This week, we followed up with Al Diamond, president of Agency Consulting Group, who has been on the road a lot in the last couple of months talking to agencies about the need for perpetuation and succession plans. We’ve spoken to Al in the past on this critical topic, and wanted to touch base with him to get his view and advice for agencies as we’re entering a different insurance market place, with firming rates and the ability to see more growth and profitability.
Annie George (AG): We see more and more agencies being sold every year, will we be experiencing more of this?
Al Diamond (AD): “Each year we claim it’s been a record one for mergers and acquisitions, because in fact more agencies are being sold. But, the primary reason agencies are being sold is not because it’s a great M&A market, but because individuals in our industry are getting older and, unfortunately, they didn’t plan properly for internal succession and perpetuation. They are selling because they want to make sure they have funding for their retirement. From this standpoint, we are seeing a lot of activity, and it continues to increase. Yet for some of this activity, we try and talk the agency out of selling, as it isn’t the right time for them.
“Selling for cash always devalues an agency because you have to discount the firm’s value for present value. If you sell to a bank, conglomerate, or broker, you’re going to take somewhat of a licking by asking for cash upfront. If you sell over time – whether through employee perpetuation and a bank loan or an agency that’s holding the paper, you get an interest rate that’s going to earn you more money and you have the ability to demand the highest price for your agency.
“It is usually beneficial to try and sell internally or to another agent. We have a tool called the Liquidity Audit that we use to help assure a seller of the buyer’s continuing ability to sponsor the agency payments during the entire term of the payout. This agreement is created at the time of the purchase and it requires the buyer to send Agency Consulting Group, Inc. (or the seller or the seller’s accountant) the company’s balance sheet every month during the term of the payout. The liquidity ratios that are created from the balance sheet are similar to a doctor’s blood work and internal tests when he determines a patient’s health. If the liquidity ratios decline into a ‘Red Zone’, the buyer is required to repair the liquidity (assuring the seller of the buyer’s continued ability to make payments). If the buyer fails to repair the liquidity ratios in a reasonable period of time, Agency Consulting Group, Inc. may take the agency and re-sell it to satisfy its obligation to the original seller. This rarely happens because most agencies have sponsored a sizable percentage of the purchase price by that point and they will not permit the agency to be taken for the remaining balance. Instead, they ‘find’ the cash to pay out the remaining obligation to the seller.
“We have been doing this for many years. It diffuses the issues and concerns of the older sellers who feel they need to sell to someone with a lot of money because they are afraid that they may someday not be paid their monthly payments. In fact, this tool permits sellers to comfortably transact their agency internally or to buyers who show great promise but may not have large amounts of ready cash (or access to it) and actually can increase the value paid to a seller from a buyer for the asset.
“Many older agents can remember their younger days when they had the desire and drive to change the world and would have loved to buy an agency only to be told that they didn’t have the funds for the purpose. Now, as these agents are getting ready to retire and can sell down to another generation of ‘Young Turks’, this tool can allow them to sell down to the next generation of ‘Young Turks’ with the knowledge that they will get the entire price that they have negotiated for their agencies (as long as the buyer is honest and forthright).
“What’s more, agents who are selling now because they’re ready to retire and don’t have a plan of action are doing so after four or five years of soft market. Their revenues and profits have declined. And the basis on which someone pays for an agency is a combination of the agency’s growth potential and profitability. So, obviously, if an agency is in decline or losing money they won’t get as much for it as they would if it were growing and making money.”
AG: How is the firming market affecting agencies and their plans?
AD: “We have reached a tipping point. In many regions of the country, the market has stabilized and starting to harden. A notable exception is in Michigan where the Detroit area is still as soft as ever. In other areas the market began to firm earlier.
“When the market “hardens,” your revenues start going up because of higher or stable renewals. If you don’t add a lot of expenses, you’re making more money because you don’t need more people to support that growth. You’re not adding a lot of customers; you’re adding more revenue. When a buyer sees that growth and profitability, they tend to pay higher prices because they feel they can continue that same growth or profitability stream or do even better.
“The agency that has been in a losing situation in the past few years has to balance out whether to sell this year or wait another year or two. Some may consider selling because of the possible change to capital gains tax rules, which are scheduled to expire after December 31, 2012. However, this is far from certain. Congress will be in session this fall and one of the changes that they’re proposing to look at is maintaining the capital gains structure the way it exists.
“If you fear that capital gains will go up and you’ll be paying more tax on the purchase, then you may consider selling this year. You should only retire because you lose your health or you lose your heart! If you lose your health, take the additional time you have and be with your families – they are more important than any business. If you lose your heart for the game – you no longer like the business or your clients, it’s time to leave – you’re not having fun any longer.
“But selling the agency is different than retiring. You should sell your business when a) it’s time for you to take the asset value and use it elsewhere, or b) you have a successor in place who needs the time to buy you out before the successor needs to cash out himself (or herself).”
AG: While you’ve been speaking to different agencies across the country, how many have a plan, a strategy in place?
AD: “About 90% of agencies don’t have a written succession plan, but the good news is that about 50% of those attending the seminar have now put pen to paper and outlined what they want to see happen with their agency, helping to secure the future of their family and the continuation of their agency in the way they envision.
“It doesn’t cost a cent to write down your succession plan, and there is no mandate because you have a written plan. A written plan provides guidelines to your next of kin should something happen to you and you’re not around. The problem is that you may know that you want to sell to the agent down the street or to your producer or manager, but your spouse may not know this. Without written documentation, your wife’s attorney is interested in only one thing – maximizing her value in the event of your death, which may not be in the best interest for your employees or for your customers.”
AG: Are most agencies family owned?
AD: “Yes, most insurance agencies in the U.S. are still family owned, and most who are family owned businesses do not necessarily have a succession plan through that family. Family owned businesses can perpetuate to other employees in the agency, who may or not be their kids. But many actually don’t have children in the business.
“An agency principal needs to document what they would like to happen to their agency should they become disable or die. Without this plan, the agency will deteriorate and lose value quickly.
“One of the things that we’re strongly urging is putting in place a Contingency Buy-Sell Agreement with either another individual within the agency or with another agency. This can be a unilateral or bilateral agreement. Under a unilateral agreement, if something happens to you in the event you become disabled or die, you will state that you want the other individual to buy your agency. Once the agreement is signed, the other individual has an insurable interest in your life, which is sponsored by a life insurance policy. The agreement costs virtually nothing and is not a requirement for you to sell to anyone. But your family and employees are taken care, and your customers are serviced. There is no long-term waiting period or questioning whether the agency is still viable.
The other option is a bilateral agreement, which is the better of the two options. Here you have two agents, neither of whom have a succession plan, agreeing that if something happens to either one of them the other will buy the respective agency, with a life insurance contract sponsoring each other. This agreement doesn’t stop you from selling, merging, or passing the agency down to your children. But if something should happen to you, you know the agency and your family is taken care of. That’s sleep insurance, and we like that.”
Al and the professionals at Agency Consulting Group help agents all over the U.S. and Canada establish their agency value. Al has been part of the insurance industry for more than 45 years, with strong agency, stock company, and direct writing experience. He has been deeply involved in all facets of insurance agency operations including mergers, acquisitions, and divestitures: perpetuation and strategic planning; organizational development, compensation, and salary administration programs; administrative and financial operations; marketing and automation planning; ESOP; and much more.
For more information about any of Agency Consulting Group’s services, please contact Al at 800-779-2430 or via email at firstname.lastname@example.org. You can also visit www.agencyconsulting.com for more information.