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Reasons Why NOT to Hire an Advisor

Reasons Why NOT to Hire an Advisor

Recently we posted a blog on the Reasons to Hire an Advisor. It made me reflect and I asked myself why someone would not hire an advisor. Hopefully, the Reasons for Hiring an Advisor were more compelling than the Reasons Why Not to Hire an Advisor.

Here are some of our reasons why you should NOT hire an advisor:

Lack of Commitment to a strategy. Our worst case client is someone who is not committed to the execution of a strategy. Our process helps you identify your goals. If you are not committed to the execution of the plan required to meet your goal, wait until you are fully engaged.

Valuation. Certain parties go through a sales process to “determine what they are worth.” The process is time consuming and distracting. Just ask us what you are worth, we will be happy to limit our involvement.

Validation. We have experienced perspective clients that have already identified the buyer and want to hire us to validate their decision. Valuation and deal structure is a very subjective process and no one deal value or structure is ideal. If you have already made your decision, save your energy and money. An advisor should be open to give you all of your options and not just validate your decision.

Lifestyle. If you are not committed to being fully engaged after a deal because of lifestyle issues, you should go it alone. We tell clients that buyers don’t expect to do deals with only saints. Be honest about your social habits and work schedule. If you aren’t able to be honest, it is best not to involve others.

Unreasonable Expectations. You should set expectations regarding value before you engage an advisor. If you expect to receive “A multiple of 12,” an advisor should state that your expectations can’t be achieved.

Buyer is Not Important – Our experience is that the most widely known buyers of most agencies are all very credible parties and offer many advantages to smaller agencies. There are subtle differences between these parties. We have had prospective clients tell us that “I can work with anyone and who I partner with isn’t that important.” This situation is rare. Matching the cultures of the parties is one of the primary responsibilities of an advisor.

Price is Not that Important – There are many components to every deal including: The projected earnings of the agency, the deal multiple, the payment at Closing and the ability to achieve an Earnout. The single most important component to most owners is the payment at Closing. Some owners focus exclusively on who the buyer is. They are only concerned about getting a reasonable price. Advisors should help maximize value. If you are only focused on the buyer, it isn’t hard to identify the most likely parties and an advisor is not critical.

Case Study in Perpetuation - TOBI Insurance Agency

Case Studies in Perpetuation

Rough Notes March 2012

By Tom Sukay and Paul Vredenburg

Successful Internal Perpetuation

In the January issue of Rough Notes, we discussed a case study for Duncan & Associates which was undergoing an ownership change. The firm’s owners concluded that their best option was to sell to an external third party. The managing shareholder preferred an internal perpetuation, but the remaining shareholders were unable to finance the transaction.

This month we present a case study on another firm, TOBI Insurance Agency. Although similar to Duncan in size and makeup of business, they have decided to take a different course of action-opting to perpetuate itself internally. Although TOBI is well situated to perpetuate internally, we believe the firm’s owner should still evaluate all of his options along with the risks and benefits for each strategy.

As we did in January, we will provide three perspectives: one from the agency owner; the second from Sukay & Associates, as the advisor; and the third from an independent third party, Assured Partners, Inc.

Background of TOBI Insurance Agency:

The agency was founded in 1933. It has revenues of approximately $4.0 million and is structured as a sole proprietorship. It is located outside of a major metropolitan area in a desirable area near several economic and cultural centers. It has been built on personal service and its staff averages more than 20 years of experience. TOBI represents many leading insurance carriers, ranking among the largest agents in the United States for one of those carriers. The owner feels a strong sense of responsibility to the current staff.

The agency is owned 100% by a single shareholder who is in his early 60’s. Several family members are involved in the business, including one of the owner’s children. The agency has been very profitable for many years. The owner’s situation is unique in that he has adequately provided for his eventual retirement and does not need any of the proceeds from an internal or external perpetuation to fund his lifestyle.

Owner’s Perpetuation Perspective:

During the last decade, TOBI Insurance Agency has been approached by many potential buyers including all of the large publicly traded brokers and several banks. We have never considered a sale because these buyers could not adequately answer one fundamental question: How would an external perpetuation affect my customers, staff and my own career? What do they have to offer than we don’t have within the current agency environment including additional markets, products or technologies? It always seemed ironic that most offered the ability to conduct my business in the same manner as we had done prior to the deal. If that was the case, why would we consider doing a deal?

