The time comes in every agent’s life when he considers cashing out. This can be for any number of reasons such as the desire to spend time with friends and family, for health reasons or even just the desire to do other things. He has built his career selling and servicing insurance and has made a good living doing so – but every agent has (or should have) considered his business like a herd of dairy cows.
Whether you inherit your herd, buy it from your father or from someone else or begin with a single cow and grow your herd “the hard way,” you earn your living from the products of the herd. But growing the herd enhances its inherent value as well. No farmer would consider just walking away from the herd when retirement beckons. Not only does the herd need tending every day, but there is value in the herd’s perpetuation. Similarly, every agent has built a value while he has earned his living and it would be ludicrous to simply stop servicing the clients and telling them to get insurance elsewhere.
So, whether the agency has been built on sub-standard auto risks, on life and health insurance products or on personal and/or commercial lines of business, sufficient value exists to make a sale a worthwhile activity for the agent to provide for his retirement or for his heirs.
There was a time when every agent expected to sell his agency for two times its revenue. When those transactions were made, half of them cheated the buyer and the other half cheated the seller. In all but rare instances, the “two times formula” was simply not justified by the earnings that the buyer could expect to generate from the agency over a reasonable period of time.
If you take nothing more from this article, be sure you understand that the value of an agency (or of any business) is defined by its potential earnings over a period of time that is justified by the buyer during which he is willing to take little or no earnings (profits after tax) from the transaction.
The interesting part of all transactions is that every buyer will have a different set of criteria that determines his earnings potential or the amount of time he is willing to abate earnings potential from the business in order to sponsor its purchase. This means that five different potential buyers will legitimately have five different offers for an agency (if they have done their homework properly) based on their own criteria. What kind of “criteria?”
The easiest criteria to explain is based on location and staff. If one buyer wants to become the agent’s replacement and has no existing agency, he must keep the office in place and all of the staff, simply replacing the owner’s expense with his own. Since either the old owner or the new would work to administer the agency, their reasonable compensation is a part of agency costs rather than after tax earnings. Whatever the earnings that the old owner has taken each year will be the earnings (profit after taxes) that the new owner takes, and that is all he has to use to value the agency. If the agency throws off $50,000/year in earnings, that is all that the new owner can spend for the cost of the agency multiplied by the number of years he is willing NOT to take profits for himself. It simply doesn’t make financial sense to spend five or 10 years of profits to pay for the agency unless you want the agency very badly and are young enough to build its value over the new owner’s remaining work life.
However, if another buyer owns a neighboring agency and has the space and staff to accommodate the seller’s book of business, while seller could earn $50,000 of net profit, the new owner could multiply that substantially because he does not need to pay for rent, overhead or for excess staff of the purchased agency. That projected profit (after tax load) multiplied by the number of years the new owner is willing to give up those profits defines what he can pay the seller in an equitable deal.
So, we know the value of the business is based on logical earnings generation, not on any “multiple” of anything. This article’s title is to permit thousands of agents, large and small, who realize that they will someday need to sell their asset in order to attain its value during their lifetime. So let’s define what can be done to maximize value and how to go about finding a buyer.
THREE YEARS BEFORE THE SALE
If you are a corporation, take a close look at your Balance Sheet. It defines one part of the agency’s value, its Tangible Net Worth (TNW) and several liquidity ratios that will make your agency more or less attractive to the rational buyer. If you have a negative Tangible Net Worth, you must alter it over your remaining ownership time or face a subtraction of the negative net worth from the value of your book of business in the event of a sale of the corporation. An alternative is selling the assets from the corporation and living with a negative worth in an inactive corporation forever. Seek advice from your agency consultant or from your accountant to determine which course if right for you. The liquidity ratios that are common and defined for an insurance agency will also be evaluated by a buyer and will add or subtract “risk” that can lower or increase your value in a sale. Call us (800-779-2430) to get a copy of our article on Tangible Net Worth and Liquidity Ratios if you want to educate yourself and begin measuring your own.
For the sake of this article, it is important to note that it takes several years to correct poor liquidity or negative net worth and that should be addressed by any agent seeking to maximize value in a sale.
TWO YEARS BEFOR THE SALE
Analyze your carriers and your book of business and clean up your house to maximize its value. Any agent in his right mind looks at historical loss ratios and company contracts when valuing a potential acquisition. If you have had loss ratios that can help the agent get or maintain high contingency income, he will value you higher. If not, he will do the job that you should have done and clean up your book of business and will not pay for the culled business (he will negotiate a retention deal). He will also take the time with your companies to correct any contract terms such as commission rates, contingency agreements, etc. to determine if he will keep your companies or roll the business to his, higher paying companies.
The same things that the buyer will do after buying your agency at a bargain price, you can do with a few years still ahead of you to maximize your value. The agency must rid itself of customers who are non-productive for the agency. These are customers who repeatedly fail to pay their premiums, those with high loss ratios and those who consistently cause more work for the agency than they pay in commissions. While most states have restrictions on actions that can be voluntarily taken for “bad” customers, there are no restrictions to “flagging” their accounts and not exerting extraordinary efforts to continue the relationship.
