovations previously in their acquisition by Mosaic, I am excited to hear of future successes for the group."
Volume 11, Issue 13, July 16th, 2024
By: Dave Turgeon and Jack Turgeon
Private equity often carries a negative connotation in the healthcare industry. However, if you are considering selling your business, it's crucial to understand the impact private equity has on the overall deal market and the sale of your company. At VERTESS, we focus exclusively on transactions in various healthcare sectors. By tracking the activity of private equity groups, or PEGs, we gain insights into the current market dynamics, allowing us to better advise our clients on what to expect when selling their businesses.
In this column, we will briefly define private equity, then dive into the influence of it on the sale of healthcare businesses, current trends in healthcare private equity activity, and what business owners should consider when planning to sell their companies.
What Is Private Equity? Private equity is an alternative investment strategy that allows institutional and accredited investors to invest in private markets. These groups invest in private businesses to increase their value over a holding period — one typically lasting 5 to 7 years. PEGs have an ultimate goal of selling the businesses for a profit.
One strategy for increasing the value of these portfolio companies is through mergers and acquisitions (M+A), where companies consolidate multiple businesses under a single entity. By acquiring regional and national competitors or businesses with synergistic lines, these portfolio companies can add revenue and earnings, thereby increasing their value when sold.
What Influence Does Private Equity Have on Selling Your Healthcare Business?
Why is private equity important for business owners? When you decide to sell your healthcare business, you will likely receive offers from multiple entities, potentially including private equity-backed portfolio companies and private equity funds. Tracking their activity in the market can help you understand what to expect when selling your business. While private equity groups are not the only buyers in the market, knowing how they acquire and invest in companies provides valuable insights into the market as a whole.
Where Things Stand: A Closer Look at Private Equity Activity in 2024
In 2023, M+A activity was sluggish across most sectors and especially in healthcare. High interest rates lowered business valuations, creating a gap between owners' expectations and buyers' valuations.
In the first half of 2024, private equity showed signs of recovery in the global M+A market. After a slow start, private equity deal activity increased, stabilizing its market share and alleviating concerns about private equity's role in the anticipated M+A rebound. Exit activity, crucial for healthcare industry growth, improved significantly after a long period of stagnation, elevating fundraising and capital availability for future investments.
Private equity fundraising exceeded expectations, showcasing the healthcare industry's resilience and continued investor confidence, despite an anticipated slowdown in the latter half of the year. Middle-market funds performed well, in contrast to the more challenging environment for megafunds.
As the stock market includes more smaller cap stocks, private equity valuations and exit opportunities are expected to improve further. The healthcare industry's adaptability and forward momentum amid challenging conditions highlight its potential for continued growth and success.
Looking at the more recent quarter of 2024 (Q2), healthcare private equity activity showed promise despite a lighter quarter overall. The healthcare sector accounted for a substantial portion of deal activity, with numerous transactions reflecting strong down-market deal flow. Notable deals included Cotiviti's recapitalization by KKR and Veritas and Thomas H. Lee Partners' acquisition of Agiliti, indicating ongoing interest in healthcare investments. Healthcare services dominated private equity deals, while pharma services also attracted significant interest, with multiple platform deals closing.
The demand for weight-loss drugs sparked interest in peptide manufacturing, aligning well with private equity's focus on consistent business models. Despite high valuations and economic uncertainties, the healthcare sector remains robust for private equity investment, driven by strategic acquisitions and divestments.
In conclusion, the first half of 2024 has shown encouraging signs of recovery and growth for private equity in both the general M+A market and the healthcare sector. Improved deal activity, strong fundraising, and strategic investments indicate a resilient and adaptable industry poised for continued success. The healthcare sector, in particular, remains a key area of interest for investment groups, with ongoing investment opportunities driven by market demand and strategic divestments.
Current Private Equity Activity Is Good News for Healthcare Business Owners
Understanding private equity activity is crucial for healthcare business owners considering selling their companies. The current market conditions in the first half of 2024 have shown recovery and growth in private equity, particularly in the healthcare sector. Improved deal activity, strong fundraising, and strategic investments indicate a resilient and adaptable industry poised for continued success.
As deal activity increases for private equity firms, this signals that buyers will be actively seeking investments in the healthcare market. Private equity firms aim to increase the value of their investments through market consolidation and eventually exit from these investments in the coming years. This positive trend in deal activity among private equity firms suggests favorable conditions ahead for the sale of healthcare businesses, regardless of their size. For business owners, staying informed about private equity trends and market dynamics can provide valuable insights and better prepare them for potential sales, ensuring they achieve the best possible outcomes in a competitive market.
At VERTESS, we specialize in healthcare M+A transactions by working with business owners to capitalize on these market opportunities and negotiate the best deal possible for their business. We have built a network of relationships with buyers in our key verticals to ensure we bring the right pool of buyers to any client. This will help not only achieve the best outcome in purchase price but also the best post-transaction fit for their business, employees, and clients. If you would like to learn more about the state of healthcare M+A and investing or how VERTESS is particularly well-suited to help sell your healthcare business, please reach out to us.
Dave Turgeon, CM&AA
I’ve been fortunate to work for several exceptional companies. I’ve contributed in roles that include CEO, COO, and managing growth. I’ve been part of private equity-backed companies focused on building value and growing, which has allowed me to acquire of hundreds of companies and invest billions of dollars. I began focusing on behavioral health about twelve years ago based on a family member. Many people know me from my experience running the M&A efforts at Civitas Solutions leading up to their successful IPO in 2014. I feel very fortunate to be in a position now to help business owners who built companies whose mission it was to care for others. I’m in the unique position of helping them get the very best deal possible
As a Director at VERTESS, I bring extensive experience in sales, consulting, and project management from early-stage startups. With an MBA from Babson College, I have a strong foundation in business strategy, operations, and financial analysis. My personal connection to behavioral healthcare through a family member motivates me to help business owners get the best deal possible while ensuring high-quality care for their clients. Throughout the M&A process, I provide comprehensive support at every step. I have a proven track record in negotiations and client management after working with companies in various industries. I’m excited to join VERTESS and make a meaningful impact on the lives of the owners I work with.
We can help you with more information on this and related topics. Contact us today!
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