I truly love the independence of owning my company and I look forward to coming to work and meeting with clients. Owning an agency has allowed me to be financially independent. However, the ownership of the company must ultimately pass along to another party, just like it passed along to me 36 years ago. My current intention is to sell the business to a family member. The amount of the sale and the manner of payment is not as important to me as my ability to maintain the independence of the agency. The most important issue is whether the family member is ready to grow and manage the business. It is my responsibility to mentor them to continue the legacy of the agency.

Sukay & Associates (Advisors) Perpetuation Perspective:

TOBI Insurance Agency enjoys favorable long-term perpetuation options. Most agency owners who want to perpetuate internally are forced to perpetuate externally because they face at least one of these major hurdles:

They have no obvious successor in the agency. No employee has the skills required to run the operation and solicit or retain new and existing clients.
The current owner does not have the financial resources required to maintain his or her lifestyle throughout retirement and is unwilling to accept a lower valuation from internal buyers.
As a result of the tight credit markets, internal buyers cannot obtain outside financing to buy the agency or are unwilling to provide personal guarantees. As a result, the owner has to accept an unsecured note from the buyers.

TOBI Insurance Agency is not burdened by any of these restrictions. We would expect the owner to transition ownership to a family member in the next five years. We would then expect that the current owner would continue to be actively involved in the business well beyond that time period.

One of the few concerns we have is whether the new owner has the ability and willingness to assume ownership risk. Just because a family member seems to be the likely successor doesn’t mean that he or she is willing to assume the headaches and responsibilities of ownership. We would assume that the agency would be transferred at less than fair market value. If given the option, would the family member choose to buy the company at a discounted price or would they prefer to share in the sale proceeds and have his or her career protected by an employment agreement? We also recommended that the owner consider all of their family dynamics if the company is transferred at less than its fair market value.

In an external perpetuation, the owner is foregoing the rights to future cash flows in exchange for the shares of their company and an upfront payment. At this point, the market risk is shifted from the seller to the buyer. If the seller has confidence in the management team, he or she always has the ability to retain ownership interest and stay involved in an oversight role. In this situation, it is extremely important that all key employees execute non-compete and non-solicitation agreements. The owner can enjoy the benefits of a reduced work schedule and always retains the right to sell the agency in the future.

AssuredPartners, Inc. – Third Party Potential Buyer’s Perpetuation Perspective:

Many agency owners wish to perpetuate the agency, and in many cases the most successful perpetuation plan is to a child or family member. In those cases, the ownership has a vested interest in making the transition successful. The agencies that fail tend to be internal sales to non-family members and the selling party does not dedicate the appropriate investment in time to make that party successful.

As a buyer of firms, we would be interested in working with firms like TOBI. The key reason is that the management team has a transition plan and we would benefit from having the next generation involved to keep the agency growing. I like to ask the following questions of sellers that want to perpetuate internally to make sure they are committed to that plan:

Can you cede control to the next generation and allow them to “manage” you and the agency?
Are you willing to take a 25% to 40% discount on the value of the firm to see it in the hands of the next generation?
If the asset is a key to your retirement, do you feel good about putting that pressure on your child?
Are you willing to invest the time to make the transition successful?
Would the next generation benefit from being part of a larger organization or would those individuals like a role in a larger organization?
Will you be able to grow if the agency is saddled with perpetuation debt? The debt will consume dollars that could otherwise be used to hire new producers, invest in systems, etc.

The owner must receive adequate answers to all of these questions to be successful. Internal perpetuation should be commended but the effort to achieve this transition is significant, all while receiving a discounted value for the firm you created.

AssuredPartners, Inc. would allow the next generation to control their destiny by maintaining operating autonomy and provide financial protection for the current ownership. We believe that you have the best of both worlds in that the next generation would have the capital to grow in their marketplace and assist in developing the direction of the company.

Summary

It is commendable TOBI’s owner wants to cede this agency to the next generation. The only issue is that most owners are making the assumption that the next generation wants or can handle the pressures and responsibilities of ownership. Pressure changes the way people make decisions. It is an awesome responsibility to continue a legacy. It is sometimes more pressure than anyone is willing or able to assume.

