Be Better, Not Just Bigger: Reviewing Top Five Compatibility Issues

August 9, 2004 by

The first step to a successful merger, acquisition or cluster is to determine the compatibility of the firms. Our observation is that when transactions fail the reason is usually poor compatibility.

The “urge-to-merge” is often based on satisfying market volume requirements. Compatibility goes way beyond having the same markets. The goal in any transaction should be to create not just a bigger firm but also a better firm. The best way to understand compatibility is to compare a business combination to a marriage. A long lasting and good marriage will be preceded by an effective exploration of each other during the romance stage.

Business combinations and marriages fail when the parties ignore or downplay compatibility conflicts. It is typical human nature to think that things will work out, so sticky topics are sometimes not even discussed. This is why it is important to use a professional third party for advice on compatibility. They will be able to ask the tough questions, see the issues from an unbiased position, and use their experience to ensure all the topics are explored.

In our experience with our clients over the years, there are five “hot topics” that seem to be the deal makers and deal breakers. A complete analysis of these five topics will allow us to know whether or not the parties are a good “fit.”

Personal goals/wish lists
Each owner in each firm should make a list of their own personal goals and wish lists for their future. The list needs to include: compensation expectations, the management and sales role they want, perks they expect, the hours they want to work and vision for the future of the firm.

If the owners are nearing retirement age, they should also be very specific about: when they expect to retire; what future duties they want to have; what price they expect for their stock and what “perks” they expect to receive until they fully retire. If the owners want to internally perpetuate, their expectations for buy-out should be realistic in relation to the cash flow available from the firm’s activities.

Internal perpetuation may not be an alternative if the appropriate perpetuation candidates are not available to manage the firm and sell and service new accounts. Also the firm may not be able to support the financial burden of the buy-out. In either case, a sale of the firm to a third party or a merger or cluster arrangement may be necessary.

Major strengths and weaknesses
Each party should make two lists. The first list is their own personal major strengths and weaknesses and a second list of strengths and weaknesses for their firm. These lists should then be exchanged with the other party or parties.

The goal is to see if each party will complement the other by minimizing weaknesses and maximizing strengths. It may be very apparent from such an analysis that the combination may just make each party’s weaknesses worse and/or will not help improve the problems each firm faces.

Organizational structure
If two firms’ operations are set up too differently, a business combination may not work. The organizational structure of a firm often reflects the philosophies of management and the talents available of the individuals employed.

Creating the new structure of a business combination may be tricky. A third party can greatly assist. Each party is usually too close to their own operations and employees to be unbiased when evaluating the organizational structure and employees of each firm. The owners may also be too focused on their own management style to have the vision on what will be the best for the new entity.

The variety of operational structures a firm may include: one firm’s belief in having a small commercial accounts unit that services and sells all accounts under a certain size, versus having all CSRs handle small accounts. Another may believe in centralization of the marketing/placement function versus everyone doing their own marketing. Still another firm may believe producers should handle the majority of the servicing of accounts versus hiring qualified CSRs to support producers.

The philosophies on these operational issues need to be discussed, explored and agreement reached as to how the combined entity would handle each of the following six functions for life, group, personal and commercial lines business: sales, marketing/placement, client service, claims, accounting and administration.

Book of business and market analysis
Each party needs to develop a good profile of their firm’s markets and book of business. This topic usually invokes the most discussion since they are often the reason for the business combination.

The market analysis starts off with a list of the top 10 companies represented by each firm.

Information for each insurance company should include: premium or commission volumes, three years of loss ratios and contingency commissions paid, volume commitments made, preferred status or special profit sharing agreements, solvency of carrier and years appointed.

A good analysis of each firm’s book of business would include:

• What split does each firm have by line of business?
• What is the average size of account by line of business?
• What target markets, areas of expertise and specialties do the producers in each entity have?
• How well developed are the existing accounts written by each firm?
• What is the attrition rate of the accounts by line of business?
• What classes of business are the top 10 commercial accounts and how much volume do they represent?
• Is there much non-owned or brokered business that may affect markets represented?

When determining compatibility, a complementary combination may be the best approach, rather than more of the same. This analysis will also be the foundation to determine the sales growth potential of the new entity.

Compensation, perks and contracts
Comparing the current compensation packages for employees, producers and owners of each firm is important. It is often difficult to change compensation plans, especially for key employees (such as owners, producers or managers), without adversely affecting their desire to stay in the new entity.

On the other hand, it is also difficult to have one entity support two very different compensation plans for owners, producers, key managers or salary differences for employees having similar jobs. It is imperative to resolve any differences in advance of the final decision to combine.

Each firm should also share the contracts that are signed by the partners, producers and other employees in the firm.

Today it is also becoming more common for all employees to sign non-piracy agreements to protect the firm’s book of business and trade secrets. Some contracts may allow producers to vest in their books of business and some may actually allow producers to obtain equity in the firm at a later date (stock options).

The new entity should come to an agreement as to what the standard contracts will look like that will need to be signed by producers and all employees.

Summary
The five “hot topics” are by no means fully inclusive of all the issues. They are, however, mandatory issues to discuss.

Other key areas that should be covered include: the financial status of each firm, reputations in the community and within the industry, exploring chemistry between the personalities and evaluating potential synergy between the firms. Information needs to be identified and communicated honestly and openly. Often during these discussions, our clients learn something new about themselves, not just the other party.

Keep in mind that a business combination is like a marriage. Owners that put the effort into reviewing all the positives and negatives with their potential business partners will find that they have fewer problems downstream. If the “urge-to-merge” is acted upon after a complete analysis of these key compatibility topics, they will not only be bigger, but better!

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@oakandas-sociates.com, or visit: www.oakandassociates.com.