Building Equity Value
Institutional buyers don't deserve
"slash and burn" label
Strong commitment to agency's employees and culture works
to buyer's and seller's advantage
By Chris Darst
I hear it all the time: "I will never sell my agency to an institutional buyer (a public broker, financial institution or private equity firm). They do not care about my people; all they care about is the bottom line. They would completely destroy the culture I have tried so hard to build over the last 25 years. My producers would be required to grow their books of business by an unrealistic amount; they would eliminate half my staff; demand a minimum profit margin of 25%; and, on top of that, expect us to generate retention rates above 95%. They will relentlessly look over our shoulder, scrutinize our culture, and meticulously micro-manage the way we do business. Any sign of a decline will result in the termination of all of us! And to add insult to injury, even if we perform, they will terminate our senior leadership anyway after the employment agreements run out."
I have even heard institutional buyers be referred to as nothing but "Ponzi schemes" and "career death traps."
Many agency owners know someone who knows someone whose cousin sold their agency and experienced some of what is described above. The reality is that there are some buyers that absolutely do have a "slash and burn" acquisition strategy. But they are few and far between. "Slash and burn" is a term that describes a strategy founded on purchasing an agency with the intention of making significant changes after closing in order to enhance the short-term profitability. It is presumed that the changes are to the detriment of the seller and are not disclosed prior to closing. In reality, most buyers are forthcoming about post-closing changes. My experience is that those buyers that keep post-closing changes secret are typically unsophisticated buyers with little acquisition experience.
The overwhelming majority of institutional buyers understand the importance of being honest and forthright with potential acquisition candidates. In fact, talking about required changes is a critical tenet of the process. The acquisition strategy for most is the opposite of slash and burn. They are more interested in retaining employees and growing the agency than they are about eliminating bodies and cutting costs. A buyer's greatest fear is that employees will leave the agency after closing and the performance of the agency will plummet. Buyers will tell you that the most valuable asset they look for when contemplating an acquisition is its people. As with independent agency owners, institutional buyers also struggle with finding quality employees. Acquiring agencies with quality people is their primary solution to this problem.
We all know an agency that sold to a public broker and then let some of the staff go. You probably have even picked up some employees from the fallout of a local deal. Undoubtedly, you heard that the buyer was ruthless and cold; they cut commissions, eliminated bonuses and terminated positions. However, what the seller did not disclose was that the reason they sold in the first place was because they had too many people, couldn't make difficult decisions and the profitability wasn't sufficient to allow for internal perpetuation. The seller waited too long to perpetuate, did not run the business in a manner that could fund an internal deal and had no other option but to start talking with buyers.
Yet, these sellers that cannot perpetuate want at least 1.5 times revenue guaranteed, plus an earnout. A buyer's response to that request is: "We will give you the number you want, but you need to get your margin up from 10% to 25%. If you can't, we still want to purchase your agency, but the price is going to be lower than the number you demand. At 6 times pro forma EBITDA guaranteed, a 10% margin translates to 0.6 times revenue while a 25% margin translates to 1.5 times revenue. And the reality is eventually we will probably make the changes over time anyway so that we can have an adequate margin sufficient to our shareholders. You might as well make the changes now and reap the benefit through a higher sales price. Had you made the decisions yourself, you would not be for sale. If we don't make them, we will eventually be for sale."
After so many of these meetings, owners begin to realize they need to make changes to increase the bottom line and to create value. Ironically, these are the same changes that are needed to create the cash flow to perpetuate internally. As a result of this process, sellers make the changes at close or subsequent to close to justify the value the owners need in order to sell the business. Too often, the sellers make the decision to drive value, and then use the buyer as a scapegoat to divert the blame in the discussion with employees, carriers, peers, and in the community.
The "real" story
Institutional buyers have made many mistakes along the way, but in general they have learned a great deal from their mistakes. When banks first began to acquire agencies back in 1999, they earned a reputation for completely destroying the sales culture of agencies. It was said that they would change producer compensation from commission to salaries, completely micro-manage the staff, require management to spend most of their time in meetings, and frown upon entrepreneurial activities. Whether the rumors were true or not, banks learned from their mistakes. Between 2003 and 2007, financial institutions earned a reputation of being the most active and attractive buyer in the marketplace. Not only did they pay a high price, but they gave the seller high levels of autonomy to continue running the agency as it had in the past. The public brokers and private equity groups have also learned from their past mistakes and have become much more attentive and sensitive to the people component of an acquisition.
Many agency owners presume that a sale to an institutional buyer means a high price in exchange for allowing a slash and burn practice to take place, whereas a sale to an independent buyer means a low price in exchange for autonomy and a new home for their employees. However, this is not always the case. I was involved in an agency acquisition years ago representing an independent agency as a buyer. Contrary to our repeated efforts to change the buyer's mind, on the day of close the buyer announced to the employees, "You are now part of our agency. We do things a little differently at our agency, so there are going to be some changes."
The buyer then informed the producers that their commission splits were going to be reduced from 35%/35% to 35%/25%. He then proceeded to eliminate 25% of the staff simply because their productivity metrics did not compare well to his current staff. While the changes were necessary, his attitude was arrogant and brash, and he clearly demonstrated a "we are better than you" type demeanor. There were 23 employees working for this selling agency at the time of close. Six months later, only one employee remained.
This buyer's attitude was extreme, but we do find that independent agencies that buy other agencies sometimes tend to slash and burn more than institutional buyers because they have more at stake. Institutional buyers have pressure from Wall Street or outside investors to maintain or increase the bottom line, but the pressure isn't nearly as great as an independent agency where debt from a particular deal represents a significant personal risk. Even for a relatively large independent agency, say $10 million in revenue, the purchase of a $2 million revenue agency is a huge transaction. Because it is such a big investment, often an independent agency buyer will be highly motivated to make changes shortly after close due to the debt payments associated with the transaction. For an independent agency, one bad deal could be disastrous.
For an institutional buyer, most transactions are inconsequential relative to the big picture, and one bad deal is not going to make or break the company. Thus, they are not as concerned about increasing cash flow in the first few years. They are more focused on creating a platform for generating long-term sustainable growth.
Most institutional buyers are not interested in gutting an agency after an acquisition. They are looking for long-term partnerships, quality employees, and a seasoned book of business. It is true that sometimes employees are terminated after a sale, but frequently it is the agency owner making the decisions behind the scenes to drive value with the anticipation of blaming the buyer post-closing. These are difficult decisions that should have been made years before, but the owners did not have the heart, motivation, or courage to do so.
Quality employees are rarely, if ever, at risk of losing their jobs after a sale. In fact, the employees generate most of the value in an agency. Almost 100% of the time, when a seller asks a buyer to provide a certain employee's or group of employees' employment agreements in conjunction with a deal, a buyer will readily agree because the primary goal is to retain the employees. If you are contemplating selling your agency but refuse to speak with the institutional buyers, you may be making a mistake. There is a reason why so many agency owners choose to sell to the institutional buyers, and it is not because of a slash and burn mentality.
Chris Darst is a vice president at Marsh, Berry & Company. He can be reached at (949) 234-9648 or at firstname.lastname@example.org.
Independent agencies that buy other agencies sometimes tend to "slash and burn" more than institutional buyers because they have more at stake.