Six reasons why mergers and acquisitions fail.
Few business transactions pack the high-stakes potential of a merger or acquisition. Done well, the deal can help an agency attain new levels of prosperity. Done poorly, it can be crippling.
Over the years we've helped scores of agents deal with the impact of mergers and acquisitions, and in the process we've learned a lot about what works and what doesn't. Unfortunately, too many agents call us after the deal is done and it isn't working out. That's a shame, because many difficulties might have been prevented with a little planning and discipline.
In fact, studies of real-world mergers and acquisitions consistently report that the vast majority fail to achieve their stated goals in the first five years of the combined operation. We find that some combination of the following six pitfalls usually leads to post-transaction difficulties for agencies and their owners:
PITFALL NO. 1: BUYING AN AGENCY THAT DOESN'T FIT
Know your objectives for combining two organizations. Is it a merger, an acquisition of an entire organization, or a purchase of a book of business? Everything about the target organization-staff, location, markets, systems, book of business, philosophy-must be evaluated to see how it will mesh with your existing business to create a new, stronger organization than either would be separately. That requires knowing your own agency well.
Ask yourself: What are my business reasons for exploring a merger or an acquisition? Some potential answers are:
- Survival
- Financial stability
- Growth
- Competitive strength
- Geographic reach
- Perpetuation
- Improved leverage with carriers
- To be a consolidator
Then learn everything you can about the target organization.
An agent without a game plan or clear objectives is vulnerable to buying for all the wrong reasons-because it's available, because it sounds like a good deal, because friends think it's a good deal, because everybody else is doing it. A merger or acquisition can be a highly emotional decision. That's understandable, but don't let it lead you into a bad situation.
PITFALL NO. 2: TAKING THE SELLER'S STATED POSITION AT FACE VALUE
Let's say you come across an acquisition opportunity and the owner says, 'I'm selling because I'm tired of being in the business.' That's plausible-but what if the seller isn't divulging all the facts? What if the agency is on the verge of losing an important market? What if key clients are vulnerable or moving their business? What if a top producer is threatening to walk?
The sooner you understand the seller's underlying reasons and motivation, the less time, energy, and possibly money you'll waste on a flimsy deal. Also, you should learn the seller's motives before you become emotionally tied to the purchase. At some point every buyer gets emotionally invested in the deal. That's not all bad-it's difficult to muster the energy to make a merger or acquisition work without a certain amount of enthusiasm.
A smart businessperson knows his or her flinch point. If it becomes evident that something's not right, you must be prepared to pull the plug on the deal. This can be difficult-once lawyers and accountants are involved, an atmosphere of inevitability settles in and both sides begin to feel committed. Remember, though-no deal is done until you write the check.
PITFALL NO. 3: LACK OF VALUE CREATION FOR BOTH BUYER AND SELLER
Most deals in which one party 'wins' and the other 'loses' aren't very good. The objective should be to create a win for both parties. In a merger, both sides will need to work closely in the future-any kind of ill will could hinder success. For example, many times we've seen the seller dictate price and terms that cause the next generation of owners to virtually starve to death. By the same token, sometimes the buyer drives such a hard bargain the seller has to dip into retirement funds to pay taxes on the transaction.
It's important in an insurance agency acquisition to remember that you're often buying a mostly intangible asset-a book of business and client relationships. You could pay a high price if the seller feels mistreated and retaliates or bad-mouths you in the community. Public opinion is a highly valued commodity for an agent. You don't want existing clients to develop the perception that you were less than honorable with their longtime insurance advisor.
This doesn't mean you shouldn't protect yourself. You don't want to pay more than is appropriate or settle for unfavorable terms. But if you have a seller over a barrel, it's in your best interest to leave him or her some dignity and a reason to feel good about selling.
Suppose you find an agency that needs to sell because it's being cancelled by a key carrier. You can maximize the deal by paying a bottom-dollar price, closing the office, and firing the entire staff. You might come out miles ahead in the long run, though, if you can afford to keep the good employees or structure the payments around a management contract so the seller can stay active for awhile as a producer.
