Insurance agency M&As remained strong the second quarter of 2017, with 135 reported transactions, according to OPTIS Partners. There were 185 deals in the first quarter, bringing the six-month total to a record 320. 

And while the industry has made much of the agencies that are being acquired, what about those that are contemplating growth by acquisition? Acquiring another insurance agency can be a significant operational and financial stepping stone to growth. Here are six steps to keep in mind when you’re ready to do it successfully.

1) Define the parameters of what to acquire. As a potential buyer of an insurance agency, you need to consider several factors when starting out. Don’t settle for any agency with a pulse. Instead, ask yourself a series of questions to help narrow the field:

• What kind of firm do we want to acquire? Do we want to expand our product mix or add to what we currently offer? Property-casualty or benefits? Personal lines or commercial? Large accounts or smaller ones? Niche focus or generalist?
• Do we want to expand our sales territory or become a bigger player in our current market?
• Do we want to create a short-term exit for a seller or a long-term growth opportunity with the seller in place? In other words, do we want to buy a firm owned by someone 55-65 years old or someone who’s a little earlier in their career?
• How large an agency do we want to acquire, in terms of revenue, number of owners and number of producers?
• What is our appetite for risk and debt?

Establishing a matrix or scoring mechanism for the type of agency you prefer to acquire reduces the likelihood that you’ll waste time, energy and resources pursuing deals that don’t fit your appetite.

2) Develop and implement an ongoing acquisition marketing plan. Identifying merger & acquisition prospects is a time-consuming process—it generally involves face-to-face visits with many individuals to determine if their agency fits your profile, then attempting to forge both a personal and professional relationship with them.

This process seldom leads to a quick transaction. Sellers are not willing to seriously consider a sale until they’re ready to sell, and that’s something buyers have little influence over. It helps if you’re able to illustrate why your agency is the best buyer for sellers to consider. This may entail some or all of the following:

• Your principals make an ongoing commitment of time and resources to the M&A process, researching viable prospects and meeting with them on a regular basis.
• Your agency develops marketing materials that describe your firm, its capabilities and the potential benefits of partnering with your organization.
• Depending on whether your search area is local or out of town, you may want to consider a targeted advertising or mailing campaign to keep your name fresh in sellers’ minds.

The goal is to make sure a variety of potential sellers are aware of your interest and think highly enough of you, their relationship with you and your organization that they contact you when they’re ready to consider their exit strategy.

3) Assess the risk and value of each prospective acquisition candidate. Once you’ve identified and courted a candidate and they’re ready to sell, it’s time to determine what the business is worth and how to pay for it. Many buyers believe this is the time for an independent assessment of fair market value of the selling agency. Unfortunately, this is the wrong use of the valuation process for two reasons:

• A fair-market appraisal of value is intended to provide an unbiased assessment of the value of the agency to a hypothetical third-party buyer as it stands, without any external influences. This type of appraisal ignores synergies associated with a specific buyer and other operational changes that may come into play.
• Value is in the eye of the beholder. Every buyer is different, and so is the value of a specific agency to each particular buyer.

Instead, focus on the key financial considerations of acquiring another agency. In order to evaluate the risk and margin of error, it is critically important to develop financial projections of revenue, expenses, cash flow and debt service under a variety of performance scenarios. If you don’t possess the skillset necessary to develop this type of financial model, engage an industry expert.

The value of an agency should be based on how much you can afford to pay under a normal set of assumptions for growth and expense management. If you’ll be able to eliminate duplicate positions, better utilize office space or create more efficient operations due to increased scale, incorporate all of that into the purchase price.

A word of caution: While it’s not unusual to provide the seller with some portion of the “synergy value” in this kind of analysis, keep in mind that it really isn’t the seller delivering this value—it’s the buyer taking advantage of the situation and their own size and scale of operations.

In addition to pure financial modeling, engage in a broader risk assessment of the seller’s firm, with an emphasis on the book of business. Consider risk attributes such as any unusual concentration of business in limited accounts, insurance companies, product niches and client tenure.

You should also evaluate restrictive language in all employment contracts and producer ownership or vesting in books of business. Consider the technical training, professionalism and experience levels of the seller’s staff and producers, as well as the office location, client locations, sales management processes, computer systems and everything else that’s relevant. All things being equal, a seller that has lower business risk according to your calculations will command a higher purchase price.

4) Establish the structure and form of the acquisition transaction. No two transactions are identical—there are countless ways to structure an acquisition transaction. Variables may include:

• Stock purchase vs. asset purchase
• Financing with agency cash reserves vs. all debt vs. a combination of the two
• Seller financing vs. third-party lenders
• Fixed price vs. performance-based incentives
• Revenue vs. profit-based performance incentives
• Ongoing compensation vs. short-term consulting arrangements vs. seller exit

Each of these points comes with its own factors to consider in terms of the final form and structure of the acquisition—some dictated by the seller, others by your needs. Both you and the seller should consider consulting external tax, legal and accounting resources to ensure the transaction structure doesn’t create any adverse consequences.

5) Due diligence, documentation and closing. Once you and the seller have negotiated and agreed upon terms in a letter of intent or term sheet, one critical step remains: due diligence. Throughout the M&A process and the exchange of information between parties, the information the seller presents is generally accepted as accurate. But it’s critical to verify the financial, operational and legal information the seller provides to you.

In an asset purchase, the primary focus of the financial due diligence review is generally verifying selected revenue information, certain expense items, and billing, collection and cash processing. But you may also need to cover other areas, depending on the structure and terms of the transaction.

In a stock purchase transaction, since the buyer acquires the entire company, you must perform a much more in-depth review of the seller’s assets, liabilities and any legal considerations in order to protect your interests. Again, if you don’t have the internal resources or skills to adequately perform these reviews, consider engaging a third-party expert.

In the final stage of the acquisition, legal advisers will take much of the information you develop throughout the above steps and compile it into legal documents in preparation for closing. Seek out an attorney who has experience in handling business acquisitions instead of a local generalist. Better yet, engage a lawyer who has an insurance background. Your attorney will prepare the initial drafts of the purchase documents and any employment contracts, and represent your interests in any subsequent negotiation of terms.

6) Post-acquisition integration. Once the transaction has closed, buyer and seller must begin the process of integrating the two organizations, at least to the extent discussed during the courtship phase.

Some buyers take a hands-off approach post-close and treat the acquisition strictly as an investment, while others attempt to fully integrate common functions to maximize efficiencies across the organization.

Regardless of your approach, there should be no surprises for the seller—they should clearly understand your intent before signing on the dotted line.

Too many acquisitions fail to achieve their intended level of synergy, revenue and profits because the parties did not spend the time planning and working through the integration process. To help everyone achieve the maximum potential benefits of the transaction, both organizations must commit to working together and understanding how the change will impact clients, employees and business processes.

Purchasing an insurance agency is a significant event in the life of the business. Don’t let the emotions involved with an M&A allow you to pay inflated values or assume operational improvements just to get a deal done.

Executing the purchase of a business from start to finish is an exhausting and distracting process. It may take several years to find the right seller, and another six to 12 months to complete the transaction. Beyond the six stages described above, each transaction will have its own peculiarities, trials and tribulations. Maintaining an objective perspective in times of adversity and staying focused on achieving your big-picture goals will help keep the process moving forward—and ensure a successful marriage.

Dan Menzer is a certified M&A advisor and principal with OPTIS Partners, LLC, a Chicago-based investment banking and financial consulting firm that provides M&A, valuation and strategic consulting services to insurance distribution firms.