Before selling your agency, get answers to these questions.
Many agency acquisitions are based on retention because buyers don’t want to purchase accounts that don’t renew. But retention doesn’t necessarily depend on how well a seller runs their agency.
Since buyers also influence retention, you take on considerable risk when selling your agency on this basis. To minimize this exposure, evaluate the worthiness of a buyer before the deal is consummated by answering these questions.
Q: “How can you make sure that the buyer is in trust?”
A: Request a copy of their current balance sheet and their “Trust Ratio” (use this formula):
Trust ratio = (cash + cash equivalents + accounts receivable)/accounts payable. The ratio should be 1-to-1 or greater.
If you’re unsure whether the numbers on the balance sheet are correct (a valid concern), request an audited statement or the right to perform due diligence on the buyers’ financials. Considering the number of agencies with material off-balance-sheet liabilities, the numbers shown on the balance sheet might well paint a distorted picture.
You might think that they can’t ask for a buyer’s financials — but they can and should. If you’re taking any risk (with terms other than 100% cash up front or a bank guaranty), you should evaluate the buyer’s financial stability.
Being in trust is only the tip of the iceberg. You should also make sure that the buyer’s revenues and profits are real. Use this quick test: Match the buyer’s internal income statements against their tax returns for the past five years. Revenues, profits, and assets should be approximately the same on both sets of documents.
Also, when reviewing the balance sheet, identify the buyer’s real assets, rather than the assets shown. Remove all goodwill, prior agency purchases, intangibles, and (possibly) loans to officers. Then adjust for bad debt (look at gross receivables over 90 days, not just net receivables over 90 days) and eliminate other assets that have no tangible value or that can quickly evaporate. Next, make sure all that liabilities are listed by asking for warranties that no off-balance-sheet liabilities exist.
After these adjustments, the buyer’s balance sheet should have these minimum ratios:
- Collection ratio: 65 or less.
- Current ratio: 1-to-0 or greater.
- Days of working capital: 30 or more.
To obtain more security, ask the buyer to warrant the truthfulness of their financials and sign any statements their attorneys or consultants deem appropriate.
Q: “How can I keep my clients from being treated like second-class citizens after the sale?”
A: Insert a clause in the sales contract stipulating that your clients will be treated the same as the buyer’s other clients. Of course, this clause will be effective only if the buyer treats clients as well as you do. For this reason, it might be preferable to include specific minimum standards in the contract. If you fear that your clients will be treated poorly, it probably would be better to find another buyer, especially if the deal is retention based.
Q: “What should you look for (besides a high price)?”
A: When selling your agency for stock, take these precautions:
- Include a provision in the contract that limits the buyer’s ability to dilute the value of your stock.
- Consider a contract provision that stipulates convertibility; if the buyer’s stock falls below a specific point, your shares will be converted to secured debt.
If the buyer is privately held, require an annual valuation.
- Make certain that your stockholders agreement allows you to sue for negligent management.
- If the buyer’s stock is privately held (which is usually the case), make sure that you agree with the methods used to value the stock.
- Sell only to a quality buyer. A quality operation is more likely than a second-rate buyer to have stability, strong growth, and valuable stock.
OTHER ISSUES
I’m leery of selling to most consolidators (agencies and banks that buy lots of agencies). Consolidators have poor histories in all industries, so I don’t recommend selling your agency for their stock.
If you’re concerned about your employees, find out what the buyer will do with them before you close the deal. Consider getting the buyer’s written commitment to keep employees if they’re important to you and, in the case of an installment sale, to your receiving payments for your agency.
If the deal includes a growth bonus, get a good definition of growth. If you use a retention clause, set a floor. In other words, if retention falls below 85%, the seller still gets paid as if retention were 85%.
And if you’re in doubt, get help! Ask for assistance from people who know the ins and outs of buying and selling agencies.