We ask a simple question to each agency owner that intends to perpetuate to a legacy. We create a hypothetical situation. The agency is valued at $10 million and the owner is willing to sell it to a legacy for $6 million. Most people would find that transaction very appealing. Our question is: Would the legacy prefer to buy the agency for $6 million and be responsible for the future payments to the owner or would they prefer if the owner sold the agency for $10 million and shared $4 million of the proceeds? You would be surprised by the answers to that question.

The consequences of failure are profound because no matter what happens to the business you can never walk away from your family. Maybe that is why internal perpetuations to family members are more successful. Or maybe it is the fear of what Thanksgiving dinner will look like for the rest of their lives.

Case Study in Perpetuation - Duncan & Associates

Case Studies in Perpetuation

Rough Notes Article – January 9, 2012

Agency Financial Management

By Tom Sukay and Paul Vredenburg

Examining an Agency Ownership Transition

Recently, Sukay & Associates has become very involved in perpetuation planning. Our firm rarely gets a call where someone says, “I want to sell my business.” The most common call is from an agency owner in his early 60s who needs some help valuing their business so they can internally perpetuate. We have found that owners believe that they have a clear idea of their goals. Our challenge is to ensure that their goals are achieved.

In this article we will analyze the goals and strategies of an agency whose principal owner wishes to sell to an outside firm. The situation that we discuss in this article is based on an actual agency’s circumstances. Names and locations have been changed. In subsequent articles we will take the same approach for two agencies whose owners wish to perpetuate internally.

In each article we will provide three perspectives. The first comes from the agency owner. The second is our perspective as an advisor. Sukay & Associates is engaged to help the selling owners achieve their goals. We are not hired to help them sell the agency or create an internal perpetuation plan. The owner decides the course of action once we have agreed on our goals. We are simply an asset that provides intellectual capital that allows them to achieve those goals. One challenge is to make sure that each client is aware of all of their options and the risks and benefits associated with each strategy, including the human element.

The third perspective is from an independent third party. Paul Vredenburg, Sr. V.P. of AssuredPartners, Inc. has agreed to provide this prospective. Paul has experience as an advisor and is now an active buyer of agencies through AssuredPartners. We thought that this would be interesting since many internal perpetuations are done at a lower valuation than an external perpetuation and the owner undertakes a significantly greater risk of funding in an internal perpetuation. We also wanted to get a Buyer’s perspective of the timing of a sale and attractiveness of each agency.

Case Study: Duncan and Associates

Background

Duncan and Associates has been a part of their community for over 100 years. They are located in an affluent suburb of a large city in the eastern United States. The agency is owned by three individuals and one owner effectively manages the agency. The managing owner, who is now 65 years of age, purchased the agency early in his career. The managing owner owns 45% of the company. The two other shareholders own 45% and 10% respectively. The two other shareholders are in their mid 50s. The shareholder with the lowest ownership percentage has committed to act in the best interest of the managing shareholder. As a result, the managing shareholder has the ability to act as the majority shareholder.

The agency has revenues of approximately $5 million. Duncan and Associates offers businesses and organizations a broad spectrum of insurance products and services. Their highly trained staff of insurance professionals has the expertise and ability to design programs of insurance that are tailored to meet the needs of their commercial clients. The owner feels a strong commitment to the people that have helped him achieve these goals, especially to his two other partners.

Duncan and Associates enjoys premier contractual agreements with the nation’s foremost insurance carriers. The companies they represent are financially sound and they can provide a wide range of coverages that are competitively priced. In addition, they have longstanding relationships with many national and international insurance wholesalers which gives the agency broad access to both domestic and foreign specialty markets.

Duncan and Associates Owner’s Perpetuation Perspective:

I believe in the independent agency model and in an ideal world I would have tried to perpetuate my business to the minority shareholders. They have helped me grow the business and they continue to service clients and provide meaningful value to the company. Many of the people that work here are like my family.

The other shareholders do not have the financial means to acquire my interest in the company. The agency is very profitable which translates into a high value for the agency. I also have some concerns about the other shareholders ability to manage the company as a team without my oversight. I would not be comfortable accepting a note from the minority shareholders for my interest in the agency and I don’t believe that they will be willing to give me any personal guarantees.

