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Agency Financial Management Growth by acquisition Many agents overemphasize the “risk factor” By Paul J. Di Stefano, CPA,CPCU Everyone marvels at the continued sustained growth of the national brokers—10% to 20% annually for most of them, excluding extremely hard or soft markets. Yet, in a typical year their organic growth rate is in the range of 2% and 4%. Where is the additional growth of the national brokers coming from? The answer, of course, is by acquisition. Even though the national brokers are public companies and therefore have marketable securities to use for acquisitions, the reality is that most of these organizations would rather “do” cash deals than stock deals because stock deals are more dilutive to their earnings. One also might think that because of the financial leverage of these institutions, they could simply issue a secondary offering of stock to raise additional capital. The reality is that, in most cases, even the public brokers are utilizing lines of credit to do acquisitions. Surprisingly, many agents never include acquisitions in their business models. I believe that mergers and acquisitions is a concept that many agency principals have not taken the time to look at seriously. While some principals think that acquisitions have undue risk attached to them, those same agencies do not hesitate to hire new producers and put them on a draw or embark on expensive promotional programs. As we all know, the success rate for new producers historically has been low. Compounding the problem is the fact that many agency principals put off ending the negative cash flow associated with producers who have not validated themselves. On the other hand, the success rate of most acquisitions that we have been a part of has been excellent. The reality is that if structured properly, an acquisition should always provide the acquirer a return on its investment, the question being what level of return. If all goes according to plan, that return should be in double digits while even a poorly executed acquisition should provide single-digit returns. Other agencies, while presenting themselves as acquirers, will consider only acquisitions that can be structured on a total retention basis, i.e., paying a seller a percentage of future commission as received with no cash up front. In the competitive market for acquisition, this type of approach is likely to attract only potentially troubled situations. If an agency has never completed an acquisition, the assistance of a merger and acquisition consultant can give the prospective acquirer the tools needed to evaluate and structure a competitive but reasonable deal. Recently, Harbor Capital was contacted by an agent who had begun conversations with a competitor’s agency that appeared to be an excellent fit. He wanted to make sure that he approached the process correctly to enhance his chances of completing this acquisition. In this case, our client was already way ahead of the game since the seller had indicated that he would like to be paid out over a number of years. Typically, one of the greatest challenges of completing an acquisition is coming up with enough cash for a down payment and funding the future cash flows. In some cases, the buyer has sufficient cash on hand to fund the down payment or maintains lines of credit that can be used for virtually any reason, including acquisitions. If the purchase is large enough, traditional bank financing may be necessary, but there are other sources. There is really no excuse when it comes to raising money. In one case, a client of ours actually mortgaged his house to come up with the down payment. We worked with the principals of another agency who were contem-plating an acquisition in order to build back what was formerly a larger agency platform. For a number of years, our client had one very substantial account that generated over half the client’s commission income. Unfortunately, our client lost that account due to an acquisition. As it turned out, our client had made significant investments in commercial real estate from the profits generated by the big account. Our client’s method of financing the deal was to mortgage some of the properties because the rates of interest on a secured mortgage loan were much more attractive than traditional bank financing. One mistake made by many prospective buyers is to expect to realize immediate positive cash flow from Day One of the deal. The reality is that when you buy a book of business, you are purchasing a capital asset. When the buyout is completed, that asset should, at a minimum, retain a substantial portion of its original value after considering the normal attrition that takes place in any book of business. The fact that it may not generate immediate cash flow is no measure of whether or not the acquisition is a good deal. Acquisitions do many things for an agency. If both parties to a transaction have similar markets, that enables the acquirer to feed its markets with business, which is one of the major challenges most agencies face. The acquisition also may bring some additional markets desired by the acquirer’s agency, which have been precluded by a lack of sufficient volume. In both of these situations, another positive is the ability to enhance profit-sharing payments. Acquisitions may also present an opportunity to acquire talent since hiring qualified people, even under the best circumstances, can be problematic. We did some valuation work for an agency recently and were struck with the fact that considering its relative size, this agency had completed many acquisitions. When I inquired as to what made him so successful, the agent’s answer was simple: “People know that I am honest and are confident that they will be fully paid.” Talk about differentiating your agency! When an opportunity arises, shame on both parties if the deal is not completed. While there certainly are cases where the seller is completely unreasonable, the vast majority of sellers demand only a fair deal. Completing even one acquisition can have a major impact on the future of your agency. As an acquirer, your philosophy should be that if an acquisition is available, there is no reason why your agency can’t be the one to complete it. While you may never achieve the success of one of the publicly traded brokers, why not emulate one of the strategies that have made them successful? * The author |
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