AGENCY FINANCIAL MANAGEMENT

AGENCY TRANSACTIONS

Avoiding the 11th hour closing crisis

By Paul J. Di Stefano, CPA, CPCU

One of the most problematic parts of a sales transaction usually arises when the closing date approaches. Typically, up until this point both the buyer and seller have felt that they have had sufficient time to contemplate both the structure and terms of the transaction, as well as define the roles the selling principal will play going forward. In many cases, a letter of intent or term sheet will have been executed which defines the terms and structure of the deal on what all parties would characterize as a fairly detailed basis. This equilibrium often is disturbed with the delivery of the first draft of the agency purchase and sale agreement, and employment/non-solicitation/non-compete agreements.

This is the time when it hits the fan. Everything that the parties to the transaction think they have agreed to is suddenly set forth in excruciating detail. In fact, there is so much detail that the parties now wonder where all these new issues and conditions have come from. The reality is that there usually are very few new issues but rather elements of the transaction which up until now have not been focused on, much less discussed. While these elements should have been anticipated all along, the reality is that the agency principals are used to dealing in broad strokes and leaving the details to others to sort out. The term "others," if you did not immediately recognize it, refers to the group of usual suspects: the merger & acquisition intermediary, the attorney and the outside accountant.

The M&A intermediary is focused on making sure that the terms being negotiated are properly reflected in the documents and that the financial assumptions used by both parties hold up during due diligence. The attorneys are focused on memorializing the terms of the transactions as well as obligations of the buyer and the seller and advising their clients of the significance of those obligations and representations. The role of the outside accountant is typically to deal with the tax issues, including structure and purchase price allocation associated with the transaction. The accountant also is expected to provide finalized numbers through the closing date as well as prepare for post-closing accounting activity, including receivable and payable run-off and post-closing balance sheet adjustments.

Since most agency transactions are structured as a sale of assets only and/or books of business, the issues dealt with below deal with that particular structure. It is much less common that the transaction is structured as a sale of the stock of a corporation, which contains the agency's assets and liabilities. An asset sale is generally comprised of the expiration list or book of business, the rights to future installments and any assumed liabilities, such as a building lease, as negotiated by the seller. The dynamics of an asset sale will require both parties to address a number of complicated issues both before and after the closing.

Some of the more common closing issues in an asset sale can include the following:

Carrier payables--Since the seller is generally liable for settling the outstanding accounts payable to insurance companies and other miscellaneous payables, the seller will need the availability of the agency's existing computer system and an experienced accounting employee to handle the payables run-off, which will center on determining if invoices are the responsibility of the buyer or seller.

Client receivables--If the seller is responsible for collection of accounts receivables, the details of the insureds' accounts receivable must be accessible in order to collect the amounts due, since these proceeds will be utilized to settle the above referenced carrier payables. Typically the seller is responsible to the insurance company for the payable whether or not the receivables have been collected. One question that arises is: Who has the right to cancel the account for nonpayment of premiums?

Data backup--In order to assure that the two preceding areas can be handled without any glitches, a full set of backup tapes from the agency's computer system, as well as at least one computer terminal should be made available to the seller's accountant for the run-off phase.

Outstanding debt--At least 30 days prior to a possible closing, you should attempt to negotiate the payoff of your outstanding debt. Debt may include seller notes or other long-term, non-bank debt where the note holder may find it attractive to receive a discounted amount today. Typically, the earlier one initiates these discussions, the bigger the potential discount since the time pressure will be minimized.

Legal due diligence--A competent attorney should initiate legal due diligence at least 30 days prior to closing. A critical item to be reviewed in due diligence is whether the agency has complete and full title to the book of business assigned to or generated by the agency's producers. Vesting agreements and rights of producers to purchase their respective books of business should all be disclosed and addressed.

Producer employment/non-solicitation agreements--Producers also should be made aware of the fact that they will be required to sign new non-solicitation/non-compete agreements. In the event that the buyer will require changes in producers' commission arrangements, the selling agency principal should be prepared to "sell" those changes to all affected producers. The selling pitch for these changes will have to be up to the task since these last-minute discussions and negotiations with producers can become problematic and potentially delay a closing.

Expiration list--A book of business is usually delivered at the closing. This book of business should contain at a minimum the client's name and address, policy numbers, line(s) of business, annualized premiums and commissions. Annualized commissions will need to track fairly closely the agency's annualized revenues for the same period. Material differences will require valid explanations.

Outstanding leases--Permission should be obtained from any leaseholders to transfer any leases that the buyer may be assuming.

In summary, the closing of a transaction need not be traumatic. Last-minute issues can and should be anticipated by both the buyer and seller to assure a smooth closing. As with any other complicated process, if the professionals are knowledgeable and experienced with the elements necessary to ensure a smooth closing, last-minute crises will be avoided. *

The author

Paul J. Di Stefano, CPA, CPCU, is the managing director of Harbor Capital Advisors, Inc., a national financial and management consulting firm that 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, or visit its Web site (www.harborcapitaladvisors.com).