Inside-Outside Game: Is an Internal Offer Really Worth Less Than an External?

By Scott Freiday | August 3, 2022
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Independent agency sale transactions are continuing at a strong pace in 2022. Organic growth rates and profitability are booming, according to Reagan Consulting. Those financial drivers continue to steer agency merger-and-acquisition prices upward.

In this environment, some agency principals are looking for a game plan to sell their firm, whether to an outside buyer (such as a strategic investor or a private-equity investor) or an inside buyer (through an agency perpetuation—continuing the independent agency as it exists but with new leadership).

Agency principals may perceive an outside sale as more lucrative than a perpetuation. But is an internal offer really worth less than an external? An internal offer to perpetuate an agency can be as appealing as an external sale or even more so. Here’s a look at why.

While the financial terms of the sale are always a top consideration, the price tag is only one of the key considerations for an agency owner. Some of the others typically are:

  • The selling owner’s role in the agency after the sale.
  • The timeline for the transaction (especially for the selling owner).

Start with Goals

Agency owners looking to sell who look at the price tags of other merger-and-acquisition transactions in the marketplace are in essence starting at the finish line. Instead of doing that, it’s productive to start by looking at goals for 1) the owner and 2) the future of the agency.

Those aspirations provide a guiding light through the sometimes-complicated process of deciding upon an agency sale or perpetuation transaction. Questions to ask include: Do I want to continue working or retire outright? What responsibility if any do I want to take after I sell to a third party or perpetuate my agency to an internal buyer?

Understand How Inside & Outside Buyers Can Differ

While any potential buyer covets the potential growth and profitability of a target agency, a handy way to categorize agency buyers is to divide them into inside buyers and outside buyers.

Internal buyers are those already working within an agency, and usually become owners through the principal’s decision to perpetuate. Commonly, inside buyers are family members and/or producers or other key employees working at the agency.

External buyers come in a couple variations. First is the private equity (“PE”) buyer, who is not necessarily familiar to an agency owner but is attracted by the agency’s financial performance, growth prospects, and/or market share. Some PE buyers acquire an agency to merge its operations into another. In fact, some sellers perceive that PE buyers are making “book of business purchases.” It’s often true, though, that PE buyers want the seller involved after the sale to run that book of business, continue to manage results, or take on a sales role.

A second type of outside buyer is the strategic buyer. Possibly already known to the owner, he or she might be a peer from a nearby geographic area or even the same city. Like a perpetuation buyer, a strategic buyer is likely to carry on an acquired agency’s operations as they are. However, it’s also possible the strategic buyer might want to change the name of the agency, consolidate operations, or make other changes. Strategic buyers might be less likely to want a selling owner to remain on, since these buyers are involved in the agency business already and might not need the support that a perpetuation buyer might want.

Look at Non-Financial Factors Driving Value

A sale to a third-party buyer may seem to have the highest number at first look. But there could be non-financial factors at play. A private-equity buyer, for example, might fold the agency into another. This may mean the agency location may close, employee arrangements may change, agency branding may shift, and so on. An external buyer also might feel less obliged to continue the agency’s community involvement. A selling principal needs to consider those factors in light of the goals he or she has set.

Examine the Earnout Component

An issue with outside buyers, often with PE deals, is the “earnout component” in the sale. These earnouts are payments triggered if the seller helps the agency hit financial targets after the sale.

Those targets can be ambitious to hit. So while PE deals might sound initially like big-dollar transactions, an outside observer might not really know how that earnout affects the price the seller gets. (Keep in mind that any agency merger-and-acquisition information available through word of mouth is usually incomplete.)

Recognize Post-Sale Role in Perpetuation

For owners thinking about an agency perpetuation, it’s vital to discuss those ambitions with potential buyers as early as possible. This can help uncover how much interest they have in being future agency owners. Having those conversations can clarify what’s possible.

Perpetuation deals, as with any transaction, also involve a transition for the selling owner. Both the seller’s role and the transaction timeline are important here. The selling owner might take a role as a mentor, produce business, work as a consultant, and/or take other responsibilities while the new owners work into to their new roles. That transition role likely would be specified in the purchase agreement.

Staged perpetuations (those that take place over several years through two or more steps) can be appealing to owners who want to get out of the agency gradually. They can result in prices equivalent to or even more than an external sale by cashing in on a portion of ownership now and building shareholder value as the agency grows. Those shares could be worth more down the road and the principal continues to benefit from the agency’s cash flow while remaining a partial owner.

But owners who want to exit the business quickly might be more amenable to selling to a third party with no involvement after the sale. However, owners who make an outside sale without setting a plan for their career after selling their agency sometimes want to get back into the agency business after a couple of years—having experienced “seller’s remorse.”

For any agency sale, it can help to think of the owner’s role in terms of his or her “runway”: The principal may be taking off by selling the agency, but if they haven’t decided fully on a destination they might not be satisfied with where they land.

Think About Tax Treatment

One other consideration for any agency owner is the tax treatment of the sale. For instance, a staged perpetuation can allow the owner to receive sale proceeds staggered over a period of years, which can be attractive not just for tax reasons but also financial reasons.

Whatever thoughts an agency owner has today about a future sale or perpetuation, the strongest advice I give to anyone is to take a broad view of the three factors: financial terms, the selling owner’s role after the sale, and the transaction timeline.

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