merger due diligence

A Missing Element in M&A Due Diligence

The army of accountants, lawyers and bankers involved in a typical corporate acquisition or merger spend a lot of time, energy and money doing what’s known as due diligence on the deal.

merger due diligence

CCIG’s Brian Parks.

As anyone who’s been through one of these can tell you, these dark-suited gals and guys will comb through reams of financial and court records, bank statements, tax returns and more to ensure that everyone has a clear view into the strengths and weaknesses of whatever is being bought or merged.

In other words, when done correctly, it’s an exhaustive examination designed to uncover any potential problem areas before a deal closes.

The problem, at least in our humble opinion, is that rarely, if ever, do these teams of excavators look at a company’s experience modification factor, or e-mod.

Simply stated, the e-mod is a numerical expression of a company’s accident and injury record compared with the average for that employer’s industry. The better the score, the less you pay for workers’ compensation insurance. Naturally, worse results produce a higher score and you pay more for the insurance.

Not to get all wonky, but a company’s e-mod is calculated by comparing actual losses to expected losses based on the employer’s industry. An e-mod of 1 would be considered the industry average. Premiums go up for companies with e-mods that are higher than the average and, as you’d expect, lower for lower e-mods. 

The formula gives the frequency of claims filed greater weight than the severity of an injury or illness. For example, six claims that occur over a three-year period totaling $20,000 will have a greater impact against your e-mod than one claim in three years totaling $20,000.

So, what does a company with a higher e-mod tell us, beyond the fact that its workers’ compensation premiums will be higher?

The fact is higher e-mods suggest inattentive, if not poor, management.

They signal the potential for inadequate safety programs, the lack of a return-to-work plan for injured workers and absence of loss-prevention procedures.

In short, it’s not a stretch to suggest that a company that’s well-run is likely to have a lower e-mod. And it stands to reason that a well-run company would be the better M&A target than a company with an inordinate history of injuries, claims and the legal troubles that typically come along with those problems.

Due diligence before a deal closes includes asking a whole series of questions about the financial health of the company being acquired. Questions such as: Are the margins for the business growing or deteriorating? Are the company’s projections for the future and underlying assumptions reasonable and believable?

There’s another sequence of questions we’d like to see added to any due diligence checklist:

What’s the company’s e-mod? Is it higher than the industry average? Why? And what is it doing about it?

All of this makes sense, we should add, unless you’re a buyer interested in buying distressed assets at a discount. If that’s the case, then go ahead, shut your eyes and jump right into the deal. You will, however, want to get serious about getting that e-mod down before you try to flip that company to the next set of owners.

Brian Parks is CCIG’s Commercial Lines Sales Director. Reach him at 720-330-7923 or BrianP@thinkccig.com.

CCIG is a Denver-area insurance brokerage with the full-service capabilities of a national brokerage. We do more than make sure you have the right policy. We help you manage your long-term cost of risk with our risk and claims management expertise and a commitment to service excellence.

Contact CCIG

We're happy to answer any questions or concerns that you may have. Please let us know how we can help.