AGENCY VALUATION WITH A LOSS OF MARKET
by the IAABA Virtual Faculty
Two things are going on in the insurance marketplace. First, agencies are continuing to be bought and sold. Second, carriers are abandoning some agencies or even lines of insurance in some states. What happens when both of these come together? For example, you’re buying an agency and learn that it’s losing an important market. How does this affect its value? The IAABA Virtual Faculty examines these questions in this document.
'I’m buying another agency’s Personal Lines book of business. We’ve agreed to pay $700,000 for $400,000 of revenue. The terms are $100,000 down, with the balance due over six years at 8% interest.
'It’s come to our attention that one of the carriers common to both of us is terminating the seller’s contract due to lack of production and loss ratio. The buyer also represents this company, but the company won’t reconsider termination for the buyer or any other agent. This book represents 17.5% ($70,000) of the total purchased revenue.
'Do you think the purchase price should be reduced due to the pending book transfer expense and possible transfer problems and, if so, how do you revalue the transaction?'
Without a market of this size, there’s no doubt that either the value is reduced and/or the expense of the sale has been increased. We ran this one by our valuation gurus and got these responses:
FACULTY RESPONSE
This sounds like a simple communication problem. You say that their only reason for termination is lack of production. I assume you’re in good stead with this company, thus eliminating the issue. If that’s so, the worst case scenario for you is rewriting the policies into your code instead of the original agent’s. The best case scenario is that the company simply converts from their producer code to yours. If there’s something we don’t know, these suggestions might not work.
FACULTY RESPONSE
Has the contract been signed? That would be my first question. If so, then hopefully you did business with an understanding seller. If not, it’s probably time to step back, take a good hard look, and do your due diligence. Many buyers and sellers get caught up in the moment of the 'deal' and forget good business sense. Without even looking at the entire situation, this is a very, very rich deal. Good for the seller, not so good for the buyer.
FACULTY RESPONSE
If possible, the deal should be restructured. However, if the contract has been signed, and depending on how it reads, the buyer might be out of luck. This is a good example of why agents need professional assistance when doing acquisitions. A consultant would’ve probably made sure the quality of the book was considered in the purchase price and made the deal contingent on obtaining all the company contracts.
If the final contract hasn’t been signed, the renegotiation might hinge on the letter of intent. Hopefully it contains a 'material adverse change' clause that would automatically open the door for a renegotiation or an end to the acquisition, as warranted. If the letter of intent doesn’t include such a clause, then renegotiation depends on what it does say.
How the price is renegotiated depends on all of the above. If at all possible, undertake complete due diligence (to avoid any other surprises) and develop a new price based on the findings. This due diligence will also enable the buyer to explain to the seller why they can no longer justify as high a price. This approach is more likely to succeed than simply stating they want a lower price due to other potential — but unknown and unidentified — problems.
If this isn’t possible, an easy way is to use the same multiple to which the parties have already agreed (1.75 times revenue) and apply it to the remaining revenues — and otherwise keep the same terms. At this multiple, the buyer might also consider changing the terms so that the price is retention-based rather than fixed.
FACULTY RESPONSE
When structuring a buy/sell arrangement, it’s important to have contingency provisions for situations like this and many others that can (and have) come up to throw a wrench into things. Aside from the issue of whether the deal itself is a good one, this is a textbook example of what can go wrong and why it’s important to use an experienced consultant who can help you structure a deal that looks out for your interests. Unfortunately, egos or the desire to save a few bucks too often results in agents who negotiate their own buy/sell deals and get burned.
Reproduced, with permission, from the VuPoint Newsletter of the IIABA Virtual University. For more information on the Virtual University, click here. The members of the University Faculty offer expertise in every aspect of agency management and marketing. Many of these faculty members are available for in-house training or consulting. For contact information on faculty members, click here.