Every business has two types of values, Hard Value and Soft Value. Hard Value, or Book Value, is equated to the Tangible Net Worth (TNW) of a business. This is the Equity of the business less its Intangible Assets (value of purchased renewals/expirations, covenants and existing goodwill). You can easily identify an agency’s TNW by analyzing its Balance Sheet.
The Soft Value of a company is the value of its book of business, a more difficult number to determine because of the many variables needing consideration. These considerations are the subject of a different article. However, the value of an insurance agency above its TNW is also defined as its GOODWILL Value.
Tax laws now require all goodwill to be amortized over 15 years for a buyer, so the consideration to the buyer of how much of the goodwill is assigned to the book of business and how much to a covenant not to compete is no longer an important issue. The exception to that relates to the importance of goodwill as Personal Goodwill vs. Enterprise Goodwill.
Personal Goodwill involves the portion of the goodwill that is sensitive to the individual, rather than to the business entity. For instance, consultants and certain attorneys develop expertise and personalities that attract and maintain clients due to the knowledge or expertise of the specific individual. Should that consultant or attorney leave the practices, the services rendered are individualized
enough that all clients would weigh their options. Rather than assuming that the replacement consultant or attorney would be able to perform equally to the individual that the client originally hired, they would rather follow the consultant or lawyer to another agency. These people have primarily personal goodwill.
Enterprise Goodwill involves that portion of the goodwill that is sensitive to the business entity, rather than to the individual. For instance, many people have a choice of many dry cleaners equally convenient and similarly priced. They may use one out of habit or they may even like the owner or counter person who helps them. But it is unlikely that if the counter person were to leave or go on vacation, that the clients would change dry cleaners (as long as the product and service remained constant).
Most agents’ egos demand that their goodwill be considered Personal Goodwill. Most producers feel that their clients depend and count on them and that they are the “glue” that holds the clients to the agencies. However, that attitude is flawed and forms a double-edged sword. If the clients of an insurance agent only dealt with the agency because of the producer (or owner), it would make most agencies relatively un-salable. After all, who would pay anything for a book of business if the clients were certain to leave when the former owner leaves?
Egos aside, in fact, the books of business of most agencies in the United States are NOT Personal Goodwill because they are not, for the most part, sensitive to the presence of a specific owner or producer for their maintenance. If an owner or producer leaves, as long as the functions of marketing to carriers, renewing, competitive pricing and the same level of service is provided, the clients tend to stay. And that forms the basis of value in an insurance agency that permits it to be sold to the benefit of the selling owners.
The primary example of this issue is the transfer of an insurance agency upon the death of its owner. If the agency has a strong management and service staff, little degradation to value occurs and a market sale can be conducted in an orderly fashion. If the owner controlled client contact and service and if the estate moves quickly to provide replacement management and service to the clients, there is still little degradation of value and a strong market may be available to the estate. However, if the estate waits and permits service or marketing to languish, the clients take note of the perceived change in service and may cause a higher rate of client degradation before a sale can take place.
Covenants Not To Compete
One of the reasons often given for considering goodwill as Personal Goodwill is the fact that book of business transfers are never conducted without Covenants Not to Compete executed for departing owners. However, the real reason for strict Covenants is that the former owner has intimate knowledge of clients’ insurance information that would give him an unfair advantage over the purchasing agent (or any competing agent) in a competitive situation. The typical Covenant prohibits the former owner from competing only on the clients that he sold with the agency and only for a period of time after which the data that he knew about the client would be too stale to be used in unfair competition. A three-year to five-year covenant assures that if the former agent wished to re-solicit the accounts that he sold after the covenant period, a) the new owner had time to cement the relationship between his agency and the clients, and b) the confidential information that was a part of the sale of the clients was no longer sufficiently up-to-date to permit him to solicit the account from a preferential position over any other competitor.
How To Maximize Value By Raising Enterprise Goodwill
Agencies have high profile owners and hire high profile producers to ‘make friends’ with clients and prospects to sell them on the concept of moving their insurance services to the new agency. Of course the clients “like” the agent! Who would do business with an agent they dislike (unless he were the only game in town)?? But if you want to build your agency into a valuable asset to be used for your eventual retirement, make sure that two things occur:
1. Make sure that a competent
staff backing up the owner or producer performs the day-to-day administrative service in the agency.If you can be away from your office without receiving urgent phone calls that require your (and only your)attention you are already there.
2. Make sure you train your customers to the fact that they have hired an entire company to properly service their account,not just one individual.
Friends and Relatives
Those of us who have been in the business long enough understand the adage, “Never insure friends or relatives.” This sound advice is given because an agent can not show preferential treatment to clients based on relationship (rates are governed by law). Another problem is that friends and relatives sometimes tend to ask for exceptions and abuse relationships. Regardless, some agents have insured relatives and friends (def. Friends = long-term relationships beginning prior to their insurance careers – not “friends” made during the insurance sale). If those friends and relatives prefer to insure with the agent regardless of ANY consideration of price, insurance coverage shortfalls or lack of stable insurance companies, the portion of the agency’s value associated with the proportion that the revenue of those accounts bear to the total revenue of the agency may be considered Personal Goodwill by a buyer this Personal Goodwill may be discounted or separated in value to assure that the buyer does not pay for accounts that leave when the former owner/producer leaves.
Unless specific and unusual circumstances arise in an agency, all goodwill in a typical insurance agency is Enterprise Goodwill, able to be transferred in a sale of the asset. This is the reason that so many sales occurred over the last 15 years and the reason that the market for insurance agencies is still so strong.