Considerations for Insurance Agency Owners Contemplating a Sale
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By Mel Tull
Owning an insurance agency is a great vocation. You get to work with people in your community everyday who seek you out for your knowledge, advice and counsel. You experience the pride and satisfaction of protecting lives and livelihoods from risks small, large and catastrophic. It’s a financially rewarding, entrepreneurial venture that performs well in all economic cycles, producing strong cash flows and from relatively low capital investments.
Inevitably though, all agency owners reach a moment when they begin to think about their agency’s future. It may be due to retirement planning, succession planning, or an unsolicited inquiry from a potential buyer. The acquisition market for agencies has held up well through the recent pandemic and the period of high inflation and high interest rates that followed. Deal volumes and purchase price multiples remain robust.
If you think a sale may be in your future, it's important to begin preparing well in advance — at least a year, and preferably as much as three years in advance. Advance preparation can increase the value of your agency in a sale, expedite the sale process, and avoid common issues that can delay or derail a deal. There's a lot to consider. Below are a few areas where advance planning can have a big impact.
Financial Disclosure: The Clear Picture
When presenting your agency to a prospective buyer, financial clarity is key. Most buyers value agencies based on operating profits (EBITDA), and pay higher multiples of EBITDA for agencies that show revenue growth and robust operating profit margins in recent years. It is important to take actions several years in advance of a sale to organically grow revenue and eliminate extraneous expenses to allow time for the results of these actions to be reflected in your financial statements.
Detailed financial statements, reviewed by an independent accounting firm, and supported with well-organized books and records, will best demonstrate your agency's financial stability, growth and profitability, and give prospective buyers confidence in the financial information reported. Buyers may discount the amount they are willing to pay for an agency with sloppy financial records due to uncertainty about the numbers. It also speaks volumes about how well the agency is managed.
Tax Considerations: Keeping More in Your Pocket
The structure of your legal entity and the sale transaction will affect the taxes you pay and can make a big difference in the final amount agency owners get to keep. Advance planning is important because some tax positions require actions to be taken well before the sale transaction is consummated. For example, a C-corp that converted to an S-corp will pay an additional entity level tax at the corporate rate on any built-in gains (asset appreciation attributable to the C-corp years) if the agency is sold in a transaction structured as an asset sale within five years of the conversion. Another example involves structuring a transaction to include the sale of the agency owners’ personal goodwill, which can avoid significant double taxation of much of the purchase price, but must be supported by appropriate written documentation prepared many years in advance of a sale. Tax planning might be one of the most complex pieces of the puzzle, and a talented tax advisor can really earn their keep, so plan this part carefully with the right expert advice.
Due Diligence: Your Legal Checklist
Due diligence is essentially a deep dive into your agency's complete history and current status. Most buyers will perform a thorough investigation of all your agency’s material documents, policies and procedures, including among other things, corporate charter documents, corporate meeting minutes, shareholder lists, loan and debt documents, employment agreements, employee benefits plans, insurance company agreements, other material agreements, real estate and equipment leases, sales and marketing materials, information about internet domain names, email addresses and other intellectual property, information technology, hardware, software, privacy and data security infrastructure and protocols, insurance licenses, litigation, regulatory matters, and the agency’s own insurance policies. Among the many things you can do to prepare are make sure you have fully-signed copies of all material contracts, and review material contracts for change of control provisions that may require you to obtain the consent of a third-party (such as an important insurance company partner) before the contract can be assigned to the buyer. Gathering and reviewing these materials in advance can speed up the sale process, prevent delays, uncover issues that can be addressed before the sale process begins, and give potential buyers confidence your agency is well organized, well run and worth a premium valuation.
Employment Matters: Smooth Transitions
Agency owners want to make sure their employees are taken care of, and most buyers want to keep the employees needed to service, retain and grow the accounts they are acquiring. Contracts with sales personnel and other key employees should be reviewed with an eye for non-compete, non-solicitation and confidentiality covenants. To retain staff through closing and the transition to new owners, you may want to consider how employee benefits will carry over and consider offering stay bonuses or change of control severance agreements.
Many agency sales include an earnout provision whereby a significant amount of the purchase price is contingent on the agency achieving specified revenue or profitability targets in the years closely following the sale. Active efforts by the agency owners during the earnout period are often critical to achieving those targets and maximizing earnout payments. If selling your agency is about retirement or moving on to new ventures, you will want to factor the likely earnout period into those plans.
Regulatory Compliance and Litigation: The Non-Negotiable Foundation
Few things can kill a deal faster or negatively impact an agency’s value more than a regulatory violation or investigation or an errors and omissions lawsuit. Buyers do not want to inherit problems that could expose them to significant liabilities or materially damage their reputation.
Well in advance of the sale process, you should undertake a thorough review of your policies and procedures for compliance with state insurance regulations and other federal and state regulations, such as privacy and data security laws. Ensure that everything from the contracts you've issued to how you manage claims is in line with industry standards and regulatory requirements.
Intellectual Property: Valuable Assets
In the digital age, your business's data — client lists, operating procedures, even your agency brand — is a valued asset that should be protected. Ensure that any proprietary information is legally secured through copyrights, trademarks, or patents. This not only safeguards your work but contributes to the overall value of your agency.
Conclusion: The Bottom Line
Selling your agency is much more than just signing on the dotted line. It is a complex, document intensive process involving issues not often encountered in everyday business. Careful planning and detailed preparation well in advance of a sale process will serve you well. Don’t hesitate to get advice from qualified financial, accounting, tax and legal professionals who specialize in agency sale transactions – you wouldn’t advise someone to obtain complex insurance products without your professional advice.
For more information or assistance with preparing your agency for a potential sale, contact Mel Tull, at Mel@TullLawPLC.com or (804) 404-7748. Mel advises insurance agencies and other companies on general business law matters and buying and selling agencies and books of business.
This article has been prepared for informational purposes only and is not legal advice.
