Ready, set, sell

Harbor Capital Advisors has savvy advice for prospective agency sellers

By Elisabeth Boone, CPCU

Spearheading Harbor Capital Advisors’ successful transactions are, from left: William Ryan, CPA, Associate Director; Paul Di Stefano, CPA, CPCU, Managing Director; and Andrew Barile, CPCU, Associate Director.

Just a generation ago, if you wanted to sell or merge your agency, or acquire a neighboring firm, the process was simple. You met with the other agency’s owner, came to terms, had your lawyers review the documents, arranged the necessary financing, and the deal was done.

That was then.

These days, there’s nothing simple about agency corporate development, and few if any owners would even consider making a purchase, sale, or acquisition without consulting an expert.

Enter Harbor Capital Advisors, Inc., an investment banking organization that provides financial and management consulting services to insurance companies, agents, brokers, banks, and others engaged in the insurance business. Based on Long Island in Huntington, New York, Harbor Capital offers services that address a range of issues: mergers and acquisitions, valuations and fairness opinions, litigation support, assistance in managing troubled situations, and strategic and business planning. In addition, the firm raises capital for business growth, acquisitions, and restructuring.

The founder and managing director of Harbor Capital Advisors is Paul J. Di Stefano, CPA, CPCU, whose name may be familiar to Rough Notes readers as the author of the monthly column titled “Agency Financial Management.” His experience includes senior executive positions with American International Group and Marsh & McLennan. At AIG, Di Stefano was responsible for creating A.I. Credit Corporation, a leading premium finance company.

In forming Harbor Capital Advisors, a priority for Di Stefano was to recruit top talent that would bring to the firm both breadth and depth of experience in key areas. In addition to Di Stefano, Harbor Capital’s roster of consultants includes William E. Ryan, CPA; Thomas Pepe; Andrew J. Barile, CPCU; Jesse J. Watkins; and Deborah Dziuban.

“We have no ‘B’ team,” Di Stefano asserts. “When working with clients, one or more of our senior directors are always hands-on in spearheading the assignment. All of our directors are accomplished entrepreneurs who have made their mark in the insurance distribution system. Many have been successful agency principals who have gone through the merger and acquisition process with their own businesses.”

Activity on the rise

At Harbor Capital Advisors, financial analysis is a critical component of every transaction. The firm’s financial analysts are, from left: Deborah Gordon, Sandra Kaufman, and Lois Christianson.

Over the span of his consulting career, Di Stefano has had the opportunity to observe significant changes in the climate for agency and brokerage merger and acquisition activity. “The pace of activity has risen year after year,” he comments. “Whether the market is hard or soft, it seems there’s no end to merger and acquisition activity. Every year we wonder if it’s going to slow down, and the next year it’s just as active, for a number of reasons. A key factor is the consolidation of major insurers that’s been taking place over the last 10 years. There’s been a lot of dislocation, and many agencies are looking for strategies to make them viable going into the future.”

Another thing that’s changed, Di Stefano remarks, is “who the acquirers are. Back in the early to mid-1980s, we still had the major alphabet houses: Alexander & Alexander, Frank B. Hall, Johnson & Higgins, Marsh & McLennan, Rollins Burdick Hunter. Today public brokers such as Brown & Brown, Gallagher, HRH, HUB, USI, and the banks have become very active,” Di Stefano says. “Players such as Marsh, Aon, and Willis have slowed down.

“That’s on the retail side. Another phenomenon we’re seeing, especially over the last two years, is that activity on the wholesale side has just exploded. The wholesale/MGA sector wasn’t very active for a number of years, and now a lot of the public brokers are seeing an opportunity. Rather than giving their wholesale business away to a third party, they’re eager to capture it,” Di Stefano explains. “Obviously that’s a double-edged sword, because with the Spitzer investigations we’re seeing some divestitures, for better or worse. We’ve been closing wholesale deals with many of the public brokers, and their attitude is that they’re going to continue growing if they see no conflicts.” With respect to the Spitzer investigations, Di Stefano says, “A lot of the public brokers have not mandated that the retail side place the business with the internal wholesale unit, and I think based on that, they sincerely believe there’s not really a conflict.”

Another change on the merger and acquisition scene, Di Stefano points out, is that “sellers have more options than they’ve had in the past. There seems to be a plethora of potential acquirers, including new firms that are popping up. There’s capital out there that hasn’t been deployed yet. We see a lot more options for our clients,” he comments.

