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Only Well Positioned Agencies Need Apply
By Robert J. Pettinicchi
For insurance agency owners, a well-conceived and properly executed perpetuation plan is a great mechanism for harvesting the value generated through their dedication and commitment to building their business. If planned properly and structured correctly, it is possibly the most rewarding and efficient method of harvesting value while allowing successors the opportunity to grow and yield value for themselves down the road.
While a sale of the business to an aggregator or public enterprise may appear to be lucrative for the seller up front, it forestalls the same opportunity for the next generation of owners, including the owner’s descendants. Further, an ownership transfer through a perpetuation takes place when the timing is right for all involved rather than relying on the vagaries of the market or “which company is looking to buy right now.”
Perpetuation is an option, however, only for well-run, profitable, and growing agencies. If your agency is not a good performer, it is unrealistic to expect your younger producers to “bail you out” with an offer. However, businesses with reliable, recurring revenue will almost always have an opportunity to improve their operations if they are professionally run and managed with a daily focus on growing value.
The best-conceived perpetuation plans that yield completed transitions share some common characteristics. As stated previously, the first leg of the stool is a profitable, well-run agency. The other characteristics are reasonable expectations on the part of the buyers and sellers, a properly structured and sustainable deal arrangement, and buyers that have the willingness and necessary experience to be agency owners. The final characteristic—one that is often overlooked until it is too late—is financing.
Show Me the Money
The willingness of the seller to finance a portion of the transaction is secondary only to the availability of third-party financing from a bank or finance company. The ability to make a substantial down payment to the owner financed by a source outside of the business is the best way to convince a seller that the internal sale can be as good on day one as a sale to a public broker or aggregator. In these days of low investment returns and ratings agency downgrades, cash received in-hand speaks volumes.
The well-run agency is one that can grow organically and produce a healthy bottom line. The agency valuation is dependent upon profitability since the value of an agency represents the capitalization of profits to the owners over time. How can an agency that is not profitable have good value? Agencies usually trade at multiples ranging from five to seven times cash flow. Even using the old revenue multiple rule of thumb that assumes an agency is worth 1.5 times revenue, there is an implicit assumption that the business has a 25-percent profit margin. The multiple represents approximately six times that bottom line. Agency profits over time not only represent value but also provide the cash flow needed to repay the debt used to acquire the agency.
Agency owners can position their agencies to be peak performers by installing a growth culture in their organization. To accomplish this:
Remember, compensation is usually the most significant expense for an agency. Be reasonable in the compensation expectations for yourselves, reduce debt aggressively whenever possible, and keep balance sheet risk low by maintaining an appropriate level of working capital and staying in trust. There is a wealth of available information to benchmark the financial performance of your agency to other agencies of similar size.
Coming to Terms
Reasonable expectations of buyers and sellers are a little more subjective to determine. However, the most sensitive discussions usually pertain to differences in perspective regarding the value of the agency. Profitable, growing, well-run agencies are more valuable and can repay the debt incident to the perpetuation transaction. Getting professional advice and a valuation from a reputable advisor is strongly recommended for both parties early in the process.
A proper and sustainable perpetuation structure is vitally important. The perpetuation plan should allow a selling owner to achieve retirement goals of reaping a solid return on the productive time and effort he put into the business. By the same token, the plan should enable the successor owner(s) to achieve their own business goals (which presumably are to buy a productive agency with a bright future). The plan cannot be one-sided. It must be designed to work for both the seller and the successors. Important elements of the plan should include how taxes will be minimized for both the buyer and seller, how control will be passed on to the succession team, how the buy/sell agreement is funded, what flexibility the plan allows, and the role of outside financing.
A strategic lending partner can help work out the details for a financing structure for an agency perpetuation. Traditional banks have not been a good source of capital for agency perpetuation transactions because they usually require hard collateral (tangible assets such as property, plant, and equipment) to back up business loans. However, insurance agencies do not typically have significant tangible assets. When traditional bankers scan financial statements, they may not view intangible business assets as valuable for collateral. Thus, some banks may require agency owners to pledge a house or other assets as personal collateral.
On the other hand, a specialized lender that works frequently with insurance agencies tends to understand agency value and the business’s ability to repay a loan. To use intangible assets as collateral requires a lending institution that recognizes how independent insurance agencies operate and create value.
When shopping for a lender for your agency, an agency owner or the acquiring parties should look for an institution with insurance industry knowledge. The more a lending institution’s decision-makers recognize the unique aspects of the agency business, the more likely they will understand the value to be created or harvested in a perpetuation transaction for an independent agency.
A good rate does not a good deal make. Just like a consumer or business owner needs to shop on more than price, an agency principal should look at more than interest rates and terms. Banking professionals should be knowledgeable, informed, and informative.
Finding the Right Advice
The guidance and perspective of a qualified, experienced lending officer and/or an industry financial consultant can help agency principals avoid costly missteps and capitalize on opportunities. Often, banks tout their insights into business to try to attract customers. However, the number of bankers with insurance experience and expertise is relatively low.
One size does not fit all in agency perpetuation. Agency principals need lenders that are fair and disciplined in their analyses, while also being flexible and creative in developing lending solutions. As an agency owner looks to realize the value held within his agency, a key ally is an experienced lender who takes a complete look at the agency to determine needs and recognize the long-term value.
A good banker is like a good insurance agent. Each looks at the whole picture of a situation, considers the client’s objectives, and prepares a professional recommendation based on experience and expertise. The independent agency owner who has that type of relationship is an agency owner with a strong ally and a bright future.
Robert J. Pettinicchi is chief lending officer of InsurBanc, a federally-chartered bank dedicated to providing banking products and services to independent insurance agents. The bank is based in Farmington, Conn; 866-467-2262.
This article originally appeared in the September 2011 issue of Florida Underwriter magazine and is reprinted here with permission.