As a result, an external perpetuation seems to be my best alternative. My goal would be to continue an active role in the company for an extended period of time. I have no anticipated retirement date as I would prefer to maintain ongoing relationships with my key clients. My schedule and hours worked would diminish over a period of time. I don’t see myself spending the rest of my life playing golf, traveling with my wife and playing with the grandchildren. These activities will be a part of my life, but I want to continue my professional life as long as possible. I would expect the two other shareholders to have a more active role with the new owners and I would expect to keep most of the current employees that have helped me become successful.

My primary concern of a sale is timing. During the last several years, the economic climate has resulted in a few lost clients and a significant decline in revenues from the softening insurance market. Although no one can be certain when, or if the market is going to harden, I believe it makes sense to wait another three to four years before the agency is marketed for sale.

Sukay & Associates - Advisors Perpetuation Perspective:

The managing owner of Duncan and Associates has done an effective job of assessing their situation and we concur that an external perpetuation is their best alternative. The key issue is the timing of the transaction. Just as interest rates will eventually increase, the insurance market will harden. The questions become: When, and by how much?

We see no evidence that Duncan and Associates would benefit from an enhanced value if the owners waited another three or four years to sell. Although the market may harden, the possibility exists that it will remain soft or even become softer. By waiting, the owners run the risk that the market would continue to soften and the agency’s value will decrease.

Sellers sometimes fail to recognize that they will have access to the deal proceeds. These proceeds can be invested depending on their tolerance for risk. Even a conservative reinvestment of the proceeds would offset the increased value of the agency that would result from a moderate increase in insurance rates over a three-to four-year period. Let’s make the following assumptions:

Revenues 2011 $5.0 million

Premium Volume 2011 $50.0 million

Profit margin 30.0%

($1.5 million)

It is difficult to determine a valuation without understanding the specific characteristics of the agency, but we can assume a conservative valuation of 6.0 times the projected earnings of $1.5 million. Based on this multiple, the agency would have a value of $9.0 million.

What would happen to the valuation if the market hardened and premiums increased by 5.0%? In this scenario, premiums and revenues would increase to approximately $52.5 million and $250,000 respectively. The company would certainly incur some costs associated with the enhanced revenue, most likely in the form of producer compensation or marketing expenses. For our analysis, we have assumed that earnings would increase by 50% of the enhanced revenue or $125,000. Based on our 6.0 multiple, the valuation of the agency would increase by $750,000.

The question is simple: Should the agency wait for the market to harden or should they sell immediately? In our example we can assume that the owner’s proceeds would be approximately $7.2 million. The $7.2 million was obtained by reducing the gross deal proceeds of $9.0 million by 20.0% which should cover their capital gains tax, state income taxes and other transaction costs. The increased valuation of $750,000 would be reduced by these same costs and would net approximately $600,000. The question then becomes: Would you rather wait the four to five years for the market to harden or realize the $7.2 million and reinvest the proceeds? We have simplified this example. It all likelihood, the seller would only receive approximately 90% of the proceeds at closing whether they sold the agency immediately or at the end of five years.

The agency owner could reinvest the proceeds at 2% and realize the same after tax proceeds at the end of the five year period. Different investment strategies carry widely different risks, but we would contend that an owner could execute a very conservative investment strategy over the next five years and still exceed a yield of 2%.

The real problem with Duncan and Associates is the age of the owner. We don’t feel that it is in his best interest to wait any longer due to the impact of his age on his valuation. We have a saying at our company, “Uncertainty diminishes value.” By waiting any longer Duncan’s owner is increasing the uncertainty regarding the deal. Will the owner continue to have the same impact on the business as he has had in the past? Most likely he will not. Will the existing staff step up and assume his role? The reality is that nobody knows for sure. As a result, uncertainty is created and the value of the agency will be reduced.

Would we be able to find a buyer for Duncan and what would happen to the multiple if he waited another five years? Many likely buyers would pass on the deal. The others would decrease the multiple or structure the deal where the guaranteed payment would be significantly reduced.

