Introduction

The information provided below answers some key questions which have been put forward to us in the past by our clients and partners. They are intended to act as a guideline. For more specific enquiries click here.

What is Deferred Finance Ltd?

We are Underwriting Agents on behalf of four underwriters for the Deferred Consideration Insurance products. We are regulated by the FSA.

What is Deferred Consideration Insurance?

Deferred Consideration (DC) is a contractual agreement by the vendor of a business to receive payment for that business at a designated point in the future as opposed to receiving the full purchase price on the date of sale. Deferred Consideration Insurance (DCI) is a credit insurance policy protecting the vendor in the event of default by the purchaser and their failure to the pay the DC payments when due.

There are two products – one protecting the vendor against insolvency and one protecting against default.

Who does it benefit?

The policy benefits the Vendor in the following ways:

• Investment rated guarantee of payment
• Taxation benefits attached to receiving payment over time
• DCI takes away the risk of non-payment for the vendor who can accept repayment of deferred consideration over a number of years.

There are a number of reasons why a Purchaser may benefit from deferred consideration:

• To increase working capital
• To reduce the requirement for borrowing because the full purchase price does not have to be raised by conventional forms of finance at completion
• To obtain an alternative to venture capital funding
• MBO directors are in full control of the company
• MBO directors obtain maximum personal benefit from their efforts in growing the business, for example following a successful exit

How does the Insurance Policy work?

Insolvency (see “How It Works”)

If the purchasers have not paid the deferred amount when due they vendor can enforce insolvency by way of a statutory demand and proceed to wind up the business.
Once the vendor has confirmation from the courts that the purchaser is insolvent then a claim can be made.

Default (see “How It Works”)

The policy provides an irrevocable undertaking to pay the DC amounts when due if these amounts are not paid to the vendor. The policy sets out the schedule of DC payments and the claim procedures in the event of a default. The policy is an irrevocable undertaking to pay in the event of a default by Purchaser. Normally, the only significant exclusion preventing payment will relate to proven fraud and dishonesty on the part of the Vendor. Remaining exclusions relate to the Vendor unilaterally changing the terms of the DC.

How does the Inter-creditor Deed work?

On the default wording the insurers always require its rights to recovery to be secured by a charge on the assets of the Purchaser. If no other finance provider is involved, this can be achieved by a simple first charge. An inter-creditor deed is required where there is a finance provider in addition to the insurer. This deed sets out the procedure for enforcing the security in the event of a default and will set out the recoveries made usually to the finance provider first, up to a defined amount, and then to the insurer for claims paid.

Why is the counter-indemnity required?

As the purchaser is not a direct party to the policy but the Purchaser’s performance is the most important element of the insurer’s risk, a separate agreement is required between the insurer and the Purchaser. This counter-indemnity document enshrines insurer’s rights to be indemnified by the Purchaser in the event of a claim payment and contains the purchaser’s acknowledgement of insurer’s rights to recover claims paid.

The exact terms will depend on all of the circumstances of the transaction but such agreements typically also provide for the assignment of rights which the Purchaser has received from the Vendor under the S&P agreement.

What is your underwriting process?

There are a number of stages that we go through when writing a transaction of which the following is a brief outline.

1) Initial enquiry – review of business plan, historical and projected financial accounts, cash flows etc.

2) Underwriting review

3) Term Sheet – non-legally binding indicative outline of the risk structure, terms and conditions, initial pricing and costs, legal and financial responsibilities of all parties. The Term Sheet is always subject to underwriting committee approval.

4) Underwriting Committee – once the Term Sheet has been signed and the commitment fee received, underwriting committee approval is sought.

5) Underwriting and technical and financial due diligence on the business. The financial diligence will normally be scoped jointly with any senior lender and will include an analysis of the business’s ability to repay the deferred consideration with appropriate cash headroom. For most transactions, financial due diligence will be extended to include a discounted cash flow valuation. This will occur simultaneously with the legal due diligence.

6) Legal due diligence – policy, inter-creditor and counter-indemnity will be agreed between parties as well as a full review of all other transaction documents specific to the deal.

7) Final sign-off from underwriting committee

8) Once all due diligence is completed, documents have been agreed and signed and Deferred Finance Ltd have received the premium and fees, the policy will incept.

How long does the process take?

