Mistakes that Buyers Make during the Acquisition of an Insurance Agency – Part 1

Everyone in the industry has heard stories of buyers succeeding in rolling up agencies and selling for huge multiples.  I bet everyone has also heard the war stories of failed acquisitions – employees and producers jumping ship, carriers terminating contracts, customers leaving in droves, etc.  We’ve reviewed the financials of numerous firms that made acquisitions and the loss of revenue is real.  With today’s high multiples, too, losing revenue post-acquisition can put you in a precarious position due to your debt leverage.

In the wild world of M&A, mistakes are costly but can be minimized with discipline.  Let’s dig in on some mistakes to avoid.

1. Letting emotions cloud your judgment

Just about every agent that we talk to wants to make an acquisition.  The motivations are numerous:  money is cheap, organic growth is slow, more carrier volume helps maximize profit sharing, increasing size creates economies of scale, etc.  The ratio of buyers to sellers is in excess of 50 to 1, so the competition is high, and acquisition opportunities are hard to find.  All these factors create an environment that makes it easy for buyers to let their emotions cloud their judgment when pursuing an acquisition.

Having acquired a business myself, I know the thoughts that run through a buyer’s head.  Information can be processed one of two ways based on your emotional state:  (1) your radar is up, and you assume the worst-case scenario, or (2) your radar is down and you see things through rose-colored glasses.  Fear and ignorance generally both stem from the same place – lack of knowledge.  You may not know the character of the person you are dealing with.  You may have insufficient data on the business.  You may lack experience actually completing an acquisition.  All of these can be remedied with knowledge, so get the information that you need to make informed, rational decisions.

The right approach to pursuing an acquisition is one that sticks to the facts and doesn’t let your emotions and assumptions, either positive or negative, override logical decision-making.  Push back the branches and see the forest through the trees.

2. Getting misled with incomplete information

If you have approached the seller directly, the odds are that they won’t want to put a lot of effort into pulling data.  They may be curious, but they will also be apprehensive.  It becomes a chicken-and-the-egg game of which comes first: the information or the offer?  The challenge, then is getting enough information to make an informed offer.  I’m not talking about doing the due diligence just yet.  This is only in relation to collecting enough information to make an offer.

I’ve discussed before what financial information you need to project the cash flow from an acquisition.  The projection is the basis for the offer, but you have to look under the hood to determine if what you incorporate into your projection is accurate.

Some questions to ask:

• How much of the revenue is non-recurring for fees or for bonuses that are based on the growth and profitability of the book of business?
• What is the likelihood that non-commission income will continue (hint: you may need carrier production reports)?
• How does the seller’s commission rate with key carriers compare with yours?
• How much revenue is concentrated with specific carriers, brokers, producers, and clients, and what are the associated retention risks?
• What expenses can be eliminated post-transaction?
• Are adjustments that the seller is providing realistic, such as if they are proposing reducing marketing or payroll?

To avoid a due diligence train wreck, as I like to say, you need to do some work on the front end of the deal.  Doing too little upfront work could cause you to have to renegotiate later in the transaction, which is never received well and may cause the deal to fall apart completely.  Contrastingly, trying to do too much due diligence on the front end could cause you to lose the deal, as the seller may lose interest if you send them a laundry list of requests and questions.

Getting an appropriate amount of information requires effective communication with the seller.  It also requires some rapport, so make sure that you invest time with the seller establishing it.

3.  Being influenced by transaction advisors

Whether the advisor is your banker, CPA, attorney, or broker for the deal, understand that everybody views things from their perspective, and their interests and objectives may not be aligned with yours.  I have great relationships with all of the above advisors (I’m one of them), so this isn’t a shot at anyone in particular.  It is just a fact.

Lenders’ main objective is to make sure the deal meets their underwriting requirements.   If your business plus the one you are acquiring has sufficient cash flow and equity to support a loan, there is a good chance the lender will do the deal regardless of what you are paying.  The mistake that buyers sometimes make is letting the lender drive their due diligence process.  In one extreme example, the lender on a deal was also the seller’s bank.  The bank received information directly from the seller and never shared it with the buyer.  The deal was closed without the buyer ever receiving anything but a P&L from the seller – and boy, did he regret that later!

Your accountant and attorney are important advisors.  Very few have significant M&A experience though, particularly with agency transactions.  Your CPA can review financial statements and help with a pro forma, but they don’t understand the insurance industry – this is coming from my years of experience.  They’re not qualified to read carrier statements or know what data to request from management systems, or even know the financial model for running an agency.  A general business attorney should have a working knowledge of purchase agreements.  Most attorneys do not know the insurance industry lingo nor understand the nuances of agency accounting that relate to earnout and working capital clauses in the purchase agreement.  Unless they are an industry specialist, your attorney and accountant are also not qualified to offer advice on the market value of an agency … but they may try!

When it comes to professional advisors, take their advice into consideration but don’t put them in the driver’s seat.  They have a role to play, but you have to be the quarterback calling the plays.

The Bottom Line

Most every agent wants to acquire another agency or book of business.  One key to keeping yourself out of trouble to achieve a successful transaction is making sure that you obtain sufficient information related to the deal and then filter that information logically so that you make the right decisions.  In part 2 of this discussion, I will delve into common mistakes that buyers make in executing an acquisition.  More to come!

Posted by:  Michael Mensch, CBI, M&AMI and President

Direct:  (321) 255-1309