AGENCY FINANCIAL MANAGEMENT
By Paul J. Di Stefano, CPA, CPCU
Balancing the needs of both buyer and seller
can be the key to a successful deal
Successful acquirers think outside the box and thus are able to consummate transactions in large part because of efforts they make to meet the particular needs expressed by the seller.
Several weeks ago, I had an interesting conversation with an agency principal who had expressed interest in acquiring one of Harbor Capital's clients. This agency principal previously had completed a small number of acquisitions through direct negotiations with the seller but had not completed a transaction in which the seller was represented by an intermediary such as Harbor Capital. So he asked to be walked through our method for handling the acquisition process.
I was not particularly surprised at his request, since his question was reflective of concerns occasionally expressed in the past by agency principals who incorrectly view the merger and acquisition process as a veritable auction when an intermediary is involved. I explained to him that as an experienced intermediary, Harbor Capital's view of the process is quite different. While maximizing shareholder value is certainly an important factor, it is by no means the only factor to be considered when consummating an agency transaction. Harbor Capital's philosophy in structuring viable deals is to begin the process by exposing our clients to the most viable opportunities. We then assist the client in weighing the pros and cons associated with each and then pursuing those that represent the most attractive operational fit with our client. Our experience would dictate that the opportunities with the clearest operational fit will also be among the most attractive financially. The ultimate deciding factor will be the best combination of operational fit and financial structure.
As one would imagine, in its role as merger and acquisition intermediary, Harbor Capital Advisors finds itself in a unique position to view first-hand the approach that potential acquirers utilize in pursuing agency acquisitions. Unfortunately, many would-be acquirers approach the process with a bit of tunnel vision. They make the mistake of attempting to structure the transaction solely from their own point of view in a way that attempts to insulate the acquiring agency from all financial risk. The reality is that successful negotiations should begin with the premise that both parties to the transaction must have their needs met. Successful acquirers think outside the box and thus are able to consummate transactions in large part because of efforts they make to meet the particular needs expressed by the seller.
For that reason, it is of utmost importance to understand what the particular hot buttons are for the other side to the transaction. For example, those hot buttons may include some of the following: the security of a guaranteed transaction, capturing an upside potential in a work out structure, partnership in a larger agency with more resources as well as general perpetuation concerns.
An example of thinking outside the box is demonstrated in a recent Harbor Capital M&A assignment. This scenario involved two agency principals who, after considering their alternatives, decided to retain Harbor Capital to contact potential acquirers. One of the major issues that our client faced was a lack of markets. Due to the agency's size and location, several key markets had canceled agency agreements, thus impairing the agency's ability to write new business and forcing the agency to work through wholesalers at lower commission rates. An additional issue was related to the difference in age of the two principals and divergent personal wish lists and objectives. The older principal was open to two options: to work on a modified schedule or to depart after a transition. The younger principal wanted an infrastructure in which he could maximize his talents as a producer.
In discussions with our client, local agency competitors were ruled out as potential acquirers early in the process, so that a roll-in transaction would not be a consideration. The buyer would have to be a regional agency which desired to maintain our client's office location with the concession that account processing could be handled off site. Harbor Capital proceeded to open discussions on behalf of our client with four distinct agencies with varying business models, all of which had the potential to fit with the personal objectives of the seller.
I have attempted with the following summaries to give the reader an insight into the thinking behind the approaches taken by the four potential acquirers in structuring a transaction. In general, all four potential buyers would bring access to needed markets. More important, several of the potential acquirers clearly recognized and addressed the hot buttons of the selling principals.
Acquirer I took the approach that the age difference between the two principals dictated a different approach for each. The older majority principal was offered a cash buyout while the younger minority partner was offered a partial buyout and a continuing but reduced equity stake in the agency. The rationale for the continuing equity stake for the producer was the ability of the acquirer to generate a substantial amount of new business by having the new location. The equity stake was attractive to the producer since it had the potential of growing in value quite dramatically over the next few years since the producer could easily capitalize on this new source of business.
Acquirer II took an unusual approach that included a purchase of a portion of the agency's expiration list equivalent to the equity of the majority shareholder. The purchase would be achieved with cash and notes. This approach left the corporate structure of the agency in place and enabled the minority shareholder to retain his equity holdings. An agreed amount of net commissions would be retained by the agency with the balance of revenues captured by the acquirer. Thus the younger principal continued to own the agency stock and could agree to allocate compensation as desired.
Acquirer III's approach entailed an all upfront cash purchase of the assets of the agency. The younger principal would be given a draw for the next several years until commissions on new and renewal business validated the draw. Acquirer III had a sophisticated telemarketing division which would provide a proven source of excellent leads to the producer.
Acquirer IV's approach was a straightforward all-retention transaction. As a multiple of revenue, this offer at first blush would seem to be a potentially more attractive until one calculated a realistic attrition rate on the existing book of business. In addition, in this case, the acquirer was a bit shortsighted in not offering a draw for the producer against new business production or a commission on the agency's renewal business. The buyer's expectation was that the producer would live off the cash flow from the purchase price until he was able to grow his book. Unfortunately, other than providing markets, this acquirer would provide little assistance in new business production. This offer had the least credibility, and we viewed it as more of a "Hail Mary" pass.
As you can readily see from the above approaches, most have one or more uniquely attractive features from the seller's perspective which are based on either the unique business models of the acquirer and/or the structure of the transaction. The key to success as a buyer is combining the most compatible aspects of the acquirer's business with the goals and personal desires of the seller.
In summary, the structure of a transaction should be based on the wish list of the seller or merger partner as closely as possible. To some extent, the value of a transaction is in the eye of the beholder--in this case the seller. Upside protection may be more important than current dollars in a transaction. On the other hand, security of a payout may be more important than maximizing the purchase price. The role of active agency principals could prove a flash point. To effectively address these needs, the pursuing agency must first understand what drives the selling principals. *
The author
Paul J. Di Stefano, CPA, CPCU, is the managing diector 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, and its Web site can be visited at www.harborcapitaladvisors.com.