What to Expect From a Due Diligence Process

If you’ve never sold or acquired an insurance agency before, due diligence is probably the part of the process you understand the least and the part that causes the most problems when people go into it unprepared.  I’ve managed due diligence on hundreds of transactions, and I can tell you with confidence that more deals die here than at any other stage.

So let me walk you through what it actually looks like.

What is Due Diligence?

In an agency M&A transaction, due diligence is the process by which a buyer validates what they’re actually buying.  That means digging into the financial, operational, and legal condition of the agency to confirm that what was represented during negotiations is accurate.

It is not a formality.  It is not a rubber stamp.  And it is not something you want to be figuring out for the first time after you’ve already signed a Letter of Intent.

What Gets Reviewed in Due Diligence?

A thorough financial due diligence process covers a lot of ground.  On the financial side, expect the buyer to request:

• Multiple years of tax returns and financial statements.
• Payroll reports.
• Owner-proposed expense adjustments and related General Ledger detail.
• Carrier commission statements and production reports.
• Bank statements.
• Agency management system production and book of business reports.
• Recent new/lost accounts over a certain revenue size.

On the operational side, buyers will want to understand your carrier relationships, any contingency or profit sharing agreements, your agency management system and data, employee agreements, and lease obligations.

One of the biggest financial issues in due diligence is sloppy bookkeeping.  Commissions, fees, and profit sharing lumped together. Premium activity recorded on the P&L.  Books that haven’t been reconciled in months.  When a buyer can’t validate your revenue and earnings with clean documentation, the deal either gets renegotiated or falls apart entirely.

How Long Does Due Diligence Take for an Agency Acquisition?

In a well-run process, financial due diligence should take four to six weeks from the time the buyer receives a complete document package.  The key word is well-run.  When sellers are in a reactive position, waiting for the buyer to ask for something, then tracking it down from a carrier or accountant who isn’t in a hurry, timelines stretch out fast.  Two months becomes three, three becomes four, and deal fatigue starts to set in on both sides.  Extended timelines almost never benefit the seller.

The best way to compress the timeline is to prepare before you engage a buyer.  Collect the documentation in advance, review it yourself, and know where the bodies are buried before someone else finds them.

Common Due Diligence Landmines

In my experience, due diligence problems trace back to two root causes: lack of preparation and misrepresentation.

Lack of preparation is usually not intentional; it’s just that most agency owners have never done this before and don’t know what’s coming.  The fix is straightforward: work with an advisor who has been through the process hundreds of times and can tell you exactly what to have ready before the first buyer conversation.

Misrepresentation, whether intentional or a matter of omission, is more serious.  If a buyer discovers a discrepancy between what was represented and what the records show, the best case is a renegotiation.  The worst case is that they walk, and you’ve just spent three or four months and thousands in legal and accounting fees with nothing to show for it.  I wrote about a specific example of this in a prior post.  The seller overstated EBITDA and it cost them over $1M in purchase price reduction during due diligence.  Negotiate from accurate numbers, not optimistic ones.

The Bottom Line

Due diligence is not where you want to improvise. If you’re thinking about selling your agency in the next few years, the time to get your house in order is now, not after you’ve shaken hands with a buyer.

We’ve guided sellers through this process over 500 times. If you want to know where you stand before you start the process, give us a call.

Posted by: Michael Mensch, CEO and Founder

Direct: (321) 255-1309