Preparing to Sell or Merge the Agency

One of the most difficult decisions that an owner will have to make is to sell their agency or merge with another party. The typical owner has spent more time working and building up the business than they have with their own family. In fact, the business is often a second family. However, having made this choice, the next step will be to prepare to sell or merge the agency.

The key to negotiating a great deal is superb preparation before you step into the market place. Jumping in without doing your homework is a poor strategy when the stakes are high—namely the owner’s life’s work. Preparing the business for sale or merger is not an overnight process. It can take months, if not years, of planning to maximize the bargaining position and the return on equity.

The best way to accomplish this is to address weaknesses and capitalize on strengths before presenting the business for sale or merger. Always assume that any potential buyer will do a thorough job of due diligence, which will ultimately uncover weaknesses. Proper planning will identify current problem areas and help determine how to fix them and/or treat them in discussions with buyers or merger candidates.

Factors affecting value
“People overvalue what they are not and undervalue what they are,” Malcolm Forbes, said. Too many owners base their agency’s worth on “sweat equity.” They put value into the years of hard work and high emotion that they have invested in their business. Unfortunately this is not what a buyer is interested in purchasing.

Over the years, we have written numerous articles on the key ingredients in agency value and the process to estimate value. It would be difficult to summarize these thoughts into a sentence or two, but here is a try. In most cases, the value of a business is based on the perceived ability of a buyer to generate a profit. The ability to generate a profit is derived from many factors of which income and expenses are the most obvious but certainly not the only factors.

The phrase “timing is everything” is especially true when selling or merging a business. Is the best time to sell/merge now at the peak of the hard market or in two years after premium rate increases level off or even drop 25 percent causing a drop in commission income from existing accounts? What is the future for the national and local economy and market conditions? What is the owner/seller’s tolerance for risk based on their current life needs and expectations into the future?

As earnings are reaching record levels and next year looks promising as well, most owners are not thinking about selling. Yet, when owners least want to sell, their company may command the highest value. The lesson learned is to sell during growth, not after it. Buyers tend to extend the past into the future and pay more when historical revenues and earnings are trending upward.

Create an agency profile
The purpose of creating an agency profile is twofold. First, it serves as a document that the buyer can use as a platform to understanding the unique features of the seller. This profile will save both parties a lot of time. The second (and perhaps the most important) purpose of creating the agency profile is that the process will help the seller better understand the unique features, strengths and weaknesses of their firm.

The first section of the profile should contain a thumbnail sketch of the operational fundamentals of the agency. Write a brief history of the firm and the background of the principals and key personnel. Develop an organizational chart, and provide the positions, salaries and start dates of all employees. Outline the profile of all producers’ book of business, compensation, contract details, vesting, etc.

Write an overview of the book of business and if there are any specialties/programs. A breakdown of the book by line of business is also helpful. The profile would also have a breakdown of at least the top 10 insurance carriers, loss ratios, contingent history and type of business placed with each carrier.

Do a third party pro forma analysis
In most cases, financial statements of privately held companies are designed to minimize taxable income in any given year. There may be non-recurring or non-operating expenses that would not be considered ordinary business expenses. It is possible to reconstruct financial statements to show the true historical income to give a more accurate picture of future performance, which directly affects value.

When recasting income statements, owners will find that most adjustments fall into one of the following categories:
• Non-recurring items such as one-time purchases, unusual bad debts or litigation expenses.
• Related-party transactions or other transactions not representing arm’s length or market value. In other words, try to adjust the owner’s compensation to reflect a third parties approach.
• Adjustments to eliminate income or losses from non-operating assets, including dividends from securities, CD interest income, and gains and losses on their sale.
• The balance sheet should also be adjusted for non-operating assets or items the buyer might consider undesirable. Examples might include loans to or from employees, excess equipment, cash value of life insurance policies or marketable securities.
• If the business owns real estate, the seller may want to place the asset in a separate corporation and enter into a lease with the buyer at market rent.

Obtain professional advice/help
In most cases, it is helpful to retain an advisor who can help prepare both the business and owner for the sale or merger process. Specifically, the seller’s representative can:
• Prepare a preliminary valuation to determine the asking price or merger value.
• Consider different transaction structures and the tax consequences of each.
• Identify and contact confidentially logical buyers or merger candidates.
• Evaluate any proposed transactions.
• Assist with negotiation and closing.

Getting the business in shape
Much like a house, a business will sell at a higher price if everything is neat, organized and in working order. Here are a few tips:
• Clean up any old bad business habits.
• Eliminate functional problems.
• Generate and keep records and management reports current.
• Prepare a business plan or budget for the prospective year(s), if time permits.
• Prepare an organization chart.
• Document the producer sales efforts and workloads of the staff.
• Write an explanation of how sales are generated; make promotional materials available.

Pick the best “fit” compatibility-wise
A seller needs to explore several options. The key will be to look at several prospects or have a consultant to help you in the process or doing so. Finding the best overall “fit” for the firm with another party does not often occur on the first try. It is not always finding the buyer/merger firm that will pay the most money. It is actually more important to find a party that will make the transition and future life together the smoothest and the most beneficial for both parties.

These are all things to think about in the sale and merger process. Selling a business can be hard emotionally, but if approached properly it will also be seamless and rewarding. Keep in mind the buyer is looking at purchasing cash flow and it is not a direct judgment on the seller’s business or insurance skills.

Bill Schoeffler and Catherine Oak are partners in the international consulting firm, Oak & Associates. They can be reached at (707) 935-6565, by e-mail at bill@oakandassociates.com, or visit: www.oakandassociates.com.