As a prudent businessperson, you want to cut the best deal possible. That's smart. But keep in mind that you're buying a book of business, which is a set of clients. If they don't renew, or if they follow key employees down the street, you may have purchased nothing.
PITFALL NO. 4: POOR OR INCOMPLETE DUE DILIGENCE
Due diligence, simply put, is getting all the information you can about what you're buying. When it comes to gathering (or disseminating) sensitive proprietary information, there's a formal and disciplined process that should be followed to protect both parties.
First, a confidentiality agreement with injunctive relief and liquidated damages clauses is a must. This helps assure that the buyer won't use the information the seller provides to gain a competitive advantage. The liquidated damages clause gives the agreement teeth by specifying monetary damages at a reasonably punitive level if the buyer breaks the confidentiality agreement.
A confidentiality agreement is mainly for the seller's protection. It encourages the full good-faith disclosure by the seller that's necessary for the buyer to make decisions. In a merger, a two-way confidentiality agreement provides similar benefits.
A letter of intent also should be signed early on. This protects the seller from dealing with a less-than-serious buyer and protects the buyer by taking the agency off the market during negotiations.
Once the due-diligence process starts in earnest, the buyer is looking for as much information as possible about the agency's legal, financial, contractual, management, employment, and operational situation.
PITFALL NO. 5: PAYING TOO MUCH
Buyers sometimes pay too much because the transaction is structured badly. Understanding the impact on the seller's taxes may provide the incentive to structure terms to both parties' advantage. For example, for a seller who wants income for 10 years, receiving annual checks for one-tenth of the purchase price could have costly implications. Will this give the seller enough to pay the tax bill when it's due? If not, will the buyer have to pay more for? Can the price be reduced by taking the tax consequences into consideration?
Buyers also pay too much when they don't factor in additional costs. Suppose an agent finds a great deal on a $150,000 book of business and agrees to make three annual payments of $50,000. Now suppose the agent also keeps a producer and agrees to pay a salary based on renewals. Even if the producer writes a ton of new business, the buyer probably overpaid. Work with your financial advisors to structure such a transaction to keep the ultimate price in line and still satisfy the seller.
Another reason some buyers pay too much is poor valuation methods. We see too many agents overpay because they use a simple multiples-of-commission formula instead of insisting on an independent, third-party valuation using standard financial methods.
Many times agents pay too much because of poor due diligence and don't get the expected value. You may buy a book of business because it contains a lot of underdeveloped accounts you plan to leverage. But maybe there's a good reason those accounts are languishing-and if they can't be maximized, the buyer probably overpaid for the book.
PITFALL NO. 6: POOR INTEGRATION
Agents by nature enjoy playing the game more than polishing the trophy. This instinct serves them well in sales, but it can be detrimental when it comes to buying or merging with another agency. Whether it's simply a book of business or an entire agency staff, integrating a newly acquired entity with an existing one takes effective management. Differences in such things as organizational cultures, operations, procedures, and computer systems can lead to friction and possible meltdowns.
Poor integration is one of the leading causes of failed mergers. To avoid difficulties, analyze potential problems before making a down payment on an agency and be sure they can be overcome. Then have a plan for making it happen. Unrealistic expectations can lead to costly mistakes, so be as clear-headed as possible.
Afterwards, stay on top of the details and take good care of new and old employees alike. The last thing you can afford is to lose key employees just when you need them most.
Mergers and acquisitions are an integral part of business today. Surprises always pop up. Smart business people anticipate or avoid the pitfalls and are more likely to pull off a successful acquisition or merger.
A BUYER'S GUIDE TO SUCCESS
- Know what you want out of the deal.
- Keep your emotions under control.
- Learn the seller's motive.
- Gather all the information possible.
- Get a third-party valuation.
- Consult an attorney.
- Consult a tax accountant.
- Strive for a win-win deal.
- Look for potential integration problems.
- Address staff concerns up front.
- Don't be afraid to pull out.