Agency Financial Management
Seller transparency: The threshold of acquisitions
Don't dive in the water if you can't see the bottom
By Rick Dennen
What is supposed to be a fun and relaxing day at the lake with friends and family can quickly turn into a tragedy. The most experienced swimmers can end up with serious injuries from diving into shallow waters. That's why diving safety measures recommend that people always know the depth of water before diving. Even when in doubt, people should test the waters first by wading in.
The same is true for agency acquisitions. Like diving in uncertain waters, acquiring a business without first getting an in-depth view is a risk that's not worth taking. In both cases, if you can't see the bottom, you shouldn't dive in—plain and simple.
While an agency acquisition is supposed to produce positive results by helping an insurance business grow and meet other goals, unfortunate stories about agency principals who acquire poorly performing businesses are not uncommon. Despite countless white papers, articles, webinars and other resources that stress proper due diligence before an acquisition, there are still too many deals that go sour for buyers.
So why is there still a problem? Owners fall victim to what I consider our industry's version of "predatory selling." They accept the seller's refusal to make critical information available to potential buyers. Instead of demanding full disclosure or walking away, buyers succumb to accepting a certain amount of risk to get in the M&A game—usually more risk than they planned to accept.
Seller transparency must be established at the beginning of an acquisition process. Even though sellers won't disclose sensitive information in the very early stages of research, buyers should still set expectations for accessing this information as a potential transaction becomes more probable. A seller who is reticent about sharing information is sending a warning sign that should be heeded by buyers. And sellers who take this posture about disclosure should expect a smaller pool of buyers and a lower sell price resulting from the increased risks. Without proper due diligence it's impossible to get in-depth insight into the following:
Likelihood of future relationships. No insight into carrier contracts provides no means to verify commissions and no guarantee of transferability. What's more, you won't know if employees are listed on carrier contracts allowing them to claim ownership of policies.
Employee loyalty. You'll be in the dark regarding how employees feel about an acquisition. You won't know if employee producers have signed an employment agreement with non-solicitation and non-competition language or if agreement provisions are even enforceable under your state laws. Without protective provisions, employee producers may view an acquisition as an opportunity to take clients and books of business for their own benefit.
Estimate of future returns on your investment. You can't accurately estimate retention levels for customers, employees and contracts. You won't know who key customers are, their revenue or loyalty to the agency. Without policy detail and history, you won't be able to forecast the future performance of the book.
Many sellers want to open up only a few details of their business to potential buyers. They've probably never been in a position that required the disclosure of such sensitive, confidential information. Like any owner, they feel it makes them vulnerable to competition. The last thing they need is for a buyer to pursue their customers and book of business during a sale process.
Other sellers may commit to transparency early on but later have a change of heart and slow or stop the flow of information with excuses, canceled meetings and other measures. Sadly, buyers often accept this behavior and mistakenly believe transparency isn't an option, so they don't even ask for appropriate information. The exchange of confidential information, however, is vital to the success of the acquisition.
So how do buyers and sellers find a happy medium between the need for in-depth insight and the fear of exposure? A nondisclosure agreement (NDA) or confidentiality agreement with some teeth can protect a seller's business in the event a sale doesn't materialize. Asking a seller to sign an NDA demonstrates that the buyer is serious and is interested in protecting the seller's confidential information. It's advisable to have an NDA drafted and reviewed by an experienced attorney to ensure it covers the interests of both parties.
The acquisition process can have positive outcomes for buyers and sellers, but transparency cannot be compromised. Be sure you have an unobstructed, clear view of a business before you take the plunge.
N.B.:The materials in this article are for informational purposes only. They are not offered as and do not constitute an offer for a loan, professional or legal advice or legal opinion and should not be used as a substitute for obtaining professional or legal advice
Rick Dennen is president and CEO of Oak Street Funding, which provides commission-based lending for insurance agents that need capital to buy, build or sell their agency. Dennen is a licensed certified public accountant in the State of Indiana. He can be reached at email@example.com.