View this article online: https://www.insurancejournal.com/magazines/mag-ideaexchange/2017/06/05/452778.htm
“I’m being bought out!”
“We’re merging with an agency five times our size that will take our revenue to a whole new level!”
While expressions of excitement like the ones above might be music to the ears of an owner considering selling an agency, beware!
When it comes to selling an insurance agency, I’ve heard my share of mixed results during 25-plus years working in the industry and underwriting specialty risk — often for insurance agents and brokers whose firms are in the process of merging or being acquired.
Some sellers happily sail into the sunset while others express regrets for a variety of reasons. Whatever the case, they all agree the process of closing a deal — which typically takes six months to a year or even longer depending on size — is both exhaustive and exhausting.
Among U.S. middle market agencies, mergers and acquisitions (M&As) reached the highest levels in more than a decade with 439 transactions in 2016 for a second consecutive year of record-breaking levels, according to research and data tracker SNL. All signs for 2017 indicate that the pace is continuing unabated with 114 transactions in the first quarter, up 15 percent from a year ago. Much of the frenzy is being driven not only by major insurance players looking for growth and greater profitability through consolidation but also by private equity firms. A prolonged soft market has made organic growth difficult and low interest rates create plenty of inexpensive capital to fuel M&As.
If your agency is doing well, chances are prospective buyers have already approached you. If you’re considering getting in on the action, here are a few guidelines that could mean the difference between success and failure.
It’s hard to resist people knocking on your door, complimenting your impressive business and inquiring about buying it. Like most owners, you’ve probably toiled for years to make your agency profitable, build a sizeable and loyal base of customers, secure contracts with key partners, develop your work force and keep up with technology. It’s flattering to see your hard work recognized, especially when the buyer is a reputable private investment firm or a major company you’ve admired from afar.
But don’t let the attention go to your head and be careful not to be overly swayed by the dollar signs. There’s so much more that goes into a transaction than the purchase price. Many agency owners have no idea what their companies are worth and buyers might try to low-ball you.
There are many ways to sell a business, probably more than you ever imagined.
Do you want to exit completely or stay on for additional years to be part of a bigger company? If you could, would you rather sell to your employees who have stood by through thick and thin? What’s really driving you — burnout, retirement or other business opportunities on the horizon?
Getting clear on what you really want and need from a financial and professional standpoint will make all the difference when considering various options.
For example, deals often include an earn-out provision based on future profitability or retention. One client was thrilled to be courted by a private equity firm until he realized that the new owners expected a five-year horizon at best and planned to flip the firm again to create additional value. Staying on through the pressures of another turbulent period only to see the firm sold again was not his idea of how to ease out gradually. On the other hand, another owner was attracted by the strategy of a global insurance broker that would allow her agency to operate essentially independently while enjoying the cost benefits of sharing back office services and the positive halo effect of being affiliated with an industry leader. Make sure to look beyond the transaction to the longer-term strategy and that it fits with your plans.
How do owners mistakenly cut corners the most when thinking of selling? They rarely take enough time to understand the agency’s worth or the steps needed to increase value and they don’t start the process early enough. Selling a business is not something to begin thinking about a few months in advance. It takes years of planning to make sure you hit all the key benchmarks that matter most to buyers in order to maximize valuation. Plain and simple, the earlier risks and vulnerabilities are identified, the more time you’ll have to address them.
Going through the process of determining a fair market price is good for both the eventual sale and for current business. Scrutinizing the books as extensively as a prospective buyer might forces you to focus on growth, streamline costs and eliminate the inefficiencies that impact profitability. The pre-sale stage also involves gathering and updating important documentation that any buyer will ask for during the due diligence period, including financial statements, operating agreements, current insurance policies, employee policies and contracts, particularly with key producers, and more.
While there are many ways to value a business, agency owners frequently estimate one or two times revenue. This is useful for ball-park purposes but resist relying on this simplistic approach because it’s earnings that will drive the sale price. If all of your earnings come from contingent commissions or profit shares, there is risk in purchasing your agency as its value is tied up in the profitability of its portfolio only. If you run expenses through the agency that might not otherwise be provided (like the country club at your vacation home) those expenses need to be taken out.