This depends on a number of factors including how far the deal has progressed before we are introduced into the structure. Some transactions may also have time restrictions within the MBO sale. Our experience has been that transactions can complete in as little as six weeks, but may often take considerably longer. Deferred Finance Ltd will always aim to operate at a pace appropriate to the transaction, and will turn key documents and provide key responses promptly.

What is your credit committee process?

Similar to the process a bank would take, in order for us to write a transaction, underwriting committee approval must be sought. The transaction is presented to the Underwriting Committee by the underwriter and initial approval is given. Once all legal and underwriting diligence has been completed and all conditions imposed by the committee are met satisfactorily, final underwriting committee sign-off is required in order to close the policy. There has never been an occasion where following final presentation of a deal, sign-off has not been granted.

What sort of diligence is required?

Although the due diligence on each transaction will vary, the key areas we undertake are as follows:

• Due diligence on the business and market – integrity of information, deal parties, credit ratings, management quality, brand strength, the market and competitors etc, commercial due diligence as required.
• Management due diligence including, but not limited to, finance director, managing director, sales and/or production director, management team equity, personal risks identified, knowledge and experience in the market, non-executive director, the culture post-MBO, any changes envisaged post-MBO and service contracts.
• Detailed financial diligence will be undertaken by an independent professional third party who will scenario test the projected cash flows and in particular test the adequacy of the repayment schedule. Diligence will also be undertaken on the historic performance of the business. The cost of diligence is normally contained by sharing the scope and benefit of the report with any senior lender.
• Satisfactory formal valuations of the business will be undertaken and a discounted cash flow (DCF) valuation may be necessary where the proposition does not have full asset backing. This will also be conducted by a professional third party, normally the party already providing the financial diligence.
• Legal due diligence – the policy, inter-creditor and counter-indemnity will be agreed between parties as well as a full review and sign-off of all other transaction documents specific to the deal including appraisal of property values, verification of contract arrangements and review of the staff and pension position. Deferred Finance Ltd work closely with legal counsel experienced in DCI transactions.
  

What sort of business are you seeking?

We look to participate in DCI transactions which involve commercially viable MBO / MBI businesses supported by management teams with proven skill and experience encompassing:

• Businesses with a successful track record and a defined market niche
• Businesses with a product or service which is recession proof, and for which demand may be reasonably predicted with certainty
• Businesses with tried and tested technology
• Management teams who have a successful track record of managing a business within the industry for a minimum period of 3 years.
• Businesses where the cash flow and historical results support the repayment of the deferred consideration.

What industries will you not accept

We pride ourselves on offering insurance solutions to a wide range of businesses. However, we will not participate in areas that have the following characteristics:

• New technology or tobacco products
• Directors have been involved in failed businesses or reprimanded by the DTI for misconduct

What is the maximum policy period?

The maximum policy period we can accommodate is 5 years. The duration of a typical DCI policy is 3 to 5 years.

How much does the cover cost?

The cost of this insurance is, in total, the insurance premium plus Insurance Premium Tax (IPT) plus fees (see below) paid on inception of the policy. The insurance premium payable is calculated using a per annum percentage on the limit of liability outstanding during the policy period and is usually in the region of 3% to 6% per annum. The premium will reflect, among other things, the nature of the business, the assets and value of the business and the experience of the management team. A simple example of how the premium is calculated is as follows:

4 year policy
Deferred Consideration of £3m amortising annually
Annual Premium Rate of 3.5%

How is the premium paid/funded?

The premium (£236,250 in the example shown above) is paid upfront and is a condition precedent to the policy. This means that the policy cover will not begin until the premium has been received. Insurance Premium Tax is payable at completion (IPT ranges from Zero to 12% of the premium depending on Vendor or Purchaser Domicile).

It is usual for Purchaser to pay the premium cost for the policy however the vendor may choose to do so.

Is the premium refundable?

The premium is non-refundable and is paid upfront to avoid a situation where any future premium installment is not paid thereby canceling the insurance policy.

Are there any other fees payable?

Upon signing of the Term Sheet, a commitment fee is payable in order for underwriting work to continue and for due diligence work to begin. This is usually between £3-5k and is refundable against the premium upon inception of the policy.

Legal costs are also payable by Purchaser

What are your legal costs?

Legal costs will vary depending on the size and complexity of the transaction. The fees will be specified within the term-sheet. Legal fees attract VAT at the prevailing rate and are payable at completion.

Is it possible to finance the premium?

Yes, in certain scenarios we can arrange for the premium to be paid by a premium finance lender so the premium payment is spread over 12 months.