Due Diligence - And The Independent Insurance Agency
In every merger, acquisition or investment transaction due diligence is not just important, it is critical. As a seller anticipate it – your preparation can mean fewer irritations and often increased value. As a buyer, don’t take short cuts – the devil is in the details.
Here then are some observations for those undertaking due diligence relative to Independent Insurance Agency transactions.
Due Diligence Is A Two-Sided Coin
Sellers must expect that a diligent Buyer is going to ask detailed questions about your personal “wish list” as well as your agency’s financial condition, operations and personnel practices. Recognizing that a quality Buyer is likely to be thorough, Sellers should carefully evaluate their agency’s strengths and weaknesses, take all steps possible to put their best foot forward and have supportable answers ready for those obvious questions that are sure to come.
Buyers must expect that a diligent Seller is going to ask detailed questions about your financial capacity, credit worthiness and, often most importantly, your intentions for him and the agency.
Due Diligence Requires Forthrightness On The Part Of Both Parties
Sellers should accept the fact that the foundation for their financial success and reputation is likely to have a few “cracks.” Hiding them or fudging answers will not only erode a buyer’s confidence but will certainly result in diminished pricing.
It is true that almost any transaction can be consummated without the Buyer disclosing his post-closing plan for the agency as a whole or for individual members specifically. Nonetheless, a failure to meet minimum and fair disclosure, or efforts that mislead a Seller or his key people will lead to disappointment post-closing and not infrequently to efforts that undermine, in subtle ways, the very success of the transaction.
Financial Due Diligence
The great majority of Independent Insurance Agencies retain independent accountants to prepare annual compiled financial statements usually based on output from one of the commercial systems. Thus, while buyers will see a GAAP presentation it will often reflect subjective, accounting decisions. Buyer Beware! Careful due diligence requires an understanding of what expenses are in each ledger account, however clearly it might be labeled, as well as when they got there. Lacking a detailed understanding of unusual or one-time revenues and expenses makes calculations of future cash flows virtually impossible. In the case of overdue receivables it is particularly important not only to know the agency’s history of overdue items as an insight into its collection practices but to know “who” owes the money as an insight into any accommodation practices for large or special accounts.
In those instances where the Balance Sheet identifies transactions with owners and / or employees, it is critical to understand the implications of each as they may identify an owner’s motivation for selling and/or employment practices that may not be acceptable to an investor
Operational Due Diligence
The strengths and weaknesses of an Independent Insurance Agency are usually disclosed during a review of its operations. Thus, such items as: the quality of company representation; underwriting results; market and account penetration; sources of sales, employee efficiency and type of systems come to light.
Often overlooked, however, is the role and influence of the owner in generating new business and maintaining existing accounts. It is not really surprising that the accounts of smaller agencies often reflect the age and actions of the owner. Reaching an age or a desire to retire, many owners settle into a comfortable existence. With a minimum sales effort price and coverage increases can result in modest growth while the underlying accounts age with the owner signifying trouble for the acquirer.
Also of significance is the source of new sales and the confidence that these sources can be maintained by a new owner. If business is brought to the agency by outsiders then the issue of “ownership” of the expirations becomes critical.
Personnel Due Diligence
The attention span of Buyers of Independent Insurance Agencies is too often limited to two personnel areas:
- Identification of producers and sources of sales; and,
- The qualifications of key underwriting and administration personnel.
Overemphasis on these admittedly important areas regularly results in inattention to other significant, but more subtle issues.
What is the Owner’s real reason for selling? The answer may affect how to price the transaction and even how the seller might be a part of the transition and post-closing plan.
Another often overlooked area is the Seller’s philosophy regarding compensation, titles and “perks.” Compensation levels for the Seller’s key people may be inconsistent with what the Buyer pays his key people and producers. Similarly, flexible working hours, bonus programs, company cars and related expenses may give rise to issues that are not easily, and occasionally impossible, to resolve.
Successful Due Diligence Supports Post- Acquisition Planning
Often overlooked completely and regularly given short shrift is the development of a post-closing plan. Successful due diligence should enable the Buyer to effect the change of control and the merger of the two businesses in the most effective fashion. Generally, Buyers will have identified opportunities for improving revenues and margins and identified personnel with potential for increased responsibilities, but surprisingly, even the most active Buyers regularly fail to assign specific responsibility for managing, tracking and reporting on the implementation of the post-acquisition plan.
If Buyers and Sellers are going to minimize post-closing “surprises” there are no short cuts to an effective “two-sided” due diligence process.