We occasionally run into insurance agencies that have independent contractor producers that own the rights to their book of business. These arrangements almost always create a problem with selling an agency. The arrangements usually evolve from the principals’ desire to take on an independently-minded producer that often has an existing book of business and/or is very experienced. The reason given for doing so is that it does not cost the agency anything since the producers are paid on commission-only, and more volume leads to higher profitability and better production bonuses from carriers.
I can not say that I disagree with their reasoning; however, the problem when selling the agency is threefold:
1) Buyers typically want to own 100% of the agency they are acquiring.
2) Buyers are usually larger organizations that have employee-producers who have no ownership interest, so taking on your producers under an ownership arrangement can upset the apple cart of their current sales team.
3) The producer(s) may refuse to sign on with the buyer, in which case any potential transaction will be renegotiated downward a commensurate level or fall apart completely.
First, there should always be a written agreement between parties whenever there is a financial relationship. Second, the best strategy is to opt for a vesting agreement in which the agency maintains ownership of all accounts but the producer can receive future compensation for growing their book of business. It can be quite an unpleasant and stressful experience having to negotiate a producer buyout late in the game. Oftentimes, principals do not even realize it will be an issue until they are ready to sell the agency and retire.
The worst case that I recently ran into was a well established, $3M revenue commercial P&C agency that was owned as a C corp and had roughly 25% of revenue controlled by producers that owned their books of business. The principals initially thought the agency would be worth around three times revenue. I had the misfortune of explaining to them that 1) agencies of their size are valued on multiples of pro forma EBITDA, which in this case was not high enough to support a revenue multiple of three times, 2) they would likely be hit with a double tax as a C corp, and 3) they needed to either buyout the producers or accept a reduced price on that portion of the business. Needless to say, they did not like what I told them and I did not hear from them again. It was a very reputable agency and the owners had a genuine interest in selling so I certainly wanted to help them but, unfortunately, we can’t change decisions that were made in the past. At the very least, I can share this story so that others can learn from it.
Posted by: Michael Mensch, CBI, M&AMI and Managing Partner