THREE WAYS TO LOWER YOUR AGENCY VALUE
by Bill Schoeffler and Catherine Oak
When you sell your business, here’s what you’re really selling.
When agency owners sell their business, what are they really selling? The purchase price might include some value for receivables, retained cash, desks, office equipment, cars, and computers. But the main value of an insurance agency comes from its intangible assets.
Agency value is based on the cash flow that the business can generate. To determine this, a buyer looks at the existing business, its current clients, employees, and other factors, including its “goodwill” or “going-concern” value.
Both high-value and low-value agencies might have similar earnings under the current structure and with the current owners, and might appear to run equally smoothly. However, an astute buyer will look beneath the veneer to analyze how well an agency is actually running — the sustainable earnings that the firm can generate year after year. In a high-value agency these potential earnings will remain long after the current owners sell. On the other hand, low-value agencies have a high risk that the earnings won’t continue — which means that the buyer will discount their value heavily.
Owners of low-value agencies are often caught by surprise because they didn’t understand the manner in which they run their business adversely affected the value of their agency. Three main factors distinguish a high-value agency from its low-value counterpart: (1) Lack of producer contracts; (2) owners tied to their accounts; and (3) overstaffing.
LACK OF PRODUCER CONTRACTS
There are many excuses not to have a producer contract: They’re expensive to draft, they cause ill will between parties, they’re easily broken, and so on. All these excuses have some element of truth. But it’s important to realize that the lack of producer contracts will lower the agency’s value because it increases the risk associated with the agency’s continued earnings potential.
Two topics that all producer contracts should cover are compensation and ownership of the business. Some agencies might also have a deferred compensation plan for the producer. Excessive producer compensation will certainly lower the agency value, since it will reduce profits.
A buyer also wants a clear understanding of who owns the business: You can’t sell what you don’t own. Buyers often make their purchase offer contingent on having all producers sign a contract. In fact, it’s a good idea to have all employees sign non-piracy agreements.
Owners without contracts for their producers might feel that the agency owns the business. It often happens that the producers disagree — and they might eventually walk away with their books of business. The agency then has little or no recourse, since there was no formal agreement. A signed contract establishing agency ownership of the business still might not prevent a producer from trying to walk away with their business, but it creates a strong legal argument that will help in the agency’s defense.
Agencies that allow producers to have ownership in their book of business might also run into trouble. If the book is owned entirely by the producer, many buyers won’t include it in the revenue stream, or will apply a discount to the book. If the producer threatens to leave, the buyer might end up paying for that business twice.
It’s better for the agency to retain full ownership of the business and then set up a deferred compensation plan to allow producers some equity for their efforts. This will eliminate any disputes about ownership while still satisfying the producers’ needs for building “equity” and a retirement plan.
OWNERS TIED TO THEIR ACCOUNTS
A typical small to medium-size agency will have three or fewer owners who started the agency from scratch. They worked hard building the business and have tremendous pride in ownership. This pride leads to the next factor that affects agency value.
Many owners see virtue in the fact that they know all their clients and have an excellent relationship with each one. But there’s a difference between knowing your clients and having your clients depend on you for most things. Agencies whose clients are tied to the owner are less desirable to a buyer than an agency whose clients don’t have that strong bond.
The buyer needs to know that there will be a smooth transition of ownership without the fear of losing key accounts. If the seller is tied closely to the accounts, a buyer might require the seller to stick around a few years to assist in the transfer of the relationships.
Many deals are also made on a retention basis. If the departure of the owner also means the departure of the clients, the earn-out to the seller will decrease dramatically.
It’s better to have the client look to the service staff, rather than to the owners or producers, for day-to-day service needs. Owners and producers should be involved mainly with the initial sale, remarketing medium-size to large accounts, and problem solving for major issues.
The service staff in high-value agencies is heavily involved in all the agency’s accounts. This allows the client to identify with the agency, rather than just the owner or producer, making the transfer of relationships to the new owner unnecessary (provided the staff remains).
OVERSTAFFING
The profitability of any agency is directly related to compensation costs. These expenses are usually two-thirds of revenue. Overstaffing lowers profits — and thus agency value.
Small agencies are affected more by overstaffing than larger firms. If an agency needs only two and a half CSRs but has three, is 20% overstaffed. A large firm could have 30 CSRs but need only 27. The extra three CSRs would account for only a 10% overstaffing condition.
It’s not unusual for an agency to have a long-term employee who didn’t develop as the firm grew. That employee often works inefficiently or performs redundant work, but the owner keeps them around out of a sense of loyalty.
Loyalty isn’t necessarily in the best interest of both parties. If the seller insists that the buyer keep all the employees, the buyer can only afford to pay a lower price. A buyer who inherits extra employees without any stipulation to retain them will probably fire them after the sale to generate a profit and pay off the seller. Either way — a lower value for the business or the firing of unnecessary employees after the sale — someone loses because of the seller’s management style.
In other words, your loyalty to an undeveloped employee does them no favors. Agency staff should always be well trained to allow them to grow with the ever-changing business environment. Set productivity standards and stick with them. Do annual performance reviews. Employees who fail to keep up should be put on notice and fired unless they improve sooner rather than later.
CONCLUSION
A buyer considers many factors when deciding to purchase an agency. The main factor is the ability to create and sustain a profit. Most buyers are interested in well-run firms that will enhance their current business situation. Agencies that are poorly managed have fewer interested buyers and often get low offers for the business.
A good credo to follow is: Always run your business as if you’re going to sell it today. Because streamlined agencies have fewer problems and generate higher bottom-line profits. The owners of such businesses will make more money now — and when they sell their agency.
Catherine Oak and Bill Schoeffler can be reached at Oak & Associates, P.O. Box 2047, Glen Ellen, CA 95442, (707) 935-6565, fax (707) 935-651, e-mail [email protected], or Web site www.oakandassociates.com.