Don’t Expect Top Dollar if Your House is in Chaos

Get the Highest Bid When Selling Your Agency by Keeping Financials, Books in Order

Whether one is looking to sell, buy or grow organically, the preparation and organization of an agency’s financial, book of business and corporate information as if a sale is imminent should start today.

In reality, a sale may not be in the cards right now. However, running the agency today as if it were going on the sales block will inevitably improve management practices and overall efficiency and effectiveness; thus translating into higher earnings and undoubtedly increasing long-term shareholder value. In short, the one sure-fire way to increase shareholder value is to get your house in order. This is something that can be started today that does not require selling a thing.

Get your books and records in order. In an actual transaction, the amount and detail of information a particular acquirer will request varies. But one thing is for sure — the quality of information a seller is able to provide goes directly to the overall quality of the agency itself and its management team. When it comes to the sale of an insurance agency, all things being equal, the higher the perceived quality of information the higher the ultimate purchase price and/or greater likelihood of improved transaction terms. Buyers want to see that a business is being run like a business.This means mimicking professional standards often found within publically traded organizations and best practices industry leaders.

Such beneficial standards and practices include:

• The routine development of accurate and timely financial statements complete with all supporting schedules and documentation;
• Full implementation of a first class client management system that includes drill down and custom query capabilities;
• Thoughtfully developed business and strategic plans, complete with budgets and management projections; and
• In force and updated requisite legal agreements that serve to protect business assets.

Financial Statements

Historical financial statements are often one of the best indicators of future performance of a business. To these ends, buyers will put your financial information under a microscope. Audited financial statements provide the highest level of assurance that the financial picture of an agency is in fact as it has been presented to be. The greater reliability a buyer can place on the financial statements, the more likely it is that a seller will receive additional purchase consideration either through a higher overall price and/or through a more favorable transaction structure (i.e., more upfront or an earn out with lower performance metric thresholds). This is simply the old risk/reward trade off: By having quality financial statements, you are helping to reduce the buyer’s perceived level of risk and thus he or she is more likely to provide you with more return.

It is a fact that historical financial statements of closely held businesses rarely reflect the true profitability of the business without certain adjustments. Whether the adjustments would be to eliminate owner perks such as country club dues or personal automobiles, or to remove one-time expenses related to moving or sponsorship of a local charity event, it is of no matter. The key to getting a buyer to sign-off on any suggested financial statement adjustment is the amount of tangible support and justification a seller can provide.

Simply saying that 25 percent of this expense line item and 50 percent of that expense line item are “personal” and therefore these line items should be adjusted will not suffice. If a buyer is expected to give “full credit” in the purchase price for discretionary items, extensive and detailed records are required.

Buyers will only recognize and pay for earnings that are easily discernable and clearly documented. On a related note, buyers become more skeptical with each “normalizing” adjustment required to arrive at the true economic run rate of a business. Bottom line: even if all of the supporting documentation is available, it does not always make sense to make adjustments for every little immaterial non-business item.

Revenue adjustments are related but can also sometimes come under the guise of a slightly different animal.

You may have the usual non-recurring revenue adjustments, such as a one-time gain from the sale of equipment, and these adjustments are understandable. However, what is clearly unacceptable to most buyers is revenue that has not been recorded on the financial statements and tax returns. An unrecorded revenue adjustment is clearly straddling the line between tax avoidance, which is perfectly acceptable, and tax evasion, which is obviously not acceptable. This type of situation should be cleaned up long before contemplating a sale, or do not expect a buyer to give you credit for this revenue.

Effectively, Uncle Sam has already compensated you for this revenue through reduced taxes. If a buyer gets wind of this type of situation the deal will likely be stopped in its tracks as this type of a situation goes right to the integrity of management and the underlying quality of the agency.

The removal of non-operating assets and liabilities from the balance sheet is another important aspect of cleaning up financial statements. Their presence will just complicate and confuse matters if and when you decide to sell. If an asset is not contributing to the earning power of the agency and it is not required for ongoing operations, then mechanisms for removing it from the balance sheet should be considered.

An example of this type of adjustment is automobiles owned by the agency (including the accompanying debt), that are in reality personal automobiles of the agency owners. By cleaning up the balance sheet a more accurate picture of the true financial position of the agency is often revealed. Most likely a buyer is going to uncover the true financial picture of the agency at some point during his or her review, so you might as well approach it honestly right from the start.

First Class Client Management System

I cannot tell you the number of times I have asked for something as basic as a production report by line of business and been looked at as if I were from another planet. If you cannot provide reports that at least break down the book of business by general and specific line of business, producer and underwriting market, then you have substantial work to do.

At the same time, just because you can provide these basic reports does not mean that they are accurate. Too often, records in an agency’s client management system do not reconcile to what is presented by the financial statements or payroll reports. All accounting and agency management systems should be communicating and reflecting the same information. There is nothing more frustrating to perspective buyers than to be provided with numerous reports generated from varying systems and to have the reports not reconcile with each other.

Business and Strategic Plans – Budgets and Projections

You may have considered developing a business or strategic plan in the past but decided to hold off as it was determined that such planning and strategizing was unnecessary given the size of the agency and its relative level of complexity. To this I say no way — if for no other reason than the existence of a well-thought out business plan and a thorough strategic plan reflect well on an agency’s management.

What are the short and long-term goals for the agency? What are the tactics that are being employed to reach these goals?

Acquirers want to know that there is a plan and that the agency is being proactively managed for future growth. Buyers almost always request budgets and management projections. Unfortunately, these requests tend to fall on deaf ears as most agencies do not prepare such information on a regular basis. When a buyer requests reasonable information and the seller comes back with “we don’t prepare that,” the buyer gets an immediate window into the sophistication level of the seller’s management team and business acumen. Remember, more than likely the seller will be joining the acquirer for a period of time post transaction, so the entire selling process should be looked at as a prolonged job interview.

Establish and Update Requisite Legal Agreements

Time and time again, sellers present themselves to the market without having first updated their legal agreements and licensing files. Frankly, it is a prerequisite to sale that can easily go overlooked. When is the last time you updated your articles of incorporation or operating agreement, or reviewed your “standard” restrictive covenant agreements (e.g., non-solicits, non-competes, confidentiality) in regard to current case law? Perhaps a previous shareholder was bought out a few years ago and corporate documents and the stock ledger were never updated.

Whatever it may be, there is often a need to update legal documents in the middle of a transaction, which does two things.

One, it slows down the process as an additional element is added to the overflowing pile of things to do. And two, it raises a red flag to buyers with respect to the sellers’ overall organization and business acumen.

All legal documentation should be reviewed to make sure they are available and in good order prior to speaking with any potential buyers. This includes articles of incorporation or operating agreements, corporate and individual producer licenses, property leases, employment agreements, underwriting market contracts, confidentiality agreements, compensation disclosures, etc. It is also very important to codify and formalize any relationships your agency has with external parties such as cross referral agreements or third-party producer arrangements.

If you take too long to gather requested information, or it is not available, the stage has been set for your agency to be viewed as not well-organized and not on top of its business. Remember, a buyer has to factor in the future costs of organizing your business if you have not already done so. An investment in time and diligence today making sure your agency is well-organized and capable of providing standard information is an investment in the future value of the business. Planning and preparation throughout all stages of ownership are essential if one is to realize an agency’s full value at the time of disposition.