By Colin O’Donnell
M&A Director
o.216-573-6000 x 8100
Successful businesses never remain stagnant: they constantly adjust strategies and operations based on changes in the industry and the economy. This is just as true for insurance agencies as for any other industry. For an ambitious agency owner, expanding their business by acquiring existing agencies is one popular method. But agency acquisitions can be a risky business, according to a recent trade association survey. Results of the survey showed that 90 percent of agency acquisitions lose money. Experts believe the failure to conduct a thorough due-diligence process is a primary reason for the low chance of success.
Before diving into what steps a buyer should take, let’s clarify the difference between buying an agency and buying its book of business.
- When you buy an agency’s book of business, the agency transfers its accounts and client relationships to your company.
- When you buy the agency, you are taking over all its tangible assets: not just its accounts and client relationships but also the intellectual property rights to the name and website, the staff, and the physical inventory, including furniture, computer hardware, and software licenses.
Why buy an agency and not a book of business? For one thing, the seller may only be interested in selling one or the other, so you may not have a choice. Secondly, buying a book of business may lower upfront costs, but it could also deprive you of important business elements that are crucial to success, such as longtime agency-client relationships and brand recognition. So before initiating any discussions with agency owners, be sure to do your homework and decide what’s the best fit for your existing business model.
Here are some steps to take as you begin perusing the market:
1. Consider Your Goals
Knowing your goals besides simply increasing revenue will help you determine what to look for in an acquisition. Are you trying to enlarge your agency’s geographic territory? Do you want to develop a specific line of business? Or do you mainly want to eliminate competition?
Seek mentors, industry consultants, and reputable experts whom you trust to help solidify and clarify your goals. Gertsburg Licata’s experienced acquisitions team can provide invaluable guidance in this regard.
2. Network With Peers
Talk to colleagues in businesses that are connected with those of your insurance clients. Let your professional peers know that you are looking around. Check out listings in publications such as Insurance Journal and Agency Equity.
3. Zero in on a Prospect
Once you find a target prospect, find out why they are selling. Buying a successful agency from a retiring owner is one likely predictor of success. But you’ll want to ensure there aren’t other, hidden reasons connected with the sale: the proverbial worm in the apple that you might not discover until after you buy.
After you talk to the owner, talk to third parties familiar with the agency. They might be able to alert you if the business is on a downward slide.
4. Sign Confidentiality Agreements
Once talks get serious, both sides must sign NDAs. NDAs remain in effect for an extended period (possibly indefinitely), whether or not the deal goes through. They are necessary because you’ll be asking for access to information about the agency’s assets and liabilities, its book of business, overall financial health, debts, and carrier appointments, among other sensitive information.
You’ll also want to learn about their competitors and find out if upcoming changes in the business environment could change the business’s profitability.
5. Understand the Underwriting Process
Look into how strict their underwriting process is. If they offer the same types of insurance as your agency, you should fairly quickly be able to tell whether their standards are tight enough. But if your agency is branching out into new and different types of insurance, you will need to do a deep dive into those industries to learn about their standard practices.
6. Survey the Industry Market
Check out the local market where the agency is present–not just insurance but the industry in which it operates, adjacent industries, and the political environment. For example, if they’re located in a different state than yours, you’ll want to find out if the legislature recently created new insurance regulations. Other new laws could also affect agency operations. For instance, if speed limits were recently increased, auto insurers could find themselves facing more claims.
7. Align Corporate Culture
Corporate culture can be elusive to an outsider, but it has a strong effect on whether an acquisition succeeds or fails. Is the target agency’s corporate culture compatible with yours? Due diligence must include determining if the agency engages in illegal or unhealthy standard practices, such as regularly inflating claim values to increase profits. This may be part of the corporate culture and artificially boost the business value. Down the road, such fraud could very well lead to legal troubles for a buyer.
Even if the different business practices are fairly innocuous, you’ll want to be sure they align with your present business, so you’ll be able to capitalize on synergy rather than trying to combine two discordant operating styles.
