Making The Most Out Of An Agency Business Combination

MAKING THE MOST OUT OF AN AGENCY BUSINESS COMBINATION

by Carol Hammes

It’s what comes after the handshakes that counts.

INTRODUCTION

You’ve done the groundwork for a successful combination of agencies (acquisition, merger, or cluster). But what comes after the handshakes will be even more critical in determining the eventual outcome.
The initial evaluation and structuring process will determine much of what needs to be accomplished. Parties involved have made an emotional and financial commitment to invest in this course of action. You owe it to yourselves to follow through for as long as it takes to maximize the payback on this investment. Here’s how:

KEEP THE SELLER INTERESTED

Most transactions involve at least one owner who is selling their ownership interest as part of the deal. In some situations, the buyers might prefer that a selling owner disappear (quickly) after the sale. However, it’s usually better to have the sellers stay involved for a while by building a retention or growth incentive into the purchase price. If you want the seller to take a hike, don’t include any incentive — except perhaps one that pays them to stay away!

The simplest and most common incentive is to buy the book of business strictly on a retention basis. Determine the appropriate percentage using the pro forma cash flow that you developed and adjust this for timing considerations. If the seller wants the money over a shorter period, the percentage of renewal commissions paid can be higher. But the total amount paid out might be lower than if the payout period is longer. For example, in a fold-in situation, you might be able to afford as much as 40% of renewal commissions for three years. An alternative that might provide more money for the seller and a longer period of involvement would be to pay 30% for five years. Since the buyer must take the tax deduction for the expirations and covenant payments over 15 years, more and more transactions will probably be structured over longer pay-out periods.

If a straight earn-out deal isn’t appropriate, there are a number of other ways to keep the seller involved over a period of time. Here are some suggestions that can work for both external acquisitions and those in which the interest of a retiring owner is being purchased internally:

• Offer an employment contract that pays the person a percentage of the commissions as a servicing producer on the book of business.
• Structure a production bonus that pays a certain percentage of total commissions received on the portion that exceeds the cash flow projections.
• Pay the seller a finder’s fee for new accounts brought to the agency. In most cases, it’s not wise to pay the person as a servicing producer on the renewal of those accounts, but a hefty new business commission percentage might be in order.
• When a branch is being acquired and the seller is being retained as a manager for a few years, set up a separate profit center with a bonus arrangement that pays a large percentage of the profits that exceed the plan. This will provide a reward for higher commissions, lower expenses, and/or both.
• Agree to a guaranteed price, but with installments to be reduced if the commissions do not remain at predetermined minimum levels.
• Hire the person to perform management functions (company relations, computer installation, training of salespeople or CSRs) and pay a combination of salary and results-oriented bonus based on an increase in contingent income, increase in revenue per employee or commissions per producer or CSR, or some other formula that tracks with the tasks that have been assigned.

You can also add non-monetary incentives to keep the seller interested in the ultimate success of the transaction. For example, you might want to include them in the agency planning process, hand out a title such as Vice President, provide an office, or simply ask for their advice from time to time.

PLAN FOR THE TRANSITION

It’s important to anticipate reactions from those parties both inside and outside the agency that the transaction will affect in some way: Agency employees, insurance company managers/reps, vendors, accounts, and prospects.

1. Spread the Word!

In general, the more information that you share with employees of all the agencies involved and the more input you solicit in advance of the actual transfer, the more positive the transition will be. Some people handle change better than others, but everyone feels additional stress when facing the unknown. If you can reduce the mystery surrounding your plans, you’ll receive more support from the key players and less disruption from those who are determined to subvert the efforts. Of course, premature announcements can also be damaging, so there’s a fine line to walk Experience has shown that it’s usually better to err on the side of sharing too much, rather than sharing too little. Those of you who have been witness to agency employees hearing about a sale from a company underwriter know what we’re talking about.

If the transfer of an insurance company contract is instrumental in the decision to do the deal, the buyer will have been involved in discussions with the branch manager at the outset of the negotiations. Companies that are shared by at least two of the agencies involved should also be contacted before closing with regard to the future treatment of contingent calculations and commission scales. Because most companies have a variety of agency contracts, you’ll want to lobby for the most advantageous one. When the acquiring agency has an important or preferred relationship with a carrier, find out if this company has a problem with the other agency before you finalize the deal. Is the acquisition worth losing an important market? The other companies involved do not need any special advance contact.

You’ll need to decide which vendors to use for office supplies, advertising, phone, cars, etc. — but that can usually wait until after the transaction has been completed. If the agencies involved have different automation systems, some advance planning and contact might be necessary. When suppliers are also agency clients, you might need to take special measures before the public announcement to decide what, if anything, might change about the relationship and then to communicate this information to the vendor-clients involved.

Most existing accounts and prospects will first hear about the business combination through the news story and/or ad in the local newspaper, cable TV, or radio. How you present the situation will leave a lasting impression so it’s important to plan the announcement carefully. In a merger or cluster, there might be a new name and new management philosophy that can be shared. If one agency is being acquired by another, it might be better for public relations purposes to refer to it as a “merger” or “affiliation,” rather than a “sale.”