As the pace and diversity of acquisitions increase, the average age of principals seems to be decreasing, Di Stefano observes. “While most agency principals look to sell because of perpetuation issues, we’re finding more and more younger principals in their 40s selling up,” he says. “They’re selling up as a strategic move; they’re asking, ‘Where is the business going to be in the next five or 10 years, and what is my best position to be in? If I can take some chips off the table and at the same time position myself for the future in terms of being able to build the business and benefit from a compensation standpoint, that’s not a bad thing.’”

More money for deals

“Another development, even with smaller public brokers, is that acquisition financing has become more available,” Di Stefano notes. “In the past, most financial institutions were asset-based lenders, and they just shrugged when you came to them with an intangible asset acquisition like an insurance agency. I think many banks have become educated over the years as they’ve become involved in the insurance business. That’s created a dynamic where lenders believe it’s a good idea to make loans to insurance agencies, because they or their competitors are actually buying agencies.” At Harbor Capital Advisors, Di Stefano says, “We’ve done a number of cash deals recently with regional brokers that have obtained either straight bank financing or bank financing supported with company guarantees.”

And what is Di Stefano’s take on developments in the bank-insurance connection?

“We’re seeing two dynamics operating right now,” Di Stefano responds. “Originally most banks wanted to acquire agencies as a platform for cross-selling opportunities. Among the smaller banks, that’s still the rationale. Today some of the bigger banks, like BB&T, Wells Fargo, and Wachovia, are looking at agency acquisition as an income diversification move: ‘We think this is a good business, and we’d like to be in it. There may be cross-selling opportunities, but we want to develop this as a consolidator.’ These banks may want to pursue cross-selling, but they tend to have more interest in establishing a new profit center,” he says.

Given this trend, and the knowledge that banks have developed about the insurance business, Di Stefano remarks, an agency or brokerage with a significant platform may find that selling to a bank isn’t much different from selling to another brokerage. As an agency owner today, “you’re not in the early days of selling to a bank, where you have to confront the cultural issues between the bank and the agency,” he says. “Once the bank has a substantial presence in the insurance sector and its people really understand the business, you might as well be negotiating with a big broker.”

Keep your head straight

“While most agency principals look to sell for perpetuation issues, we’re finding more and more principals in their 40s selling up.” —Paul J. Di Stefano

In the agency business, as in the dating game, it’s human nature to be flattered when someone desirable shows an interest in you. But, as we’ve all discovered, it’s one thing to flirt and quite another to walk down the aisle. Before agreeing to be courted by a suitor, Di Stefano cautions, it’s wise to keep your head and do your homework.

“There are so many potential buyers who are always trolling for potential acquisitions,” he says. “They’re talking to a lot of agents. It’s always a heady experience to get that phone call from a big broker or a bank. The problem is that in a lot of cases the agent gets drawn into a conversation and starts to share financials and other confidential information, but he or she hasn’t made the critical decision: ‘Do I want to sell?’ I always encourage owners to take stock of where they want to go before responding to a potential acquirer,” Di Stefano says. “If you want to sell, there’s a different process. You’re not going to wait until someone calls you.

“A lot of agency owners misunderstand the market,” he continues. “Owners often say to me, ‘If a bank offered me enough money I’d sell,’ but you can’t realistically expect that to happen. It’s a matter of backing up a bit and understanding as a potential seller what you want to accomplish. You need to know the agency’s value and know what your exit strategy is,” Di Stefano says.

He recommends that owners be a bit skeptical when they hear about deals that sound fantastic. “Sometimes I have to laugh,” he says, “because an owner will call and tell me about some incredible deal he heard of. It turns out Harbor Capital was the intermediary for the deal, and the terms were nothing like the caller described.”

The bottom line, he says, is, “Agency owners need someone to advise them about the real marketplace instead of relying on assumptions. They need to acquire enough information so that if they make a decision, they won’t be second-guessing themselves. If there’s someone you’re considering selling to, you really have to ramp up. The prospective buyers know what they’re doing. In most cases they’ve done a lot of deals, and they know what they’ll pay for an agency. They know cash flows, multiples, risk factors—and as an agency principal, you ought to be armed with this information as well, so if you’re approached, you can ask the right questions.”

