When it comes to small businesses, no other sector has as much competition as the independent insurance agency market. That means that the demand for independent agencies is greater than the available supply. These five tips on buying an insurance agency can help you.
In truth, for an agent that presently does not own his or her agency, the challenges are even greater, especially for those that are not a strategic acquirer. Anyone who is considering an insurance acquisition should understand the issues expected to be encountered during the process. On the other hand, if you are considering selling an insurance agency, it is essential that you understand the value of your business.
The size of the agency will have a significant impact on the demand for the agency. The larger the agency, the larger the demand. The increase in the number of buyers has also benefited smaller agencies. Agencies that were too small to be considered by a buyer a few years ago will receive more interest today. This is good news for those agencies that are selling. However, the enhanced demand is not positive for anyone thinking of purchasing an agency. It doesn’t mean that there are not available opportunities. It only means that the competition for buying an insurance agency is a lot tougher than what it was a few years ago. We have found that there is a significant opportunity for someone to buy a smaller agency located outside of a major metropolitan market.
Below are several tips to consider before you buy a small insurance agency.
Know The True Value Of The Agency
Do not rush into buying an insurance agency. To acquire the business, buyers often wind up paying much more than they should have paid. Before you decide on going through with the actual insurance acquisition, you need to know the TRUE value of the agency. Determining the real value of an agency is one of the most difficult parts of the negotiation process. You should know and understand exactly how the profits are derived.
The agencies historical profits are meaningless. Did the agency generate any new business that was not reflected in the historical profits? Did it lose any major accounts that make those profits unsustainable? Were the contingencies overstated or understated due to a unusual loss history in the past year? Is the agency overstaffed or understaffed? The number of issues are too lengthy to highlight in this article. Once profits are determined, this is just the first step in the valuation process. How do I assign a multiple to those profits? Every agency is unique and they should be valued to reflect that uniqueness.
Know How Much You Can Afford
While it is good to have aspirations, you must also be realistic. Most people thinking of buying an insurance agency have enormous dreams and often have unrealistic expectations. However, you need to know exactly what you can afford to pay. The critical question is to determine how the agency acquisition will be funded. Once that is determined, it is CRITICAL that you estimate the future cash flows of the agency. If you overpay for the agency, the future cash flows will not be sufficient to cover the operating expenses and any debt service.
There are many ways to fund the acquisition. The simplest method is to fund the acquisition in cash. Of course, many buyers do not have the resources to pay for the agency. The agency can be acquired by obtaining a loan for the purchase price, giving the seller a note or paying commissions to the seller.
If the buyer is informed, they will should require that 80% of the purchase price be paid at Closing. Most larger deals receive a much higher percentage of the transaction value at closing. The remainder of the transaction value is paid out at the end of the Earnout Period. An Earnout provides the seller with an incentive to grow the business after the Closing and it also protects the Buyer in the event of a material change in the business prospects of the agency.
Why Do You Want To Buy This Business?
In any business you consider buying, you need to know the motivation behind the acquisition. The same applies to the insurance acquisition process. The vast majority of the buyers have an established agency in place. Why are so many buyers so aggressively pursuing insurance agency acquisitions?
I wish I could say that it was because they love the business and want to create something bigger and better. To a certain extent, this is very true. Most professionals in the industry seem to love what they do. We are constantly amazed that so many of our clients can’t imagine not working in the industry. The thought of retirement is scary and intimidating. I’ve never encountered a similar attitude in any other industry. Why are most acquisitions completed?
There are some very good financial reasons to acquire an insurance agency. Smaller agencies normally have capacity. They can buy another agency and fold it into their agency. They can service the accounts at a lower cost and thus generate additional profits. The reasons why larger agencies acquire other agencies is much more complicated.
These larger agencies also benefit from being able to service the business at a lower cost. However, they have several other significant opportunities that are not available to small agency buyers. The first benefit is that they can buy an agency at one value and create value for their agency at a higher value. As an example, they can buy an agency at a multiple of seven and then have their larger agency valued at a much higher multiple.
The greatly expanded list of private equity buyers based their model on that assumptions. They also have an additional benefit in that their transactions are leveraged. The earnings from any synergies or organic growth are retained by the Private Equity backers and not shared in any way with the parties that provided their financing. The insurance agency industry falls perfectly into their model because of the reliability of its cash flows versus other industries.
Have The Money Ready
When it comes to business acquisitions, there are typically three parties involved. They are the buyer, seller and the financier. Before the deal can go through, all three need to be satisfied. As noted above, in some cases the seller may be the one financing the deal. In most deals, outside financing of some type is involved.
There are a limited number of lenders that finance insurance acquisitions. Before you go full throttle on the purchase, you need to know the requirements of the lender. Many insurance acquisitions never materialize. The Buyers and Sellers often can agree on the transaction value. Buyers often end up making offers that they are not able to complete because of financing. I am always amazed when a seller accepts a deal that does not require a significant down payment at Closing. Too many things can go bad and ultimately impact the proceeds that they will receive.
Know What You Are Buying
We are involved in each phase of the agency acquisition process. One of the most important phases is the due diligence phase. Let’s consider this situation. You are buying an agency and you have agreed to terms with the seller. You have arranged outside financing. However, you should not consider closing the deal unless you have performed a thorough due diligence of the agency.
The list of due diligence tasks is very extensive. They include a thorough review of the historical financial statements and the development of the Buyer’s Proforma. The due diligence review includes a review of all legal contracts plus many other areas.
Here is an example of how things can go seriously wrong if due diligence is not performed. You’ve bought the business and the seller assures you that they own the book of business. You close the deal and then a major producer tells you that they are leaving and taking their business. If they don’t have a non-solicitation agreement, they are legally able to leave and take all of the accounts that they service. The results can be devastating and could have been addressed with a simple review of their contract.
We believe that we are successful as a firm because we try to identify as many of these issues as possible prior to the Buyer’s due diligence review. In any event, never buy an agency where the acquisition is funded up front without a thorough due diligence review.
Some Other Tips To Consider
These are just some of the many things you should know before you embark on buying an insurance agency. When meeting with potential sellers or buyers, remember that first impressions count. We tell our clients to treat these first meetings like a first date. Try to make a good impression. The goal is to get a second date.
All insurance owners are not driven solely to sell their businesses for monetary purposes. Most of these parties have spent their entire lives in the business. They are proud of what they have created and they want to see that legacy retained. There worst nightmare is to spend the rest of their career and lives thinking about how the buyer destroyed something that they worked so hard to create.
Many sellers often view their employees as family. If they don’t feel that way towards all of their employees, there are always employees that are special because they helped create the value of the agency. The sellers want those employees treated well. Agency owners also feel a great sense of loyalty and dedication to their customers. They have been actively involved in those companies for many years.
There has never been a better time for selling or buying an insurance agency. Knowing these tips can help you make sure that you are making the right business decision.
The Value of Your Agency
As a firm, we believe an accurate valuation is part of our responsibility and the foundation of a great working relationship – even if that is further in the future. Because of this we, unlike most firms, offer free insurance agency valuations for those who qualify. Click below to apply!
