Case Study
“Right-sizing insurance is just as important as purchasing adequate coverage. A risk-averse lender may default to simple, conservative requirements that are more punitive than protective.”
BUSINESS INCOME & LENDER REQUIREMENTS
Right-Sizing a Lender’s Insurance Requirement
One of the interesting realities of search fund deals is that SBA lending rules are widely interpreted by different banks in different ways. Some lenders require evidence of products liability spelled out in the policy form. Others require policies to be in force prior to closing—which doesn’t make practical sense for an asset-only acquisition. The inconsistency means that insurance requirements can become a source of friction late in a deal.
In this case, we were engaged by a searcher evaluating a government contracting business trading at a relatively high 4× multiple. Because of the regulatory environment, insurance information wasn’t provided until late in the process.
The target had been run by the same owner for 20 years. The company carried neither products liability insurance nor business income interruption coverage—sometimes called “business income” or “BI” coverage, which reimburses a business for lost income and continuing expenses if a covered event (like a fire) forces it to temporarily shut down or relocate.
How Our Diligence
Made A Difference
The SBA lender did not flag the missing products liability as a concern, but it did require business income interruption insurance. The lender’s standard requirement was either an “actual loss sustained” policy—meaning no dollar cap, just reimbursement for whatever the loss turns out to be—or a scheduled limit equal to three months of gross revenue.
Insurers were unwilling to write the open-ended “actual loss sustained” form because the business was located in California, in a high wildfire risk area. That left the scheduled limit. But here’s where the math gets interesting: because this was a government contracting business with relatively thin margins, three months of gross revenue represented roughly 2× annual EBITDA. Since premium is a direct function of the limit purchased, buying more coverage than necessary would be punitive.
We helped the searcher evaluate the probable loss in the event of a property impairment—essentially modeling what a real claim would look like. That analysis included net income, debt service, continuing payroll, the additional expense of relocating on a short-term basis, and the cost to repair or replace records and inventory. The result: the appropriate limit was approximately $1.5 million, not the $3 million the lender initially required.
By pushing back on the lender’s requirement with a well-supported analysis, we saved the searcher approximately $8,000 in annual insurance expense.
The Takeaway
Right-sizing insurance is just as important as purchasing adequate coverage. A risk-averse lender may default to simple, conservative requirements that are more punitive than protective. Thoughtful pushback grounded in actual loss modeling can produce meaningful savings without compromising protection.
Evaluating a deal?
We work with searchers, acquisition entrepreneurs, and private equity sponsors to independently evaluate insurance programs before close.