SELLING AN AGENCY - REASONS WHY

THE VARIOUS TYPES OF AGENCY SALE SITUATIONS

The first chapter was about getting ready, and included a general overview of an agency sale from a seller’s perspective. This should help both buyers and sellers start thinking about the key issues in an agency sale right away; but an agency sale is not a one size fits all situation. The details that apply in a specific situation will not all be the same.  Before proceeding further, it’s important to step back a bit and look at the big picture for agency sales in a variety of circumstances. Not all agency sales are for the same reasons, and the circumstances of the sale can have a big impact on how a sale should proceed. 

What KIND of Buyer is it?
Before considering the various sale situations, it helps to consider the KIND of buyer. In almost all cases, the buyer will be either another agency or an individual. 

If the buyer is another agency, then it is likely the buyer will be able to run the agency successfully. The buyer’s ability to pay may be fairly secure. Training the buyer may not be critical, but assistance with customer retention after the sale may be critical. The buyer may be more sophisticated, or at least have more sophisticated advisors.  Consideration for the sale may include some form of performance and/or retention-based incentives (i.e., an earn-out).

If the buyer is an individual, training the buyer may be even more important than assisting with customer retention.  Since the buyer’s ability to run the agency successfully may not be as certain as it would be if the buyer were another agency with a proven track record, the cash and/or collateral the buyer brings to the table may be a major factor in the sale.

The Most Common Sales Situations
The following are the most common sales situations, and whether you are a buyer or a seller, one of these situations most likely fits you (additional details applicable to each will be covered later in subsequent chapters):

Very Small Agency
These are usually sold to an outside buyer - an External Sale.


If the buyer is another agency:

• The book of business is often all that is sold, with the accounts folded into the buying agency’s operations.
• This often leads to economies of scale and better carrier contracts than the selling small agency was able to achieve on its own, thus justifying a higher price than the profits of the seller prior to the sale would otherwise seem to justify.
• This is not commonly seen with other types of small business sales, and can be especially confusing to banks with experience with other types of business, but not with agencies.

If the buyer is an outside individual who will simply step into the seller’s shoes, then the potential for operating economies of scale and better carrier contracts is much less.

• The price for this sale may be less as a result.
• The price differential can sometimes be bridged with creative terms.

Sometimes a sale will be to an insider - an Internal Sale.

• Very small agencies may not have a producer with both the interest and the ability.
• The person needed can sometimes be recruited.
• If the right person is available, these can often be creatively structured as a win/win, even if the buyer has little money.

Somewhat Larger Agency
External Sale

• Generally, many potential buyers.
  

Internal Sale

• May be easier to structure than for a very small agency, but can still be difficult to find the right successor.
• NOTE:  Finding the right successor(s) is almost always the most difficult step in an internal sale.

Family Sale

• The IRS has insanely complex rules designed to make sure they get all the tax revenue they think they are entitled to . . . which is A LOT!
• May need an appraisal to support the price.

Divorce

• Often VERY contentious, with expensive appraisal and attorney fees, and the eventual price and terms set by a judge.
• Can sometimes be greatly simplified with advance legal planning, such as, Shareholders Agreements.

Partner Buyout

• Can also be contentious.
• Can sometimes be greatly simplified with advance legal planning, such as, Shareholders Agreements.

Sale for Health Reasons

•  If the seller is in ill health but not clearly dying
• Time is not as critical as for a dead or dying seller.
• Potential buyers may try to take advantage of the situation.
• The seller’s help with the post-sale transition may be negatively affected.

If the seller is still alive but clearly dying

• A sale planned to occur upon death can sometimes be arranged.
• This has the potential to save a LOT of taxes.

Seller has passed away

• The agency may be in turmoil.
• Can be more difficult to find a buyer.
• Tax issues can be VERY complex.

