AGENCY FINANCIAL MANAGEMENT
By Paul J. Di Stefano, CPA, CPCU
Four steps to making a deal that works
If one element distinguishes agencies with a successful acquisition track record from those that are constantly left at the altar, it is the fact that the successful agents have put a process in place.
The past several years have seen intense activity in the area of agency acquisitions. Many agency principals are eager to pursue acquisition opportunities, even though they may not have been successful in the past. In our role as financial consultants, we have developed a unique perspective on the areas in which prospective acquirers tend to stumble in the merger and acquisition process. On the basis of our experience, we have identified four key aspects of successful deal making:
1. Presenting a formal discussion agenda
2. Constructing a reasonable time frame for negotiations
3. Ensuring access to information and a rigorous due diligence process
4. Ensuring availability of external financing
Before discussions begin, the parties should establish an agenda that specifies each of the issues to be explored. Doing so saves valuable time and ensures that the parties will focus on the matters they have agreed are relevant. Without a formal agenda, discussions tend to ramble and stray into issues that may be extraneous or irrelevant.
Deals don't age well
A basic premise of deal making is that deals do not get better with age. Permitting conversations to go on endlessly is a tactical error made by many potential acquirers. Conversations that go on for a long time raise red flags. For example, perhaps the seller is not ready to exit but is enjoying the courting process and his newfound opportunity to share information and concerns with a competitor. Certainly the seller may have some legitimate interest in pursuing discussions, but conversations can rapidly be transformed into collaborative sessions.
In other cases, the buyer effectively drops the ball. A client of ours had $1 million in commission income, and the majority shareholder was looking to retire as soon as possible. The seller had a specialty book of business and was well known to several close competitors. One competitor had a clear early advantage in suggesting acquisition discussions because there was a personal relationship between the two individuals. On the basis of this relationship, the two principals had reached an initial agreement. The prospective acquirer, however, then turned the process over to his outside accountant. Unfortunately, the accountant dragged his feet with the discussions because of other commitments. The lack of progress frustrated the seller, who in turn contacted Harbor Capital for advice.
After we reviewed the offer, our advice was fairly straightforward. We believed that the offer, which our client had been willing to accept, was not competitive. While not eliminating this prospective acquirer as a potential buyer, our client agreed with our recommendation to present the acquisition opportunity to others. After receiving several very competitive offers, we did, at our client's request, go back to the original prospective purchaser, effectively giving him the right of first refusal. Unfortunately, he was not in a position to respond in a timely manner and lost the deal. The lesson learned is, as Yogi Berra might say, "A deal is not closed until it's closed." Getting complacent with the process and the pace of progress can be a big mistake if one is serious about converting an acquisition opportunity into a completed transaction.
Information and due diligence
Early access to information is another basic requirement in successfully managing the acquisition process. A client called us recently to discuss an acquisition target with which he and his partner had had several preliminary conversations. The principal contacted us when he became frustrated with his inability to respond to the seller's unsolicited proposal. His frustration stemmed from his attempt to reach a conclusion with very limited information, including an agency trial balance and the compensation requirements of the selling principal. The target agency was highly dependent on the selling principal, who desired to stay active and receive market compensation.
It was clear to us that our client did not have sufficient information to respond intelligently to the seller's proposal and was wasting valuable time and effort. The biggest unknowns revolved around the selling principal: how a transition could be accomplished and whether the book of business would stay in place. We decided that the only way to answer these questions was to conduct due diligence on the target to determine whether the business model was sustainable.
Many agents believe that they cannot compete when it comes to acquisitions. The reality is that they are not willing to accept any business risk and routinely put forward offers that are structured primarily on retention. In some cases, because of risk factors, a retention structure may be totally appropriate. In most cases, however, that kind of offer will not be competitive. In most cases, sellers expect a meaningful down payment. In our view, the reason that many buyers offer total retention deals is that they have not done the appropriate due diligence. The simple philosophy that "If the business is there, we will pay for it," does not excite most sellers.
Financing is essential
Having financing available is vital to a successful agency acquisition program. Some buyers actually offer sellers all-cash deals. They are able to make such offers because they have already arranged for financing from their banks and/or carriers. This strategy puts them way ahead of their competition in attracting sellers. We had an interesting deal several years ago in the Midwest when one of our clients offered an all-cash deal. Surprisingly, one seller who was attracted by the all-cash offer ultimately decided to take a payout because he did not need all the cash upfront and was reluctant to pay all the taxes at the closing.
An all-cash deal in most instances involves a lower purchase price than the competition would pay when using seller notes and/or retention deal structures. Many sellers prefer to close a transaction for fewer guaranteed dollars and have all the money in the bank rather than worry about the buyer's ability to perform under the purchase agreement and accept retention risks. A rigorous due diligence process takes much of the risk out of doing deals.
If one element distinguishes agencies with a successful acquisition track record from those that are constantly left at the altar, it is the fact that the successful agents have put a process in place. That process starts with a series of organized discussions to see if there is a fit between the two agencies and continues with the gathering of sufficient information on which to base an offer and the financial ability to execute it. *