Deploy equity by using it as collateral or releasing it in return for something else of value.
If you aren't leveraging the equity in your agency, you probably aren't getting the most value from your intangible assets. Since equity doesn't appear on the balance sheet until goodwill is capitalized in a merger or acquisition transaction, most agency principals never realize its value until the deal is done. However, just as they can buy stocks on margin, agency principals can leverage the value of their intangible assets.
This article will explore several ways in which agency owners can leverage equity in the agency to satisfy their personal and business objectives.
In simple terms, equity is what someone will pay for your percentage of ownership in the agency. It's your portion of the economic value placed on the agency by a willing buyer. Value is determined from a variety of factors, including revenue, profitability performance, projections, account mix, carrier relationships, staff, and strategic fit.
However, the value of equity can vary significantly. It depends on many factors influenced by the circumstances of a particular transaction-such as a merger, acquisition, sale, or loan-or by a component of a compensation package. And it depends on who's determining the value of equity. Banks for example, are notorious for discounting agency equity value in lending transactions. Producers, on the other hand, almost always perceive equity as having more value than it does.
Because there are potential differences in the perceived value of equity, we recommend that the principal obtain a professional appraisal of the agency before taking any action in regard to encumbering or releasing equity. In this way, the principal is provided with a sound baseline for assessing the value of equity as it may be perceived by others.
Once the agency principal has obtained an appraisal, he or she can then develop plans for deploying the equity to reach individual or agency goals.
There are essentially two methods for deploying equity: One is to use equity as collateral. The other is to release equity in return for something else of value. Releasing equity may be permanent or only for a period of time, conditional upon some requirement being achieved.
Using equity as collateral is normally associated with the traditional bank loan, or debt financing. Such loans are designed to be repaid at a specified rate over a specified period of time.
As was mentioned earlier, however, banks might not be the best source for debt financing, since most commercial lending operations don't understand insurance agencies-which we find ironic, considering that banks want to sell insurance. More attractive alternatives for debt financing would include premium-finance companies and insurance carriers, both of whom understand the cash flow characteristics of insurance agencies.
Premium finance companies often take into consideration the amount of premium financed by the agency, and they're willing to provide more favorable rates based on anticipated future business. Insurance companies often consider the amount of profitable premium on the books, and may even negotiate forgiveness of a loan based on achievement of new premium and profitability objectives negotiated at the beginning of the loan.
However, careful consideration should be given to any debt financing, since the cost of the loan (interest paid) can sometimes cause the transaction to be unprofitable. For example, using debt financing to pay for a producer of marginal ability often results in a situation in which the agency loses more than it makes, no matter how long the producer-generated accounts are retained.
In summary, debt financing can be an appropriate method to leverage the agency's equity, once careful analysis of the transaction indicates a favorable cost/benefit relationship.
Releasing equity in return for something else of value may include a number of attractive arrangements. One of the most intriguing arrangements that Harbor Capital Advisors has been involved with relates to an opportunity presented by a large Life insurance company seeking equity in agencies with commercial expertise.
In this case, the Life company wanted to purchase up to 51% of the agency equity in exchange for the ability to write Commercial insurance for the company's clients. The benefits to the agency principal included an up-front cash payment plus a five-year payout, and the increased value in the remaining agency-owned equity due to new Commercial commissions from the cross-sales.
Property/Casualty insurance companies are another excellent source for leveraging equity. In many cases, an insurance company will take an equity position in the agency in return for a book transfer and/or a guaranteed level of new business. Very often, the agency principal is given the opportunity to retrieve the equity based on achievement of prescribed performance objectives.
Equity also can be leveraged to achieve internal production or other performance goals. The promise of equity is often attractive to high performers and can be used to attract and retain top talent. For example, producers may be encouraged to join the agency with the promise of equity, or they may earn equity in accounts over time based on achieving agency goals.
We've been involved with clients in other innovative uses of equity. One recent example is when agency A transferred a portion of its retail business to agency B in return for a percentage of equity in agency B. Agency B was better suited than agency A to handle the retail business. As a result of the transfer in equity, both agencies gained in value.
Agency principals should consider equity an important resource to be leveraged to achieve increased current and future value. First, however, obtain an agency appraisal. Once you have a good understanding of your equity value, define your objectives and consider how you can make your intangible assets work for you.
Agency principals that effectively leverage their equity can outpace the competition.