Financially Distressed Sale

• If the agency is in trouble, the buyer will need to see a way to fix the problem, or a sale will not happen.
• Most of the time the book of business can still be sold, even if the agency itself must be shut down.
• May be forced by the agency’s lenders.

Sale to a Large Buyer

• Likely to be fairly sophisticated buyers.
• Likely to include an earn-out as part of the price.
• Publicly traded buyers (Brown & Brown, Gallagher, etc.)
• May involve tax-advantaged strategies involving the buyer’s stock.

Large, closely held buyers

• There are many of these, many of whom can offer competitive price/terms to what is offered by a publicly held buyer.
  

Start-ups

• Often done with personal funds, or support from family.
• Can be difficult to secure favorable carrier contracts.
• Several entities exist that support start-ups with access to contracts, etc.

Employee Stock Option Plan (an ESOP)

• Very complex and expensive.
• Closely-held agencies are rarely large enough to justify the cost and complexity.
• Can have significant tax advantages.
• Might have motivational effect on employees.
• Not as popular as initially expected when they were originally created.

Very Small Agencies
These agencies are sometimes referred to as Mom & Pops, Main Street Businesses, etc. Although each agency is small with only a few employees, they or course represent a huge part of the insurance services available in our economy, and are the embodiment of the American Dream for many people.

Sale of these agencies is the most common sale situation. As compared to most other businesses, it’s extremely rare for an agency to simply shut down once the owner decides to move on to something else. At a minimum, the book of business is usually salable even if the agency itself will be shut down.

Unrealistic expectations on the part of the seller, particularly the value of the agency, are one of the reasons blocking sale of many of these agencies.

Ultimately, the value of these agencies is determined just like the value of any other business: What a willing buyer and willing seller agree on. Both sides must see it as in their best interest to do the deal, or it will not happen.  In other words, it must be a win/win or it will not happen.

An often overlooked way to sell these agencies is to arrange an internal sale. The key to this is finding a producer(s) who has the necessary skills and entrepreneurial drive. Entrepreneurs are often harder to find than the people with the necessary skills. For agencies that do not already have that person, it may be possible to recruit them based on the possibility of their being able to buy the agency in the future. 

Sales of this type can be arranged even for buyers who do not bring much of their own money to the table. Finding advisors who can assist with this can be challenging as well.

Somewhat Larger Agencies
Many of these agencies are still small enough that they do not achieve the operating economies of scale and favorable contracts available to larger agencies. If so, then the highest price for these agencies can often be obtained by selling to another agency that will be able to obtain these benefits after the sale.

Those agencies that are large and profitable enough on their own will be priced based on the adjusted profits a buyer can reasonably expect in the future. The key to their sale will be the ability of the buyer to continue operating the agency profitably in the future; which often means the seller will need to help with the transition. As always, preservation of the book of business after the sale is critical.

Divorce
A divorce often means half the agency might, in effect, be sold to the spouse who runs it. If both spouses worked in the agency prior to the divorce, one of them most likely will seek employment elsewhere.

The biggest question in these sales is usually price. Terms tend to be based on asset trade-offs, with cash paid for whatever value cannot be offset by other assets. Bank financing is sought as necessary to provide the cash.  Appraisals are used to establish value, with a judge determining the final result if the appraisers used by each side differ in their opinion of value.

Advance legal planning, including agreement on how value will be determined, can help simplify the process dramatically.  Most owners are aware of the possible use of a pre-nuptial agreement, but do not have one. Less well known is that a proper Shareholders Agreement can simplify the divorce issues, including valuation, by quite a bit.

Shareholder/Partner Buyout
Buying out a fellow shareholder/partner may or may not be a contentious process, but it is still likely to involve disagreements over value. EVERY multi-owner agency should have a Shareholders Agreement (or equivalent) to address the multitude of issues that need to be spelled out in advance in this situation. How value will be determined, as well as the terms for a buyout, is just one of the topics that should be covered in that agreement.

This is a huge topic with its own chapter later in this series.