This does not affect nonstandard agencies or agencies with poor loss ratio books of business. Nonstandard agencies bear a value of their own based on cash flow potential. Standard lines agencies with historically poor loss ratios are less valuable since poor loss ratios without one or two losses that can reasonably explain the loss ratio define a problem agency. You can make a living as an agent that takes “all comers” but will not have much value built to pass on to the next owner beyond the cash flow that forms your paycheck.
ONE YEAR BEFORE THE SALE
Market your agency. This means that you need to identify the likely buyers that you can trust to both pay you and maintain your agency in a manner similar to or better manner than you have yourself. Many agents know their potential perpetuators, whether or not they have discussed the possibility with them.
Be careful that marketing your agency isn’t used against you. We market agencies without identifying them to avoid competitor agencies telling the target agency’s clients and prospects that the agency is “on the block.” Here’s how you can do it:
1) Develop an Over view – This is a document that generally describes the agency in terms of size and complexion (premium size, commission income, percentage distribution of PL and CL, number of clients and policies, historical loss ratio and growth rates). This Prospectus gives potential buyers an idea of what is available.
2) Identify the profile of the logical buyer. No, it is not anyone with enough money to buy the agency. You may think so at the outset, but there are many qualifiers for people with whom you should do business and the amount of money in their pocket is only one consideration, but not the most important consideration.
a) Determine the size and complexion of agency that would best serve your customers
b) Determine if you need (or want) cash or terms in a buyout (there are many advantages and many disadvantages to either)
3) Use the Overview to attract prospective buyers to contact you (through a P.O. Box if you are trying to do it yourself). Send the Overview to every agency you have identified as a potential buyer. We do a Search and Screen process on behalf of sellers that use us as the point of contact (call us 800-779-2430 for more info on Search & Screen).
4) Respond to each buyer with a Confidentiality Agreement that provides you security that none of the information given to the potential buyers will be used in any way beyond evaluation of the prospective deal for valuation purposes. Your attorney can help you construct a Confidentiality Agreement that will serve the purpose. We have constructed a Confidentiality Agreement that can be purchased (call us if you’re interested at 800-779-2430) but we INSIST on its review by a qualified attorney in the State in which the transaction is being done because state laws differ and you need an attorney to review and correct it for your state.
5) Send each respondent a full Prospectus of your agency fully redacted (without any identity information). The Prospectus gives the responding agents ALL of the information they would need to value your agency from their perspective and to evaluate their desire to purchase it. Each agent is asked to respond with an “indication” of value to them. This indication is non-binding and simply gives you an idea of your agency’s value to that buyer if his due diligence proves all of the information you have given him in the Prospectus. Call us for a copy of our Agency Evaluation Questionnaire that forms the body of your Prospectus (with all attachments).
6) Identify your expectation of the value of your agency against which you will compare the indications that you receive. You may have a specific need for cash for some designated purpose. You may want to avoid large cash payments if the taxation of that money has adverse effects on you. You would never buy a “pig in a poke”. Don’t sell one that way either. If you don’t know your agency’s value and cannot establish one logically, call us to perform an agency valuation for you (800-779-2430).
7) Group all of your responses based on the indications that are at or near your expectation of value. Be as wary of values far higher than your expectation (and the majority of indications) as you are of low-ball indications or the amateurs who will write you and tell you that they will give you “what you desire” or “a reasonable amount.” These are horse-traders who will not be adverse to taking advantage of you if they can to their own financial benefit.
SEEK WIN/WIN SCENARIOS ONLY IN A SALE. ANYTHING ELSE WILL LIKELY END IN A LEGAL BATTLE.
8) Only deal with the most likely candidate from your research of their reputation and the logic of their value indication. Send a letter to the others indicating that you will be in touch with them if your current discussion does not bear fruit. Do NOT be tempted by the buyers who will call you and try to persuade you to change your mind. Deal with the most likely buyer first and deal with him only until the deal is concluded or until a roadblock is reached that requires you to move to another prospective buyer.
9) Once you have agreed to price and terms, define the agreement, in English in a simple Letter of Intent and give that letter of intent to the buyer’s attorney to convert into a legal agreement. The attorney (or a qualified consultant) should review all agreements to assure your protection.
The description of the sale process is how we at Agency Consulting Group, Inc. aid sellers to the completion of their transactions in a fair and honorable way that is businesslike and without undue pressure on either the buyer or the seller. We also locate and purchase agencies for our clients using this method. We would be happy to walk you through the process of selling or buying an agency or assist you with our services. Most agents are very good at building client relationships and selling and servicing insurance products. However, they have never sold or bought a business and quickly realize that their best interest is served by using a professional for this purpose. Others decide to learn how to buy and sell and use us as their education device. The only foolish ones are those who decide to buy or sell based on a whim or their “feelings”. This is much like Do It Yourself root canals or appendectomies. Can it be done? Probably. Is it the wisest course for your health and security? Probably not. Call David or Al Diamond to discuss any part of buying or selling an agency — we’re here to help you through the process.