HOW TO BUY, SELL, MERGE OR PERPETUATE AN AGENCY: INTRODUCTION, PART II
by Larry Morrison and Gary Jacobson
A Comprehensive Look at the Best Ways to Handle One of the Most Significant Financial Events in the Life of Your Agency
Editor’s note: This is the second installment in a series that covers buy/sell arrangements for agency, valuation and tax issues, shareholder internal buy/sell agreements, related estate planning, employment contracts and non-competes. It’s part of a unique pre-publication book by the authors that gives you practical street-level understanding of one of the most significant financial events in the life of your agency.
In Part I of this chapter, we talked about sellers considering a sale. The focus in Part II starts with the buyer, and then moves on to look at the big picture aspects of price.
CHAPTER 1, PART 2 - Introduction / Getting Ready
A critical point worth repeating before moving on to rules for buyers is: Do you really have a willing seller – or is the seller so emotionally tied to his or her agency that no buyer will ever be good enough? Is the seller willing to sell – but only if the price/terms are unrealistically high?
Part I discussed these issues in more depths from the seller’s perspective. Potential sellers should think these things through very carefully before spending a lot of everyone’s time and money on something that’s unlikely to happen.
Buyers need to be highly sensitive to these critical issues, as well. Once it becomes apparent to you as a potential buyer that the seller isn’t really ready to sell, it’s time to walk away politely. Don’t burn bridges; the seller might well be ready at some point in the future. However, don’t waste time and money before the timing is right, either.
Buyer
Although we present these rules from the buyer’s standpoint, sellers should also be aware of them:
First: Know what you’re looking for.
Buying an agency is risky, expensive, and a lot of work for the buyer. Do your homework first.
- Not every agency is worth the same to you as it is to other potential buyers.
- What agency would fit the best with what you already have?
- What can you bring to the table to enhance the agency’s value after the sale?
- In other words, what agency can you buy that will result in 1+1 = 3? (or 4?)
- This is so important that if 1+1 does not add up to more than 2, you might not want to buy the agency.
Second. You’re “selling” yourself here, too.
If you really want to buy that agency, someone else does also. It’s about a lot more than price and terms. So, why should the seller sell to you?
- Be ready to “sell” yourself and/or your agency.
- The seller is almost always looking for a buyer who he or she feels comfortable with personally, and believes will take proper care of the agency, its employees, and its customers post-sale.
- If you fail this unspoken test, you can lose the opportunity before you ever get to such issues as price and terms.
Third: Be ready.
- Be ready financially – a strong balance sheet, good banking relationships, and enough uncommitted cash flow to do the deal are essential.
- Be ready with your own time – if your time is already committed fully, how are you going to handle the additional management burdens?
Fourth: Know the basic steps in an agency sale. Ask yourself these questions:
- Should you sign a confidentiality agreement up-front? When?
- What role does a letter of intent (“LOI“) play? What kind of LOI should you create?
- What due diligence is needed, and when?
- What contracts are likely to be needed, and where can you find an attorney with specialized expertise in agency matters to draft them?
- What should you expect at closing?
Fifth: Know the legal basics.
- What are the crucial legal distinctions between an asset sale and a stock sale?
- What will you do with the employees, both producers and CSRs?
- What about a non-piracy agreement with the seller (and any key employees)?
- You need to know the basics, but you’’’ need professional help to get this right.
Sixth: Know the tax basics.
There are three parties to every agency sale : the seller, the buyer and the IRS. A sale can be a lose/lose/win (guess who the losers are…); or the same sale can be re-structured to be a win/win/lose. If there’s a “loser,“ you want it to be the IRS.
- The taxes on an agency sale can exceed 50% of the purchase price if the sale is structured wrong.
- You don’t need to be a tax expert, but you do need to know that there are ways to mitigate this kind of tax disaster and be able to point the seller in the right direction for professional help.
- You need to be willing to work with the seller to resolve what might be an issue critical to the success of the transaction.
- Although you need to know the basics, you’ll need professional help to get this right.
Seventh: Know how to use your professionals and when to bring them in (early is better…)
- Control your professionals – it’s your deal, not theirs!
- Get advice from them, but don’t let them renegotiate the sale.
- Keep relationships cordial. You’ll almost certainly need help of some kind from the seller after the sale. Don’t let your professionals poison that well.
MOST IMPORTANT: The most important rule for buyers (and for sellers too): Both sides must perceive The sale as a “win-win“ scenario.
- In most cases, neither side is compelled to do this transaction. If either side concludes that the sale is a “lose“ for them, then the sale is off.
Special Situations
Some special situations will be covered in more detail in later columns but deserve mention now.
Internal Sales: Many agency owners would like to sell to their key employees, but don’t think it’s possible. The most frequently cited reason is, “They don’t have any money.“
You work with these key employees every day. You probably already know they have the basic talent to run the agency, or you wouldn’t even consider selling to them. However, the money issue seemingly stands in the way.
