If you think 'Goodwill Value' has something to do with the amount you contribute to the March of Dimes every year, you better take a look at this document. Al Diamond defines the terms in ways that spell out the dollars-and-cents implications.
Every business has two types of values: hard value and soft value. Hard value, or book value, is the tangible net worth (TNW) of a business. This is the equity of the business less its intangible assets (the value of purchased renewals/expirations, covenants, and existing goodwill). You can easily identify an agency’s TNW by analyzing its balance sheet.
The soft value of a company is the value of its book of business — a more difficult number to determine because of the many variables involved. However, the value of an insurance agency above its TNW is also defined as its goodwill value.
Tax law requires all goodwill to be amortized over 15 years for a buyer. This means that the division of goodwill assigned to the book of business and that assigned to the covenant-not-to-compete has no significance to the buyer — except for the distinction between 'personal goodwill' and 'enterprise goodwill.'
Personal goodwill is the portion of goodwill that’s sensitive to the individual, rather than to the business entity. For instance, consultants and certain attorneys develop expertise and personalities that attract and maintain clients due to their knowledge or expertise. Should that consultant or attorney leave the practice, their services are individualized enough that clients would weigh their options. Rather than assume that a replacement could perform equally to the consultant or attorney that the client originally hired, they might prefer to follow the consultant or lawyer to another firm. These experts have primarily personal goodwill.
Enterprise goodwill involves that portion of goodwill that’s sensitive to the business entity, rather than the individual. For instance, many people can choose among many dry cleaners that are equally convenient and similarly priced. They might use one out of habit or they might even like the owner or counter person who helps them. But it’s unlikely that if the counter person left or went on vacation, clients would change dry cleaners (as long as the product and service remained constant).
Most agents’ egos demand that their goodwill be considered personal goodwill. Most producers feel that their clients depend and count on them and that they’re the 'glue' that holds the clients to the agencies. However, this attitude is flawed and forms a double-edged sword. If an agent’s clients only dealt with the agency because of the producer (or owner), it would make most agencies relatively un-salable. After all, who’d pay anything for a book of business if the clients left with the former owner?
Egos aside, the books of business of most agencies have little Personal Goodwill because they usually don’t depend on a specific owner or producer for their maintenance. When an owner or producer leaves (as long as marketing, renewals, pricing, and service remain unchanged) clients tend to stay. This forms the basis of the agency’s valuation that permits it to be sold.
The primary example of this issue is the sale of an agency on the death of its owner. If the agency has a strong management and service staff, there’s little degradation in value and a market sale can be conducted in an orderly fashion. If the owner controlled client contact and service and if the estate moves quickly to provide replacement management and service to the clients, there’s still little degradation of value and a strong market might be available to the estate. However, if the estate waits and permits service or marketing to languish, clients will note the change in perceived service — which might well trigger a higher rate of client degradation before a sale can take place.
COVENANTS NOT TO COMPETE
One of the reasons given for considering goodwill as personal goodwill is the fact that book of business transfers are never conducted without Covenants Not to Compete executed for departing owners. However, the real reason for strict Covenants is that former owners have intimate knowledge of their clients’ insurance situation that would give them an unfair advantage over the purchasing agent (or any competing agent) in a competitive situation. Covenants usually prohibit former owners from competing only on those clients that they sold with the agency and only for a period of time, after which their knowledge of the clients would be too stale. A three-year to five-year Covenant assures that if former agents wished to re-solicit the accounts that they sold after the covenant period: a) the new owner would have had time to cement the relationship between the agency and the clients, and b) the confidential information that was a part of the sale of the clients would no longer be timely enough to give an advantage over competitors in soliciting the account.
HOW TO MAXIMIZE VALUE BY RAISING ENTERPRISE GOODWILL
Agencies have high profile owners and hire high profile producers to 'make friends' with clients and prospects to sell them on the concept of moving their insurance services to the new agency. Of course clients 'like' their agent! Who’d do business with an agent they dislike (unless they were the only game in town)? But if you want to build your agency into a valuable asset for your eventual retirement, make sure that two things occur:
- Cultivate a competent administrative service staff to back up the owner or producer on a day-to-day basis. If you can be away from your office without receiving urgent phone calls that require your (and only your) attention, you’re already there.
- Let your customers know that they’ve hired an entire company to properly service their account, not just one individual.
FRIENDS AND RELATIVES
Those who have been in the business long enough understand the adage, 'Never insure friends or relatives.' The reason: an agent can’t show preferential treatment to clients based on relationship (rates and coverage are governed by law). Another problem is that friends and relatives sometimes tend to ask for exceptions and abuse relationships. Nonetheless, some agents insure relatives and friends.
If friends and relatives prefer to insure with the agent regardless of price, coverage shortfalls, or lack of stable insurance companies, the value of their accounts might be considered personal goodwill and discounted to assure that the buyer doesn’t pay for accounts that leave with the former owner/producer leaves.
In the absence of specific and unusual circumstances, all goodwill in an agency is enterprise goodwill that can be transferred in a sale of the asset. This is the reason why so many agency sales have occurred over the past 15 years — and why the market for agencies remains strong.