AGENCY FINANCIAL MANAGEMENT
By Paul J. DiStefano, CPA, CPCU
Being up front with buyers saves time and builds trust
Preparation to sell an agency starts well before any discussions begin with potential acquirers. Understanding the factors of concern to a buyer is essential to ensuring a successful acquisition.
When agency principals begin to contemplate the sale of their agency, one of their first priorities is attempting to calculate precisely what a buyer should pay for the agency. While this is a question that must be resolved, it is in most cases premature and somewhat out of sequence from the buyer's perspective.
It goes without saying that buyers realize they will have to pay a fair market price to consummate a transaction, but they have more pressing concerns that must be addressed before purchase price discussions take place. Sellers should be aware that buyers need to evaluate many key factors relevant to an acquisition target. Sellers can help by providing prospective buyers with detailed information about the agency operation. For the transaction to proceed smoothly, sellers should be aware of the buyers' requirements and be prepared to respond to these requests either directly or with the assistance of an experienced intermediary.
Harbor Capital's financial consultants have seen many instances where a prospective buyer's request for information has given rise to a cat and mouse game. The seller wants to give out as little information as possible and would prefer that the buyer make a formal offer before the seller bares his soul. The buyer, on the other hand, is reluctant to put an offer on the table before having gathered sufficient information. Buyers think that presenting a premature offer can make altering that offer problematic, once initial fact-finding has been completed. I distinguish between fact-finding and formal due diligence. Fact-finding is the gathering of enough information about the acquisition target to construct an appropriate initial offer. Due diligence is the process of ascertaining that the information that was used to make an initial offer was in fact correct, and supported by the agency's books and records.
Critical factors
Prospective buyers look at many factors when considering an acquisition. Some of the critical pieces of information buyers typically require before constructing an initial acquisition offer are:
* Detailed historical financial statements
* Producer contractual arrangements
* Management depth and producer stability
* Client and specialty product concentration
* Sources and stability of profit-sharing income
* Market diversification and loss ratios
* Sources of commission growth
A key concern for prospective buyers is the agency's management team and key people. Sophisticated buyers do not simply acquire books of business; they acquire people. Buyers know that the stability of a book of business is largely a function of the agency's client relationships, and that these relationships in turn are a function of personal contact and service. Buyers' primary focus, when it comes to integrating management and key staff, often is acquiring the team of individuals who have contributed to the agency's success. Buyers want to ensure that the culture of the organization is maintained and that an orderly transition can take place over a reasonable period of time.
Producers' relationships and contractual agreements with the agency are extremely important. Buyers will want to know if producers have ownership rights with regard to their books of business and whether producers have executed non-compete agreements with the agency. The buyers' philosophy concerning acquisition is simple: They do not want to buy the business twice. Sellers should review producer agreements thoroughly when positioning an agency for sale. Our experience shows that attempting to resolve disputes over producer ownership issues at the eleventh hour, when a deal is about to close, can be extremely disruptive and costly to the selling principals.
From a financial standpoint, buyers will seek assurance that the agency's stream of cash flow and its profitability model are sustainable. Buyers will typically look critically at revenue components such as new business commissions vs. renewal price increases, contingent income and profit-sharing commission history, and concentration of revenue by client. From the buyers' perspective, one great year of profit-sharing commissions may not be sustainable, and accordingly buyers will look at the agency's historical profit-sharing commissions and compare those figures to industry averages.
Don't stonewall
Waffling and stonewalling when discussing these points is not recommended. Nothing turns a buyer off faster than a prospective seller's failure to respond to basic questions about agency management and finances. Perceived weaknesses in any of these areas are more easily handled in negotiations when sellers are armed with appropriate "talking points."
Many sophisticated prospective buyers have detailed questionnaires that they will ask a prospective seller to complete. Although agency principals may choose to delegate to a subordinate the task of responding to formal information requests, the principals should review all information to be shared with a potential acquirer to ensure its accuracy. Any confusing or misleading information will raise buyer questions and concerns, thus expanding the process of due diligence. We have seen cases where the selling principals did not take the information gathering process as seriously as they should have, which sends the wrong signals to the buyer. Sellers should not assume that buyers will have unlimited patience in waiting for relevant information.
Preparation to sell an agency starts well before any discussions begin with potential acquirers. Understanding the factors of concern to a buyer is essential to ensuring a successful acquisition. To prevent serious missteps in this critical process, agency principals may want to retain an experienced financial consultant to help them prepare for a sale. *
The author
Paul J. DiStefano is managing director of Harbor Capital Advisors, Inc., a New York-based national financial and management consulting firm that offers services to the insurance industry. Harbor Capital Advisors can be reached at (800) 858-2732; its Web site is www.harborcapitaladvisors.com.