We would recommend that the seller entertain proposals immediately and structure a deal where an Earn Out would capture some of the value of the hardening market. Although we don’t have the benefit of hindsight, we would have recommended the same strategy five years ago. We believe that it is not generally in the best interests of the owner to wait to market the agency after they have reached the age of 60.

AssuredPartners, Inc. – Third Party Potential Buyer’s Perspective

The biggest challenge of working with a seller is having him or her make the mental jump to accept an external sale. Duncan’s principal has made that decision and understands that there is a trade off from being an independent owner to becoming part of a larger organization. Once that decision has been made, the buyer and seller can focus on the areas that will allow both parties to achieve the highest return.

The first discussion for Duncan & Associates should be with the buyer to understand how the agency will be operated after closing. While the proceeds are important, the shareholders must get an understanding of the operating model of each particular buyer as well as the targeted goals for both profit and growth. Since a significant portion of the proceeds will be tied to achieving goals after close, a seller should ensure that they are connected with the buyer on all aspects of life after close. This would include financial, operational, quality control and information technology.

The second area for Duncan & Associates to address is the timeline for the majority principal with regards to his interest in continuing to manage the day-to-day operations. This timeline will give us as a buyer an idea of how to structure the Earn Out so that it matches up with the seller’s expectations. The second reason for the timeline is to prepare for a transition of management by identifying the person or persons within the organization that will operate the firm after the Earn Out. It is important for the seller to guide a buyer in understanding where the management talent lies in the organization. A strong bench will result in a buyer paying a premium for the firm.

Once a model has been created, both parties can focus on determining the correct value for the agency and work towards a financial transaction that makes economic sense. If you bypass the areas above, both parties will get consumed by the “price” and lose sight of the fact that the sale is for both parties to create an agency that will continue to serve their customers and carrier partners in a consistent manner.

Duncan and Associates is an attractive opportunity for buyers because of its size and market location. The age of the owner is a big concern. A potential buyer needs to understand how important the owner is to retaining the existing clients and the agency’s growth. In evaluating this or any proposed transaction, the buyer must acquire detailed knowledge of all aspects of the agency’s operation, both tangible and intangible.

The authors

Tom Sukay is President of Sukay & Associates, an advisory firm that represents insurance brokers.

Paul Vredenburg is a Senior Vice President of AssuredPartners, Inc. an insurance agency that was formed in March 2011.

Tom Sukay Paul Vredenburg

President Senior Vice President

Sukay & Associates Inc. AssuredPartners, Inc.

www.sukayassociates.com www.assuredptr.com

Independence versus Employment – How Difficult is the Transition?

When meeting with new prospects, we always get asked three questions (probably in this order):

1. Is this a good time to sell?

2. How much is my agency worth?

3. What would it be like working for someone else?

I believe that I have the experience to answer the third question, but I wanted to receive feedback from others who have sold their agency and are now non-owner employees of other agencies. My experience is the opposite of most agency owners. I started out working for a public accounting firm and then worked for two banks and then a large corporate travel firm. I then started Sukay & Associates. My experience is that the question isn’t what it would be like working for another firm; the question is what is your new boss going to be like?

Companies tend to work very hard to develop a corporate wide culture. The best culture in the world can be destroyed by the acts of a single individual. Our advice is to start by learning the culture of the new firm. If it isn’t healthy, it will be difficult for individuals to act in a positive manner. Then get to know the people that you are going to work with on a daily basis. We frequently do deals with a certain party because our client develops a rapport with someone during the deal process.

Who is normally successful in the transition? We had one client who wanted to prove they could be successful in a corporate environment. He felt he had something to prove. We had another that enjoyed the expanded social and professional relationships. We had another who felt that they were being held to unreasonable expectations. Our advice is to be truthful during the deal process. If you want to reduce your schedule, don’t tell the buyer that you work 60 hours per week. If you like to take off eight weeks in the summer, tell the party that you have a flexible schedule. If you like to have five drinks at lunch, don’t do a deal.

In the end, if you are a committed professional who enjoys your business, there is no reason why you won’t make a smooth transition. Just make sure you assess your most important relationship (other than your spouse and dog), the next highest employee in the company’s hierarchy.

What has been your experience?

Sukay & Associates

understanding the essence of partnership