AGENCY FINANCIAL MANAGEMENT
By Paul J. Di Stefano, CPA, CPCU, and Thomas Pepe
A careful assessment process can result in successful agency growth
Agency principals should take a long, hard look when making a decision to create additional offices.
When agency principals are attempting to grow an agency geographically, their most important decision is the justification for establishing a satellite office. Harbor Capital has found that agency principals are generally reluctant to create new startup offices, with initial cash flow concerns and management time requirements generally cited as reasons weighing against expansion.
If, however, agency principals are presented with an opportunity to hire producers or make acquisitions outside of their immediate geographical territory, the only logical option may be to establish or maintain an additional office. In many of these situations, the opportunities are compelling enough to pull the trigger. Nevertheless, agency principals should take a long, hard look at the details. The decision may be more complex than it initially appears on the surface, and there may implications that carry far into the future.
In many cases, the impetus for starting a new office is the availability of a successful producer in that area. It is not uncommon to create an office around one or more producers or, in some cases, a team of people. At first, the creation of a satellite office might appear to be a much less expensive and more controllable endeavor than an acquisition. However, if that were truly the case, it begs the question as to why the major national brokerage organizations typically acquire rather than opt for opening a branch office in a new geographical area.
The reality is that there are more opportunities to acquire existing agencies than there are to partner up with successful producers since most producers in that situation are looking for equity participation. From a structural standpoint, it is likely that a new entity will be formed to own all new business produced and/or purchased, which will enable the producers to have an equity stake in this new business opportunity. Alternatively, the producer may simply have an equity stake in his book of business.
When these opportunities arise, the critical question is how to structure a deal that is acceptable to both the agency and the producer. Harbor Capital recommends the preparation of an initial feasibility study, which would address the how, where and why questions of opening a satellite office, including revenue opportunities, staffing costs and infrastructure costs as well as the logistics of communicating with the home office.
This feasibility study is usually framed in very general terms and should serve as a prelude to a full-blown business plan. The business plan should be a three- to five-year roadmap for the new branch office and should take into account any changes to the home office. The business plan is a difficult and time-consuming procedure, but it is a step that must be taken since a lack of planning is one of the primary reasons that new business ventures are not successful. The following items must be considered when preparing a viable business plan:
* Projected realistic cash flows
* Management time allocated to the new office
* Potential impact on existing key company markets
* Targeted accounts and specialties in the new location
* Ability and timing of moving existing books of business
* Management and staffing issues
* Agency automation system expansion capabilities and related costs
It is a good exercise to prepare a realistic, five-year financial projection including all fixed and variable costs associated with the new venture. A break-even analysis should be carried out, taking into account all of the fixed costs, particularly lease commitments, which must be covered in a reasonable period of time by commission revenues.
A major question that is part of the feasibility study deals with the thorny issue of existing producer non-compete agreements. In some cases, there may be an opportunity to acquire the producer's book of business from his old agency. The producer's former agency may be realistic about the probability of keeping the producer's book of business and decide to sell it to the producer and/or his agency partner at a reasonable price.
It is best to avoid litigation in the hiring of a new producer. In many cases the producer may decide to wait out his non-compete and go after the business after it expires. This may appear to be costly, but if the producer's new business production is high, the cash flows may support this type of approach. If this approach is taken, it is critical to determine the realistic amount of the producer's business that ultimately may be captured.
The kinds of opportunities that may arise vary. For example, when a group of tested producers approached one of Harbor Capital's clients and proposed a new venture, the client set up an office 50 miles from its main operation. In this case, as in many others, entrepreneurial producers felt financially constrained in their existing relationships and decided that the only way to achieve adequate rewards was as equity owners.
In another example, a Harbor Capital client decided to fund a producer startup in an adjoining town. The decision-making in this case was rather straightforward since a new auto plant was being constructed in the area and the growth demographics surrounding the new plant were very attractive.
Another opportunity involved a high-powered producer who decided to leave one of the large public brokers and partner with a local agency that was able to provide him with both infrastructure and markets. The producer was confident that after his non-compete expired, he would be able to recapture most of his current book. In the interim, his new business production would create adequate cash flows to make the new venture viable. The producer's deal with the partnership agency included an equity stake for the partnership agency in the new venture. The deal worked for both parties because the partnership agency would benefit from the growth in value of the joint venture and the producer had the option of buying total control in the future if he desired.
In summary, agency principals should be prepared to respond to growth opportunities because industry relationships will sooner or later result in unexpected approaches. The key questions to ask when considering partnering with a producer are (1) how realistic are his revenue assumptions and (2) how should a deal be constructed that is equitable for both the agency and the producer. Creating a feasibility study and, ultimately, a detailed business plan is an absolute necessity in order to answer the questions that arise in evaluating an opportunity, as well as to avoid the possibility of endless red ink. *
The authors
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 and acquisition representation, strategic and management consulting.
Thomas Pepe is an associate director for Harbor Capital and was previously president of A.J. Gallagher of New Jersey. Tom was a partner at the time of the sale of his agency to A.J. Gallagher and spent six years with A.J. Gallagher.
Harbor Capital Advisors, Inc., can be reached in New York at (800) 858-2732 or visit its Web site at www.harborcapitaladvisors.com.