In addition to the general announcement, each client and prospect in all of the agencies involved should be sent a letter describing the business combination and its purpose. Even if the insured is associated with the “surviving” agency, it’s important to provide reassurance that nothing will change, or that the changes will be an improvement. This would also be a good opportunity to solicit additional coverages on Personal Lines and small Commercial Lines accounts.

2. Review All Accounts:

Immediately after closing, review all larger Commercial Lines accounts. Within the first month, the seller and the new producer should visit all accounts in the selling agency that produced more than 1% of the total agency commissions. The purpose is to get acquainted and do a risk management review of the exposures and coverages. Accounts that produced from .5% to 1% of agency commissions should receive a similar visit within the first three months. Any other Commercial Lines accounts that produced more than $3,000 or so in commissions in rural areas, or $5,000 in urban areas, should be visited before the first renewal to let them know that the new agency wants to keep their business.

PLAN FOR THE FUTURE

Since you’ve done the acquisition, merger, or cluster to enhance your opportunities for growth and profitability, you need to develop a business plan that addresses the new options and defines who needs to do what for the agency to pursue the most advantageous course of action. Use the attached Worksheet as a starting point in the planning process. Add the revenues, total number of employees (including owners, producers, and former owners if they will be working at the agency more than 30 hours a week), number of producers, Commercial Lines commissions, Commercial Lines staff, Personal Lines commissions, and Personal Lines staff.

Use these basic standards to compute the productivity measurements for the combined agencies, compare them to the average agency standard, and then project future needs based on anticipated revenue and commission growth. This involves several elements.

Staff Restructuring

Some employees might not be comfortable with the new organization and decide to leave. If you determine how many people you need in the agency and in the major departments, you’ll know in advance whether you’ll need to replace those who quit, and, if so, what type of candidates you should look for.

When several stand-alone agencies are being combined, certain positions will invariably be redundant. In a cluster or merger situation, you’ll also face the problem of who is to be in charge at the top management level. Each agency had its own management structure and now one person must be given the responsibility for managing each of the functional areas of the agency. It’s critical that you discuss this and decide where the responsibility and authority will reside before the agencies combine. Perhaps one former owner can be the Sales Manager, one the Operations Manager, one the Marketing/Company Relations Manager, one the Financial Services/Health Manager, etc. But where will the buck stop for real?

Although the new organization will not need two Office Managers, a higher level job position of Operations Manager might be called for. An agency with automated accounting in which the CSRs do the invoicing will probably only need one person in bookkeeping unless it’s larger than $2.5 million or so in revenues. One receptionist with a part-time back-up can handle all but the very largest agencies. You might be able to reduce the number of people handling claims — or you might have the luxury of deciding whether to separate the claims function from the service function and set up a new Claims department.

The combined agency might be large enough to have an Administrative department handle the clerical duties of the CSRs. This might also be the time to create a new type of sales position that’s dedicated to servicing accounts (perhaps those of a retiring owner). You might also have the opportunity to differentiate between the types of CSRs, with some dedicated more to sales, others to technical processing, and still others to marketing/placement.

Growing so rapidly, can easily compound over-staffing situations and end up adding more of the wrong kind of bodies. Having a management plan will reduce the chance for error. It will also allow the individual employees to see how the business combination can benefit them. With more specialization and differentiation in the types of jobs, they can see the advantage of continuing their education because there is indeed “room to grow” in the agency.

Procedures

As part of the initial planning for the new agency operation, be sure to conduct a complete review of all procedures. Sometimes organizations are forced into this evaluation because everyone had a different computer system and they are all converting to one. But even if there’s not such a dramatic need, this is an ideal time to track down and eliminate the duplicate work and the lost delegation opportunities. It’s far better to come up with a new “better” way than to force one group of employees to adopt a set of procedures that don’t seem to be an improvement over what they did in their agency. The morale problems that can develop from the battle over “ours versus theirs” can literally destroy all of the hoped-for economies from the merger.

Company Relations

The new strategic plan should also address company relations. Draw up a chart with the combined premium volumes, policy counts, and loss ratios for each carrier represented. Decide which companies you want to grow with in what lines of business, who is hot on what types of accounts, and where there might be sales opportunities for the agency if additional markets were obtained for certain lines or niches. At the end of the first calendar year, present your plan for growth to selected companies, old and new. Renegotiate contracts with the lead companies based on the new volume levels. The agency might now qualify for Top-of-the-Heap status — or, at the very least, you might be able to get some better commission rates. Use the merger as a catalyst to pursue actively the type of company relationships that the agency needs.

BUSINESS COMBINATION PLANNING WORKSHEET

The late Carol Hammes, principal of The Middleton Group, was one of the Independent Agency System’s most widely respected management consultants. She will be sorely missed.