8. Review Client Retention
If the target agency is reasonably successful, you and your financial advisor will need to look at the books and investigate client churn. Are agents spending more time bringing in new clients than working on retention? If so, why did the others leave? Retained customers are high-value customers–studies have shown they are more than twice as valuable as new sales. Maintaining clients will add to an agency’s value.
Client retention is often a function of strong client relationships. If the agency has long-term clients, how many have chosen to stay because of their working relationship with agency personnel? If the accounts are turned over to a new agent, this may provide them with an excuse to scout around and see if they can get a better deal, no matter how much effort their new agent puts into establishing a cordial relationship.
One way to minimize this possibility is to include a client-retention incentive in the buy-sell agreement, with the seller being paid more if clients remain for a specific amount of time after the business changes hands. Be sure to stipulate that the duration is long enough to allow the new owner to develop positive relationships with the clients. Ideally, they will have become accustomed to the new ownership by the time the seller fades from the scene.
9. Retain Financial Analysts
Due diligence includes retaining a financial analyst to check the agency’s track record in collecting receivables and its overall profitability. Profitability is not the same as the profit figures listed on profit and loss statements. It is an adjusted figure based on predicted fluctuations in income and expenses and the varying riskiness of revenues based on the types of policies.
Gertsburg Licata’s advisory network can help you work through these tricky calculations. Gertsburg Licata can also develop risk models for you based on agency specifics, such as policy retention, profitability, personnel, and the agency’s image, to help you figure out the likelihood of revenues remaining the same or increasing.
You’ll also want to confer with your accountant about the tax implications of any acquisition before the sale closes.
10. Errors & Omissions Insurance
Once you know you’re going to buy another agency, you should alert your E&O insurer and ask for guidance regarding their requirements before they will provide coverage that encompasses the new agency. You will also want to procure tail coverage for claims made against the purchased policies based on past events–some types of policies allow for claims years after the events that gave rise to the claim. Note that tail-insurance policies are not assignable, so the seller cannot simply transfer their policy to your agency.
Depending on its rating basis, your insurer may impose an additional premium charge for the acquisition; if not at the time of the sale, then at the next renewal. Some E&O companies provide 90 days of automatic coverage. This is worth looking into if you’re renewing your E&O coverage in the near future and you are considering buying one or more other agencies.
Be aware that if the new acquisition moves you into an industry presenting more risk than those your agency presently handles–for example, one that involves pollution or toxic substances–the E&O insurer may not be willing to accept the new exposure.
Don’t Fall in Love Too Quickly
Finally, even if everything checks out, the seller is cooperative, and the agency fits in well with your current business model, be careful not to get carried away with enthusiasm when negotiating a sales price. Be especially careful to distinguish goodwill based on business aspects such as good management, a long history in business, a sterling reputation, loyal customers, and a steady, predictable cash flow, from blue sky forecasts –where you overestimate the upside based on the seller’s enthusiastic predictions about the agency’s potential for future growth.
Colin O’Donnell is the M&A Director of Gertsburg Licata Acquisitions. Contact Mr. O’Donnell today at [email protected] or (216) 573-6000 x8100.
Disclaimer: Note that Gertsburg Licata Co., LPA (the “Firm”) is a law firm. Although Gertsburg Licata Acquisitions and Gertsburg Licata Talent are affiliates of the Firm, they are NOT law firms and neither they nor their representatives can provide you with legal advice. Nothing in this website should be deemed as soliciting any legal business by the law firm or any attorney in it, nor as an advertisement of legal services to individuals who have no prior relationship with the law firm or its attorneys. No legal advice will be given except by an attorney, after an engagement letter with the law firm is executed, or in anticipation thereof after speaking with an attorney. If applicable, then to the extent required by Rule 7.3 of the Ohio Rules of Professional Conduct, please note that parts of this document may contain ADVERTISING MATERIAL.