What’s more, Di Stefano says, the information an agency principal shares with potential buyers needs to be packaged properly. When Harbor Capital is representing a client, one of the first orders of business is to prepare an acquisition profile. The profile contains all of the information an acquirer needs to make an initial assessment of a potential acquisition and is shared with the prospective buyer after the signing of a nondisclosure agreement.

Agency valuation

At Harbor Capital Advisors, Di Stefano says, “We do appraisals, and we also do what we call an agency assessment. It’s a detailed study of the agency in terms of what we consider the full range of positives and negatives. In a lot of cases, rather than just doing a straight valuation in dollar terms, we also perform an assessment, which is more of a management consulting tool,” he explains. “An appraisal is a good starting point for the assessment process because both procedures routinely examine risk factors like the size and composition of the book of business, sources of business, vulnerability of markets, large accounts, qualifications of producers and whether they have non-compete agreements, and other considerations.

“There are an extraordinary number of things to look at in terms of valuation,” Di Stefano continues. “In addition to determining a dollar value for the agency, I always like to go the next step in the assessment process. I encourage owners to determine if they have issues and, if so, how those issues should be addressed. In a lot of cases we find that when an owner is unsure of what he should be doing, an assessment helps clarify his strategy,” he comments. “For example, it can provide guidance on questions like whether to fire or retain certain producers, whether it’s desirable to become an acquisition candidate, or whether to consider merging or selling.”

In conducting an agency appraisal, Di Stefano says, “the best test is comparable closed transactions that have taken place. A lot of people use multiples and throw them around very loosely, and that’s disturbing to us. It’s just like when you’re selling your house: your best guide to its value is what comparable houses in your area have been selling for,” he says. “We do a lot of litigation support, and in these cases we have to convince the judge or the jury that a valuation is accurate and is supported by the facts. We find that when we use comparables, it’s hard to argue with them; those are real transactions that took place.”

A successful transaction, Di Stefano points out, is defined not only by terms and price but also by cultural compatibility. “A good cultural fit is extremely important,” he says. “We always assume that we’re going to make the best deal for the client financially. We introduce our client to a number of possible partners and ask, ‘Where are you going to feel most comfortable? We’ll negotiate the deal, but you need to tell us where the future’s going to be for you.’”

The value of leverage

Although it’s possible for agency owners to make a reasonable deal on their own, Di Stefano observes, it may not turn out to be the best deal. “To get the best deal, you need to have some leverage,” he says. “You achieve that leverage by having a number of suitors. It’s not the same as holding an auction, which buyers typically don’t care for. But we always tell our clients that it’s in their best interests to explore as many potential acquirers as possible so everyone can get comfortable. When you make the decision to join forces, that decision is solid. Buyers appreciate that,” he asserts. “A lot of acquirers tell us that they prefer that the seller be represented. The buyer doesn’t need representation; the buyer understands how to negotiate a deal—but the seller is only going through this once.”

Once that comfort level has been achieved and broad terms have been agreed to, the next step involves the drafting and exchange of what may seem to the seller like a blizzard of documents. Here too, being represented by a firm such as Harbor Capital Advisors can be invaluable. “The buyer may present the seller an 80-page-plus document that’s full of representations and warranties. It gets pretty complicated with respect to the legal issues,” Di Stefano says. “If you’re going to sell your business, there are certain things you’re going to represent and warrant to the buyer. The language may sound intimidating, so we assist the client’s counsel in walking the client through the document and explain that these provisions are standard practice.”

At the risk of sounding self-serving, Di Stefano says, proper representation in a merger or acquisition can go a long way toward ensuring a solid, profitable deal for all parties. “The clients Harbor Capital represents are happy because they had the opportunity to review the available options and because the deal was handled in a methodical and professional way. I always describe the sale of an agency as an educational process,” he comments. “If you understand what the options are, you can make the best decision without wondering later if there was another deal that might have been better.

“There’s a big psychological component in selling your agency,” Di Stefano says. “It can be traumatic. At the point of sale, a client may panic and say, ‘I don’t have to sell!’ I say, ‘You don’t have to sell—but this is a good deal for you.’ Invariably, the client comes back after the transaction has been completed and says, ‘This is the best thing I’ve ever done—I wish I’d done it years ago.’” *