Mistakes that Buyers Make during the Acquisition of an Insurance Agency – Part 2

In my last post, I discussed three common mistakes that buyers make when acquiring an agency: (1) letting emotions cloud your judgment, (2) getting misled with incomplete information and (3) being influenced by transaction advisors.  All three deal with collecting and processing information.  In this post, I want to talk about three mistakes that buyer’s make in relation to deal execution.  Let’s get to it.

 4.  Not structuring the deal appropriately

Most agency sellers want all the money upfront.  That may be reasonable under certain circumstances, but it’s not always feasible, and you will need them to assist you through a transition period.  Depending on the seller’s involvement in the business, that period could be one month, or it could be a few years, such as if they are the producer on larger accounts.  Money motivates people, so you have to build an incentive into the deal if you expect the seller to do any work.  The incentive could come in the form of (1) an escrow holdback of proceeds, (2) an earnout, (3) a promissory note, or (4) an employment or consulting agreement.  The contingent consideration should be material enough to motivate action.

Escrowing funds at closing is typically used if you need assistance for up to 6 months.  An earn-out is typically used to incentivize retention or growth over a period of one to three years.  Seller promissory notes can be for any period longer than one year and, while often a fixed amount, can have performance requirements such as revenue retention or abiding by a non-compete term.  Employment and consulting agreements are typically used to offer additional income opportunities for the seller for whatever period of time they wish to continue working (more on this below).

Outside of how you structure the payment of funds, another consideration is what the seller wants to do post-closing.  Not every seller wants to walk away.  Many agency principals enjoy sales or enjoy training staff but are burned out on dealing with all of the stress and mundane tasks that come with owning a business.  Additionally, some principals want to sell their agency, but the proceeds won’t be enough to fund their retirement.  Offering a “sell and stay” option could open up more acquisition opportunities as you create a win-win solution for those individuals that want to cash in but don’t want to exit.  Be aware that a key component of this type of offer is coming up with a compensation plan that supports the seller’s income needs.

Mistakes made on the front end of the deal are typically related to how the deal is structured.  The right deal structure is one that meets your needs and that of the seller while creating an incentive for them to ensure a smooth transition of ownership.  To be successful, the economics need to work for everyone.

5.  Not knowing what you don’t know

I’ve been involved in over 400 deals.  Every deal is unique in at least one way and teaches us something new.  The variables to a deal are numerous and include (1) the personality, motivation, and personal finances of the seller and buyer, (2) the relationships and revenue concentration of the selling agency with carriers, brokers, producers, staff, customers, and referral sources, (3) the selling agency’s sales, service and marketing processes, (4) the selling agency’s accounting and management system records, (5) the selling agency’s technology and intellectual property, (6) the selling agency’s ownership and legal structure, (7) the underwriting requirements of the buyer’s financier, (8) the due diligence process for the buyer, (9) the terms contained in the buyer’s purchase agreement, and on and on.

Our firm has learned a lot over the years.  I actually keep a log of things to look out for based on the attributes of a client or their agency.  If you are less experienced in performing due diligence, then you probably don’t know what you don’t know.  That can be dangerous if you are spending big dollars on an acquisition.

As much as I would love to be able to give someone a step-by-step guide to due diligence, it is not possible.  As I said, every deal is unique.  My best advice is for you to outsource the due diligence to an expert that has extensive industry experience.  We offer this service, as do a number of firms like ours.

Mistakes during the course of an acquisition are typically from the buyer’s inexperience or lack of knowledge.  When in doubt, hire an expert to assist you with the transaction.

6.  Not properly planning for what to do post-closing

When you get into the thick of a transaction, there is a lot going on.  You are regularly communicating with the seller, running due diligence, trying to get through the lender’s underwriting, managing the drafting of legal documents for closing, and preparing to integrate the agency’s operations into your business.  From LOI to closing, the time frame can be 45 to 90 days, and the time moves quickly.

How a buyer handles the first few months post-acquisition can make or break the success of the transaction.  Keys to a successful integration include (1) having “boots on the ground” on day one, (2) having a plan to communicate the transaction to your staff, the acquired agency’s staff, carriers, and customers, and (3) minimizing disruption to the day-to-day business.

I closed an 8-figure transaction where the buyer took a lasses faire attitude after the deal closed.  They waited more than 30 days to meet the staff and took their time with the integration of the business.  As a result, they lost over 15% of the revenue in the first year, and a number of staff.  I could write a book from that deal alone on what not to do.  The most successful buyers have a transition plan, are prepared to attack the transition before the deal closes, and send in an integration team to meet with the new staff on day one.  That is the right way to do it.

One thing I see buyers fail at is having an organic growth plan for the acquired business.  Once you close a deal, you add volume to your book of business.  No agency has 100% retention.  You have to scale up your marketing to offset the normal attrition from your increased volume.  Budget for the additional marketing and allocate resources to ramp up.  If you don’t, then your revenue will go backward and you’ll be stuck in the acquisition trap of having to make more acquisitions to cover up the shrinkage.  The danger there is that the debt keeps piling up, and your equity could shrink even though your agency has grown in size (that’s a topic for another day).

Mistakes made on the backend of the deal typically happen because the buyer didn’t have a solid game plan for integrating the acquisition and investing in organic growth.  As Ben Franklin said, “By failing to prepare, you are preparing to fail.”

The Bottom Line

Winning a deal opportunity in the currently highly competitive acquisition space is a great feeling.  For the most part, it requires presenting a compelling offer and employing some salesmanship skills to convince the seller to go with you.  Execution is where the rubber meets the road.  Not structuring an offer appropriately, not performing a thorough due diligence, or not having to have an integration plan can be very, very costly and leave you with a lot of debt and tight cash flow when the dust settles.  I’ve seen it happen numerous times!

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

Direct:  (321) 255-1309