AGENCY FINANCIAL MANAGEMENT
By Paul J. DiStefano, CPA, CPCU
Understanding the entire process
As with all successful endeavors, selling your agency means utilizing a logical process to achieve one or more defined goals. The goals in the case of an agency sale usually encompass financial security, continuing cultural fit, continuing opportunities for key members of the agency, as well as perpetuation of client goodwill. While most sellers can easily enumerate these goals, they are usually much less focused on the details of the process.
Having represented many agency principals over the years, we have found that the common concern among our clients relates to understanding the various steps which they should anticipate and be prepared for in the process of selling their agency. Responding to this concern is fairly straightforward to the extent that we can certainly identify the general steps in the process. But in reality, the process is more complex since we are dealing with an emotionally charged endeavor. The principals of Harbor Capital, although serving as advisors in many agency transactions, never take the selling process for granted since we realize that our clients rarely go through this process more than once.
Acquisition profile
One of the initial steps in the process includes initiating the preparation of an acquisition profile. The acquisition profile is created in an attempt to provide, in a comprehensive fashion, the information necessary for potential buyers to make initial evaluations as to whether the selling agency fits within the acquirer's operations and strategic plans.
Some of the qualitative information included in the acquisition profile includes:
* Operational history of the agency
* Analysis of market relationships
* Account stratification
* Book of business analysis
* Presentation of sales and operating personnel
Some of the quantitative information included in the acquisition profile includes:
* Current and historical financial performance
* Pro forma financial statements
* Carriers' loss ratios
* Contingent income history
The preparation of the acquisition profile by a financial advisor, such as Harbor Capital, is important from two major standpoints. The first relates to the fact that the profile is probably one of the first opportunities that the selling principals have to view their agency in this type of comprehensive presentation. The profile puts a different perspective on the agency, with the agency principals now viewing the agency through the eyes of the potential buyer. We have found that reviewing this document with our client is an excellent first step in preparing for the sales process.
The profile gives selling principals the opportunity to prepare responses to questions which are likely to be raised from the information presented. The interpretation of the information is as important as the information itself and agency principals are the logical candidates to render those interpretations. For instance, trends in the agency's book of business become readily apparent in year-to-year comparisons which may be presented in the profile. Questions such as, "Where is the agency's future growth coming from and how much of that growth is new business versus hard market pricing increases?" require an in-depth interpretation.
The availability of an acquisition profile eliminates one of the major problems that many agency principals encounter when choosing to represent themselves--a lack of data which the buyer can review or worse, misleading data. Without the necessary correct data, a potential buyer is likely to make an uneducated offer which inevitably leads to a host of other problems.
Non-disclosure agreement
Confidentiality related to the selling process is also a natural concern of most clients. Because of the sensitive nature of the information contained in the acquisition profile, an important part of the process is the requirement that potential acquirers execute a comprehensive non-disclosure agreement.
Due diligence
Jumping ahead, once negotiations are complete and a letter of intent or term sheet has been prepared, the next part of the process that sellers should prepare for is due diligence. Due diligence is the process of verifying the accuracy of information received by the potential acquirer. Typically there are three parts to the due diligence process: operational, financial and legal. The financial due diligence usually proves to be the most extensive of the three.
In most cases, a buyer will have his accountant review the agency's financials. Some agencies have accountant-reviewed statements which are no more than compilations of the agency's trial balances. Other agencies use the actual trial balances generated from their agency management systems as financial management reports. Sellers should anticipate that the financial statements will be reviewed carefully and should be prepared to have all data reconciled well in advance of the due diligence phase.
The process of preparing the acquisition profile involves reviewing the agency's financials. Thus the financial advisor can address potential issues which may come up in due diligence. We have seen many cases where the agency's principals could decipher the agency's financials, but they would have been Greek to the buyer's accountants. One case in particular stands out where the prior year general ledger balances were not closed out. While the agency principal was quite comfortable manually adjusting these balances when assessing the agency's financial results, preparing for due diligence would be another matter. The necessary adjustments should be made long before due diligence commences, to avoid unnecessary concerns being articulated by the acquirer's auditors. Preparing an acquisition profile eliminates many of these potential problems.
Document preparation
The next phase after due diligence is preparation of transaction-related documents. Purchase and sale agreement, escrow agreement, promissory notes and employment agreements are all part of this process. Many clients get intimidated when a three- to four-inch thick set of documents arrives to be reviewed by the agency's lawyers and other professionals. The main concern, at this point, is whether the documents match the terms of the deal that was agreed to.
In many cases, issues may emerge that may not have been addressed earlier, such as what the appropriate cut-off date is for the split of revenue between the buyer and seller and the time frame for indemnifications. Clients should not be surprised that they will be required to provide indemnifications to the buyer, which typically cover obligations of the seller that may come to light after the close of the deal or misrepresentations related to the sale.
The preparation of an acquisition profile is a critical initial step in the sale of an agency and will help move the process through the negotiation phases of the transaction. Sellers often believe that once negotiations are over, the rest of the process consists of formalities. Sellers should be aware of the fact that due diligence and document preparation and review are all part of the package. Being prepared to go through all phases of the process will avoid missteps in closing what--for many agency principals--may be the largest transaction of their lives. In many cases, having a financial consultant available to guide agency principals through the process may be the difference between closing and not closing. *
The author
Paul J. Di Stefano, CPA, CPCU, is the managing director 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 representa-tion, strategic and management consulting. Harbor Capital Advisors, Inc., can be reached at (800) 858-2732 or www.harborcapitaladvisors.com.