Agency Financial Management

Navigating the winds of change

Charting your agency’s course depends on the outcome you want

By Christel L. Sarchet, CPA, and Robin C. Frost, ACA

Have you been giving some thought lately to changing the direction of your agency? If so, what is driving that consideration?

When we pose this question to agents and brokers throughout the country, the answers generally fall into one of several categories:

• Increased capability, whether it be geographic or product driven;

• Reduction of management responsibilities;

• Expanded market access;

• Access to capital to fund long-term growth; or

• Retirement planning, which involves transferring a large portion of one’s personal wealth from the investment in his or her agency to alternative vehicles.

While some of the initiatives mentioned can be accomplished without outside assistance, many of them involve entering into a partnership, merger or agreement with another firm.

Increased capability

Expanding an agency’s capabilities may be as simple as training or hiring an employee benefits producer or outsourcing this function to a “friendly” competitor in exchange for a share of the commission.

Many agency principals would like to capitalize on the benefits side of the business but prefer not to spend the time required to develop producers in lines of business in which the principals themselves are not experts. In other cases the principals would simply like a bigger share of the benefits commission or more ownership of the process than a traditional commission-sharing arrangement would allow. This often leads the principals to consider a merger, especially when they contemplate the potential revenue they could earn by cross-selling their entire account base.

Merger or acquisition also may be the strategy of choice for principals who seek to expand their agency’s geographic reach or to pursue new classes of business on the property/casualty side.

Expanded market access

At some point in their careers, most agents and brokers believe that they missed an opportunity to write a lucrative account because they didn’t have an appointment with the right carrier. Although there are several ways to gain access to markets, agency principals who have their sights set on market access on a grand scale will often consider partnering with another firm.

Capital for growth

Several years ago an agency principal asked me: “Would you rather own 100% of $1 million in revenue or 60% of $6 million in revenue?”

Bringing in new partners can often create stress for a principal, but from an economic standpoint, the answer to that question is obvious. Once you go below the significant 51% ownership line, the answer becomes a bit murkier. The question becomes even more interesting if you take it a step further. How about 20% of an agency with $50 million in annual revenue?

Agency principals who want to expand at a rate faster than their current cash flows allow are likely at some point to consider seeking outside capital to help them achieve their goals.

Reduction of management responsibilities

Most agency principals grew up in the industry as producers, and at some point many decide they would like to get back to their roots. When the challenges of managing personnel, operations, and technology have become too onerous, many principals find that they still have the passion to sell. Principals in this situation often contemplate entering into a strategic alliance that will allow them to return to active selling.

Retirement planning

Retirement is one of the most common reasons that agency owners sell their businesses. In most cases, when the agency is sold by an owner who is retiring, the owner will not remain involved in the ongoing operations for an extensive period of time. In this case, the seller will look for buyers who do not require his or her continuing involvement beyond a specified transition period.

Selling one’s interest in an agency requires careful planning to ensure the appropriate reallocation of one’s assets from the agency to other investment vehicles. In the current economic and political environment, many business owners are carefully considering the timing of their retirement because an increase in the capital gains tax could significantly reduce the return on their investment.

Finding a fit

Once you have identified your specific goals, you can begin to consider what kind of firm may be the best fit for you. Common acquirers include other retail agencies or wholesale operations, financial institutions (i.e., banks and credit unions), private equity groups, and non-insurance entities. Insurance agencies can be further broken down into national brokers and regional/local brokers.

National brokers. The so-called “mega-brokers” bring a lot to the table for smaller agencies that are seeking a partnership. They enjoy wide name recognition, have broad access to markets, and possess the resources to handle large and complex accounts.

Joining forces with a national broker can be an excellent option for both agency principals who want to retire and those who want to remain actively involved in sales but would prefer to relinquish responsibility for management.

A key consideration is whether a move into the large corporate world suits the style of your agency. Larger companies in all industries tend to have bureaucratic structures with mandated policies and procedures that may not be a comfortable fit for everyone. In addition to conducting due diligence, you may want to meet with the principals of other smaller agencies that have been acquired by a national broker to learn about their experiences.

Local and regional brokers. If merging with a national broker is not feasible or attractive for your agency, another possibility is to form a partnership with a local or regional broker. Depending on how the transaction is structured, your agency’s principals may be able to retain an ownership interest and continue to play an active role in management.

Just as you must consider the corporate policy issues with a national broker, you need to become familiar with the culture of a local or regional broker with which you may form an alliance. Are the firm’s market focus and sales organization compatible with yours? How are leads generated and monitored? What is the compensation structure?

Financial institutions. In the current economic climate, one could argue that more banks are sellers of agencies than are acquirers. There are exceptions, however, notably Wells Fargo and BB&T, which continue to expand their insurance operations. In addition, a number of smaller regional banks and credit unions have not been hard hit by the financial crisis and still see the attractive cross-selling opportunities that an agency operation would afford them.

Whatever their size, most financial institutions have a culture that differs from that of an insurance agency in some key respects. With a larger bank, as with a national broker, policies and procedures are most likely mandatory for all operating units. In performing due diligence, agency principals should discuss how the bank intends to run the business and ensure that the bank has a full understanding of the challenges involved in operating an agency.

Private equity groups. Given the state of today’s economy, private equity might not appear to be a viable source of capital for agency growth. Although activity may not be as robust as in previous years, many private equity groups are either expanding their presence in, or entering into, the insurance space. These players are generally acquisitive by nature, given the financial model behind their plans. An agency whose principals are seeking capital to pursue long-term expansion initiatives may be well advised to consider a private equity partner.

Private equity firms that do not currently conduct insurance operations usually do not want to take over the management of an agency in which they invest capital, so current agency principals likely will retain their executive role. Private equity partners, however, will demand results, usually within a relatively short time frame. For agency principals who are comfortable with this scenario, an infusion of private capital can be great opportunity; also, a private equity partner often can provide a valuable outsider’s perspective on the agency’s operations.

Non-insurance entities. Potential acquirers in this category often are companies whose products or services require the buyer to purchase insurance. Rather than outsource this function, the company is seeking an additional source of revenue from the sale of insurance. Examples of companies where insurance plays a significant part in each sale are car rental firms, storage facilities, real estate brokerages, relocation specialists, and staffing firms. Affiliating with one of these non-insurance entities could be a significant opportunity for an agency to apply its skill set to a ready-made customer base.

Depending on its motivation for change, an agency that has been well run with a goal of enhancing agency value should always have access to a partner that can help it attain its long-term objectives.

The authors
Christel L. Sarchet, CPA, and Robin C. Frost, ACA, are vice presidents of Mystic Capital Advisors Group, LLC, a national merger and acquisition advisory firm that focuses exclusively on the insurance industry.