The fact is, the money issue can almost always be handled. The real question is, “Do they really have the fire in the belly, and the risk tolerance, to be entrepreneurs?“
The heart of an entrepreneur is an intangible that’s difficult to pin down. However, if your employees have what it takes to be entrepreneurs, then you can probably arrange win/win terms that work financially for them and give you a better long-term price than you could get from an outside 3rd party sale.
As always, make sure that your expectations are reasonable. As with a 3rd party sale, the price and terms must “pencil-out“ for the buyers in an internal succession. The down payment is likely to be less, and the seller financing will probably run for more years. Terms are likely to include a way to split the fruits of the agency’s future success.
Although we’ll discuss this issue in more detail later, suffice it to say that if your key employees have what it takes to succeed after you leave, then internal succession can be by far your best exit strategy financially. It can also be an excellent way to attract and retain top notch employees, to ensure a satisfactory sale of your agency when the time is right in the future.
Family Sales: Family sales are a particularly difficult kind of internal sale. All the usual considerations of internal succession apply, plus complex tax considerations, and extremely complex family dynamics.
The IRS is deathly afraid parents that will do something nice for their children. That’s why an entire chapter of the tax code focuses making certain the IRS gets its “fair“ share (estate taxes are extremely complex and constantly changing). Needless to say, this adds to the complexity…
Family dynamics can be even more complex. Just because a child has the talent, doesn’t mean they have the experience to run the agency – and talent plus experience still does not mean that the child has the intangible heart of an entrepreneur. Even setting the price can be more difficult than in an arms-length sale. A child can find negotiating price and terms with a parent to be essentially impossible.
Price
What about “price“?
Ultimately, the “price“ must be justified by (i) the future cash flow the buyer can reasonably expect from the agency, and (ii) the risk the buyer must take in order to get it.
However, “price“ means far more than just money to a seller. They can even see this as a reflection of their personal “worth“ as an individual. A buyer overlooks this at his/her peril.
Starting the conversation with comments designed to push down the price can be fatal to an emotional negotiation like this. You‘re not haggling over the price of a car. “It will have to pencil-out, of course, but it’s probably worth quite a bit…“is often a good starting point for you as a buyer.
Emphasize creating a “win/win“ transaction. Remember, the seller most likely does not have to sell – and you don’t have to buy. As soon as either party perceives the transaction to be a “lose“ for them, the sale will die.
An emphasis on after-tax cash to the seller is also helpful. Thanks to our complex tax laws, it’s often possible to restructure a sale with a lower “price“, but more actual after-tax cash for both the seller and the buyer.
An “all-cash“ deal carries little risk for the seller, but is far riskier for the buyer. This means that price is almost always less in an all-cash transaction in order to compensate for this mismatch in the risk.
What about payment terms?
Although terms are not as emotional, in a practical sense, they can be more important than price. In fact, your authors are fond of saying “The price is not the price…terms are everything!“ Terms determine how the sale will “pencil-out“ for the buyer. For example, seller financing over a period of 10 years is far easier for the buyer to pay from ongoing cash flow, and thus justifies a higher price.
Terms can also dramatically affect taxes for both sides. Since it only counts if you get to keep it, this consideration alone can be more important than price.
Terms affect the risk for both sides. Terms so stiff that the sale cannot possibly pencil-out will obviously raise the risk for the buyer. Less obviously, the seller might incur more risk from draconian terms like this as well. An “upside-down” buyer is far more likely to seek an excuse for rescinding a sale, suing the seller for misrepresentation, or for breaching the seller’s representations and warranties in the purchase and sale agreement.
Terms can be massaged to share the risk, thus lowering the effective risk for the buyer. Lower risk translates to a higher price. It’s fairly common for part of the price to depend on future results (a partial “earn-out“), which is a great way for both sides to share risk and reward to their mutual benefit.
Other factors will also affect the price For example, account retention post-sale is crucial. Are any key non-owner employees likely to leave? Do key employees have, or can you create an enforceable non-piracy agreement? What about the major customer accounts? Will key carriers terminate their contracts when the “founder“ no longer around? What about the building? Is the lease transferable? Is rent likely to be raised post sale?
Finally, it’s not all about “price“ anyway. Price certainly matters, but is rarely the key to the sale. A seller will probably have other “hot buttons“ that can make or break the sale. Some potential hot buttons are obvious, such as how key employees will be treated post sale.
Other hot buttons can be quite unusual. . We well remember a sale that hinged on providing a parking space out back on company property for the retiring seller’s yet-to-be-purchased RV. The buyer balked, initially which would have killed the sale. It’s been many years now, and the seller never did quite get around to parking his RV in that spot that seemed so crucial to him at the time.
Larry Morrison, CLU, ChFC, is president of the Business Transition Network (Arlington, WA), a firm specializing in agency evaluation, purchase, mergers, and business succession planning. You can reach him at (866) 475-9992 (toll free); or e-mail: [email protected].
Gary E. Jacobson, JD, a partner at Vander Wel, Jacobson, Bishop & Kim, PLLC ( Bellevue, WA), offers expertise in the legal aspects of agency evaluation, purchase, mergers, and business succession planning. You can reach him at (866) 498-0008, toll-free; e-mail: [email protected]; or visit www.vjbm.com.