We recently were conducting an acquisition search on behalf of one of our clients. Actually, I should describe the assignment more broadly than that. Our client was really quite flexible about the type of transaction that it would consider.
In the past, our client had acquired agencies outright. One particular agency was a distressed situation where the balance sheet of the firm being acquired was "upside down," meaning that it was heavily into its trust account and thus unable to pay the carriers. Other "deals" which our client had completed included bringing in an older principal with a good personal lines book of business on a servicing basis with right of first refusal to buy the book of business. The principal being brought in--along with his staff--did not want to sell but recognized that he would ultimately require perpetuation. He saw this relationship as his ultimate exit. In addition, our client had merged several years before with a smaller agency. This transaction proved to be very successful, with both agency principals benefiting financially.
I share this detail with you to give you some background with regard to a particular agency that we had approached on the client's behalf. That agency was approximately one third the size of our client and was open to discussing some kind of combination--although its owner had a number of concerns.
One concern was the relative size difference between the two agencies which created a feeling of discomfort about how a relationship could work among "unequals." What impact would that size difference have on its ability to continue to have a meaningful voice in the combined entity?
Since the owner of the smaller agency had already indicated that he was not interested in selling, the first issue that needed to be addressed was the issue of structure of a transaction. We discussed a relationship where the agencies would potentially merge and consolidate their operations at our client's location. This seemed to be an obvious solution since our client owned a large building and wanted to fully utilize the space available. It also would work to the advantage of the smaller agency because the economics of the space costs allocation were very attractive.
We also discussed a cluster relationship, but he quickly rejected that concept on the basis that if he was going to make a decision of this magnitude, the less formal relationship of a cluster did not demonstrate the appropriate commitment to what he expected to be a long-term business relationship. As he pointed out, it was like going into a marriage with a prenuptial agreement, which in his mind would make a breakup too easy and therefore provide less incentive for all parties to work out any potential issues that might arise.
The question of the size difference kept popping up in our discussions. It was at that point that I started to play devil's advocate. I pointed out that restricting a merger to an agency of his size, while it would seem to address some of the issues that he faced, was not a complete solution. Specific issues of concern to him included being tired of dealing with day-to-day personal issues as well as a need for additional markets. I pointed out that while some of these issues might find temporary resolution in a merger of equals, on a long-term basis other issues more than likely would require that still relatively small agency to seek additional partners.
We also discussed some of the issues on the horizon: the more and more aggressive posture of banks regarding the selling of insurance; the consolidation of underwriting markets; the lack of availability of qualified staff, as well as the impact of the selling of insurance products over the Internet.
I pointed out that if he restricted his options because of size differential, this issue would continue to be a factor since future mergers would most assuredly put him in a minority position. The question really revolved more around making intelligent decisions regarding "partnering up" and avoiding the trap of not thinking outside the box.
In summary, agency principals need to think longer term when making strategic decisions. Just solving the current problem is not enough. The impact of the dramatic changes taking place in the industry must be taken into consideration in making serious strategic decisions for your agency. Agency principals seeking to have critical mass must make some hard decisions regarding the compatibility of potential partners as well as the positive implications of a merger where the operations of the combined entity are significantly enhanced.
Harbor Capital Advisors has a philosophy that we impart to our clients: They should explore all potential options with regard to corporate development and not be stymied with pre-conceived ideas that restrict them to considering only limited options based on a lack of experience. By considering all options, you as a principal will either reinforce existing views or learn of new opportunities that you had not considered previously, but which hold tremendous promise for your organization.
An intermediary such as Harbor Capital Advisors can prove to be a valuable resource in uncovering many available opportunities. Our experience has clearly demonstrated that our clients are able to make strategic choices much more comfortably after they have explored several different types of opportunity. *
The author
Paul J. Di Stefano, CPA, CPCU is the managing director of Harbor Capital Advisors, Inc., a national financial and management consulting firm which offers services to the insurance industry. Services include agency appraisals, merger & acquisition representation, strategic and management consulting. Harbor Capital Advisors, Inc., can be reached in New York at (800) 858-2732.
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