Sale for Health Reasons
Some agency sales are triggered because the owner is in ill health but not clearly dying. The seller has a very good reason to want to sell, but is not under pressure to do so immediately. These sales are very similar to any other sale for a similar agency, except the seller may not be able to provide as much help during a transition.  If an internal sale is desired, there may not be enough time to recruit key employees, and longer term planning may not be an option.

If the seller is facing a potentially terminal disease, the sale will be much more complex. Seller assistance post-sale is much more problematic, thus lowering the value to a potential buyer.  Likewise, the agency itself may be suffering from neglect by the owner because health matters take priority. The seller will be at a disadvantage in negotiations as well, since potential buyers may sense that the seller HAS to do the sale.

Tax planning for the seller’s heirs may play a major role for a seller facing a terminal illness. The tax issues include potential estate taxes, plus potentially dramatic differences in how the sale itself will be taxed. 

It is possible to plan a sale in advance, with the sale itself deferred until the seller’s death. As a protection to the buyer, the sale generally includes a no later than sale date, and may include provisions for the buyer to operate the agency prior to that date as well. Under the right circumstances, this can reduce taxes substantially provided the sale itself is structured properly. The technical elements in the sale structure for this situation may be quite different than for a typical sale.

Financially Distressed Sale
Some agencies are put up for sale as a last-ditch attempt to avoid bankruptcy or being forced to shut down, although this is very rare. 

If an outside buyer is sought, the potential buyer will need to see a way to fix the problem causing the financial distress, or the buyer will not buy. Sometimes this will involve buying only the profitable parts of the agency, leaving the difficult parts behind. This can also lead to unexpected legal complications on both sides of the sale, so be sure to include experienced legal counsel in the process.

If no way can be found for a buyer to solve the underlying problems, or the profitable portions of the agency (if any) cannot be sold separately, then the agency is unlikely to be salable as a going concern at anything close to what the owner was expecting to receive for it. In that event, the agency will most likely be forced to simply sell off its book of business in a distressed sale, apply the proceeds to its liabilities, and then go away. If liabilities remain and the owner is legally liable for them, the owner may have to personally make up the shortfall.

Sale to a Large Buyer
Larger buyers generally have the ability to run the acquired agency successfully, and are often more sophisticated that the typical individual buyer. The price they are willing to pay for a large and profitable agency is likely to include a portion of the consideration in the form an earn-out based on performance of the acquired agency after closing the sale. If the buyer is a publicly traded company, the sale may sometimes include use of the buyer’s stock to help improve the tax effects on the seller and to reduce the cash required by the buyer.

Start-ups
Starting an agency is often done with personal funds and LOTS of sweat equity.    

If multiple owners are involved in the new agency, a Shareholders Agreement, or its equivalent, is strongly recommended right from the beginning. This should include provisions covering how the entity will be run, how it will be valued, how owners will be bought out in the future, how to handle disputes, etc. A whole chapter later on in this series will be devoted to this topic.

Employee Stock Option Plan (ESOP)
An Employee Stock Option Plan (an ESOP) is a way to sell agency stock to its own employees and gain some tax advantages for the owner at the same time. Since the employees also become owners in the agency, an ESOP has the potential to be an employee motivator as well.

Technically, an ESOP is a qualified retirement plan with all the regulatory requirements that status entails plus a host of additional regulatory requirements to go with it. In other words, they are complicated and expensive. You will also need to have the agency appraised essentially every year, which adds substantially to the cost over time. 

Although initial expectations were high when ESOPs were first introduced, the complexity, costs, and restrictions on owners have proven burdensome enough that they are not a common form of ownership transition.

Conclusion
These are the most common situations buyers and sellers of an agency are likely to find themselves in. Each of them has unique elements that make them different than the others. We will cover each of them in more detail in subsequent chapters.

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Gary E. Jacobson, JD

Larry Morrison, MBA, CBA, CMA