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Agency Financial Management M&A negotiations Avoiding missteps By Paul J. Di Stefano, CPA, CPCU Whether you find yourself on the “buy” side or the “sell” side of a transaction, you may encounter many potential pitfalls in the negotiation process. Unfortunately, as many have discovered, some of these pitfalls are quite difficult to recover from and may prove ultimate deal killers. Buyers and sellers have been misled into thinking that deal negotiations are a game of brinksmanship, where the object of the game is to get the edge on the other party. In many cases, that strategy is revealed only when documents have been prepared which outline the deal. Documents are typically prepared by one side of the transaction or the other. More typically, the buyer drafts the contract. Deal points that were taken for granted during the process are now laid out to be scrutinized by the other party. As a starter, one must be careful to choose the right attorney because many attorneys may not be familiar with the intricacies of the insurance business and may rely on the client to assist with the structuring of the agreement. In many cases, Harbor Capital has helped our clients’ counsels become familiar with the general commercial terms contained in agency purchase and sale agreements. Constructing a detailed letter of intent or term sheet is always a good idea. Typically the more detailed the better, since this will eliminate misunderstandings later in the process. It is also an opportunity for both sides to consider and discuss all aspects of the deal structure. Although I have touched on the issue many times before, many principals continue to believe that negotiating their own deals is a piece of cake. Buyers’ terms and sellers’ expectations are often so far apart that, for all intents and purposes, any prospect of negotiations becomes a non-starter. As examples, from the seller’s point of view, down payment amounts may be too low; earn-out periods may be too long; the deal may not be tax efficient; financial guarantees may be nebulous; employment contracts may lack reasonable guarantees. From a buyer’s point of view, the valuation of the seller’s business may be affected negatively by issues such as books of business not owned by the agency, excessive compensation agreements, absence of noncompetition agreements and large account concentration. One of the biggest problems that we have encountered is the occasion where a seller wants to shortcut the negotiation process. In these situations, the seller typically wants to have the prospective acquirer agree to the tentative terms of a proposed deal right after preliminary discussions have taken place. Even if the seller’s expectations are reasonable, this course is likely to turn the buyer off because, in most cases, the buyer may believe that he or she has an inadequate amount of information to respond intelligently. The reality is that the deal negotiations stand the best chance of success only after both parties fully understand the future opportunities associated with the transaction. In order for both parties to attain that full understanding, sufficient interaction must take place between the parties discussing the benefits of the transaction which arise from the integration of the two organizations. In some cases the buyer will want to perform due diligence prior to making an offer. In general this is not a very good idea. Due diligence is a fairly intrusive and disruptive part of the deal process and should not be commenced before there is a meeting of the minds. On the other hand, sufficient information should be shared with potential buyers so that informed offers can be constructed. The first step in this process is usually accomplished by having the buyer execute a confidentiality agreement. The second step in the process is to organize agency data in a way that helps give the buyer a clear understanding of the seller’s business model. Very sensitive information such as account lists and specific clients’ names, of course, are not shared at this stage of the process. We have seen several cases where the seller was reluctant to share information because the information was not in the best of shape due to systems problems. Unfortunately, the buyer took this as indication that the transaction might be a difficult one and moved on to other opportunities. Sharing limited information creates problems of its own. We have seen situations where the seller was reluctant to share information, other than vague generalities about agency revenues and profitability. These situations are typically a result of an irrational fear that information will be all over the street. On the other hand, there are cases where a major competitor may be a viable buyer and rather than avoid opening discussions with that buyer, additional steps may be necessary such as limiting the information shared, to protect the seller’s interests. Information sharing can become somewhat of a judgment call. One of the more sensitive issues to deal with is deciding when to bring key nonshareholder staff into the confidential circle of discussions. Bringing these individuals in too early creates its own set of problems, while bringing them in too late may actually delay the close of a transaction. Since key individuals will be required to sign noncompetition agreements, Harbor Capital’s approach is to bring these individuals into the circle once it seems clear that a deal is likely to take place. The exact timing will be a function of whether that individual’s compensation arrangement will change or remain the same. In summary, there are many obstacles to successfully closing a deal. In Yogi Berraesque terms, “A deal is not closed until it’s closed.” Stumbling through the deal process can be costly in terms of potential lost opportunities. Working with an intermediary experienced in agent and broker deal negotiations is something like hiring a captain on a cruise. Although the voyage may look simple, there will certainly be obstacles that could not be forecasted, and it is also nice to have someone knowledgeable at the helm. * The author |
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