Understanding items that could negatively impact the sale before you approach the market allows you to address them ahead of time and put your agency in the best position. Everything from top producers without employee contracts to a lack of diversity with carrier relationships to a weak bench due to a lack of succession planning can drive your valuation down or sour a promising deal.
One of your best investments is hiring the appropriate people to advise you, including an M&A advisor seasoned in insurance deals, an attorney and a CPA. Seek their advice upfront when first starting to think about preparing your business for sale and during the transaction process.
Selling a business is time-consuming and distracting. The last thing you want to do is to take your eyes off operations, especially since performance will be a top priority for any buyer considering making an offer. Since the M&A advisor’s function is to sell the business, let them focus entirely on every aspect of making the sale from valuation to marketing to negotiation to closing. The advisor can facilitate letters of intent, deal points and purchase agreements to be reviewed by your attorney and CPA.
The advisor will also know how best to position the company and contact approved buyers through a blind profile, which describes a company without revealing its identity. For serious prospective buyers who have signed a confidentiality agreement, he or she will prepare a more detailed and compelling profile to educate them on your business.
The advice of other financial and legal advisors will prove equally invaluable. As one seller recently explained, “My M&A advisor suggested retaining ownership of some of the assets we were selling as collateral for the owner financing portion of the deal. But my tax attorney advised us not to go that route due to both tax implications and potential liability exposure from retaining partial ownership after closing.”
Remember that first impressions are everything, even in the quality of documentation. Having a team in place with updated company documents, financials and data available at a moment’s notice demonstrates that your agency is organized, professional and on top of business.
It’s imperative in the transaction that sellers and buyers are clear about who is responsible for existing liabilities, as well as current and future insurance. The best way to avoid misunderstandings or coverage gaps is to evaluate each active policy and to coordinate coverage. If it is an asset-only sale, the liabilities rest with the seller, even those of which you are not yet aware. Your existing insurance can be a great tool to protect you after the sale. Be sure to include your insurance agent or broker, who preferably is not you, in the discussions as early as possible to make sure you are properly protected.
Be aware that some policies turn into reporting only once a change of control or transaction has occurred. This is true for management and professional liability coverages. After the sale, wrongful acts are typically not covered unless you have specifically negotiated coverage with your carrier. You may also be covered under the new owner’s policy so think about the best place for this protection. You can purchase an extended reporting period to keep the policy in force for several years after the transaction to protect from those future unknown liabilities arising from acts that occurred under your ownership. If you’re told you’ll be covered under the new owner’s policy, make certain the coverage actually includes the prior firm.
If you do not address issues like these properly, you could be vulnerable going forward. The greatest risk is unidentified errors and omissions (E&O) claims. Perhaps an additional insured wasn’t added to a client’s coverage as requested. After sitting quietly in the file unnoticed, it suddenly becomes every owner’s worse nightmare. Nine months after the asset sale closed and your E&O coverage expired, a claim occurs for that client and the additional insured is not covered. The new owner says, “Not on my watch. That policy was placed by the prior firm.” If your E&O is no longer in force, the sale proceeds might end up being tapped to defend that client’s negligence claim. Another example is when an employee, unhappy with how they’re treated by the new owners, sues the buyer and seller for making promises about advancement that never came to fruition.
Planning, paperwork and protection are necessary considerations, but people are always the most important ingredient.
One key to a successful merger is culture. When the cultures of the two firms are similar, integration stands a much better chance of success. If you have an earn out, think ahead about fitting your team into the new structure so you’re able to meet financial goals.
Finally, don’t forget you’ve spent years building and cultivating important relationships with your employees, customers, partners and vendors. If you’re exiting the company, do as much as you can to leave them as well-positioned as possible.
One gesture that put a departing owner’s employees and key clients at ease was her taking the time to personally introduce them to the new owners. The buyers also appreciated the gesture as it gave them the opportunity to get to know the employees better and ensure clients that their accounts would continue to receive the same level of care and attention.
Your reputation is everything and all the more important if you decide to start a new venture. As the adage goes, people may forget what you said but will never forget how you made them feel. As the seller, your actions can go a long way toward making everyone feel great about the transaction.
Good luck and enjoy the sunset!