Most agency owners have put their time, energy and heart into building their business. The business is a part of their life. The sale of one’s business is usually a one-time event. It therefore makes sense to take the time and get it right the first time.
Just like building a business, there is no exact cookie cutter approach in selling the business. However, there are general guidelines to follow.
These seven steps outline the overall approach agents should take in selling their business.
Step One – Planning to sell
You wake up one day and realize it would be great to spend more time with your spouse, grandchildren or even playing golf. Perhaps, some client or underwriter gave you a hard time and you figure that was the straw that broke the camel’s back. You lost a key market and don’t have the energy or time to remarket your accounts.
It may seem funny, but situations like these are usually the trigger point for many owners to actually do something about selling their business.
When deciding to sell the business, an owner needs to see what the real expectations are. Selling a business is not like selling stock in General Motors. The agency is part of the owner’s life and it is not a simple commodity to trade.
Snap decisions to sell usually result in long drawn out negotiations or other complications. When an owner spends some time planning the sale of the business, many common problems are minimized or avoided.
The first step is to work on a plan to sell the business. Theoretically, this plan should be started the day one becomes an owner. More practically speaking, planning to sell the business should start at about five years out.
Planning should include a review and initial analysis of the areas covered in the next six steps in the process.
Step 2 – Whom to sell to
The thought process on whom to sell to is basically a decision tree. First, should the sale be internal (to someone in the agency) or external (to another agency or outside party)?
If the sale is to be internal, who are the candidates? Will new talent need to be brought in to help with the sale?
If the sale is to be external, will it be to a local agency, large regional agency versus, a publicly traded national broker or even a bank? It is a seller’s market–finding a buyer is not a problem. Finding the right buyer is what it is all about.
Regardless of the buyer, it is important to do a thorough compatibility analysis. The goal is to match up the expectations and philosophy of the buyer to the seller. This will lead to the next step.
Step Three — Hire professionals
Should the owner of a business research, analyze and buy insurance without an agent or broker? Most of the readers of this article would say “no.” Agents and brokers provide a value added service through their experience and training. Likewise, there are professionals that can greatly assist with the sale of a business.
The merger and acquisition consultant should be brought in early, to help in the planning process. A good consultant will advise on when to sell, whom to sell to and what to expect. Consulting firms that specialize in insurance agencies will work with sellers and buyers to determine the best fit so that any sale or acquisition is a win-win deal.
The qualified consultant should develop the framework for the deal, which will be refined by the certified public accountant and the attorney. The CPA is needed to review the terms of the deal to see the tax implications. In most cases, taxes are the main driver in the structure of the terms of a transaction. Attorneys should review the sale of any business. Often, the buyer is the party that drafts all the legal documents. The seller’s attorney is the final advocate for the seller in making sure that all is fair.
Step Four – Agency value
Many agency owners describe the value of an agency in terms of a multiple of revenue or commission. While this rule of thumb is useful, its limitations need to be understood.
The astute buyer will determine value as a multiple of profit–after reasonable income and expenses are established. The multiple of earnings typically ranges between 4.5 and 7.5 based on the perceived strengths and weakness of the agency or book of business.
Agency owners should always be conscious of how business decisions impact the value of the business. Owners should always strive to run the agency in a way to maximize value. This concept should be a fundamental part of the business perpetuation planning process.
It is important to keep in mind that value, price and net proceeds from a sale can all be different. Think of value as a theoretical benchmark. Price is the number of dollars agreed to between the buyer and seller, as what it will take to transfer ownership. Net proceeds from the sale are the actual dollars the seller can put in his or her pocket–after taxes, and after other expenses.
Step Five – What to sell
The question is: “should the owner sell the stock or the assets?” If the business is an “S” corporation, partnership, sole proprietorship or a LLC this step is usually straightforward–just sell the assets. For “C” corporations, that is another story.
A buyer will want to buy just the “assets” of the firm, which is just the good will of the book of business–sometimes called the expiration list. This is because it helps limit liability and the cost can be amortized over 15 years. Buying stock does not allow either of these goals.
Sellers want to sell the stock in a “C” corporation to receive only capital gains treatment and avoid the double tax (corporate and personal). Thus the tax man has set up the conflict between the buyer and the seller. If the buyer is willing to buy the stock of a “C” corporation, the seller should be willing to negotiate on price since the tax treatment is more favorable to them.
There are creative ways to structure a deal to minimize tax impact for both the buyer and the seller. Assigning value to consulting agreements and non-compete agreements is commonplace. Both are ordinary income to the seller and can be written off by the buyer. Some deals assign up to 50 percent of the value to these agreements.
In some cases assigning value to personal goodwill can be used. Personal goodwill is not owned by the business, but by the individual. Thus any gains from the sale of personal goodwill can be taxed under capital gains only–avoiding the corporate tax from the sale.
Also, the use of a deferred compensation plan could lower the value of the stock and thus lower the double tax. The buyer, however, is still obliged to pay the seller the deferred compensation, which is now an expense to the buyer that can be written off for tax purposes and just ordinary income to the seller.
Consult with a knowledgeable CPA to determine the best approach and the tax implications on the allocation.
If the business is a “C” corporation run, don’t walk to convert to an “S” corporation. Keep in mind there is still a 10-year transition period per IRS regulation before the owner can receive full “S” corporation tax treatment.
Step Six — Determine the terms
As a seller the goal is to get a fixed price with as much paid in cash as possible. As a buyer the goal is to put very little down and pay over several years a percentage of commissions as they renew. In other words, the buyer and the seller usually have opposite goals.
Most deals today tend to be asset deals based on retention of the business. Retention can be limited in scope to just the riskier parts of the book of business. Terms typically include a down payment of 10 percent to 30 percent with the balance paid out over three to seven years. The seller typically finances the sale of his or her own business. Keep in mind everything is negotiable.
There are many other terms that need to be negotiated and the list will vary. Most important, is the seller staying on?
Sellers that remain on for a period of time after the sale will need to have a clearly defined role and compensation plan for that role. There is no “typical” situation, but it is not uncommon to have the former owner help with the transition of the business for three to five years.
Step Seven — Close the deal
Once the terms are agreed to, a Letter of Intent should be drafted. This is a semi-formal document written in plain English that outlines the key components of the deal. Typically the mergers and acquisitions consultant will draft it and then both parties will sign it.
The Letter of Intent is the blueprint that the CPA and attorney will use to finalize all the documents. A word of caution, the Letter of Intent is intended to save time and money. It is the starting point for the CPA and attorney. Don’t let the CPA or attorney start all over again and renegotiate the deal.
As mentioned earlier, the buyer typically prepares all the necessary documents. The main document is the Purchase Agreement, but there could also be employment agreements, producer agreements, consulting agreements, separate non-compete agreements, personal guarantees, etc.
The seller’s attorney needs to review these documents and ensure that they meet the goals of the Letter of Intent and are in the best interest of the seller.
A Final Thought
Know up front, there will be bumps in the road. Despite all the planning, there is a good chance some unforeseen situation will pop up. These glitches should be handled using a professional systematic approach.
Remember, it is not personal, it’s just business. When it is all in place, sit back and relax. Enjoy the fruit of your labor.
Bill Schoeffler and Catherine Oak are partners at Oak & Associates. The firm specializes in financial and management consulting for independent insurance agents and brokers. They can be reached at (707) 935-6565, by e-mail at bill@oakandassociates.com, or visit www.oakandassociates.com
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