Selling an Insurance Agency Based on Retention
I enjoy writing these topical discussions. It gives me the opportunity to articulate items that come up when I am speaking with agency owners, buyers and lenders, which is something that I do every day of the week so I should have plenty of material to work with. One topic that comes up on occasion is structuring transactions with retention-based payouts to the seller.
Truthfully, very few of our closed deals have included these terms and most of those transactions had retention set against a handful of larger accounts, not the entire book of business. A number of our larger transactions have included earn-outs, but that is not quite the same thing. An earn-out is based on future performance pegged against total revenue and/or earnings. The key difference is that a retention-based payout is pegged against the in-force policies as of closing. Here are some reasons why I don’t believe this structure is reasonable for most insurance agency sale transactions:
1) The seller gets no value for his/her lead generation systems. Certainly, if a buyer is just acquiring a book of business from an agency that is stagnant or declining then a retention-basis may be warranted. But most agencies pay for, and have developed, means for generating new business. Particularly if the agency is growing and spending a normal amount towards marketing (e.g. 3-5% of revenue), then the seller should not be penalized if the buyer chooses to terminate these mechanisms.
2) It is very difficult for the seller to verify what was actually retained. Let’s be realistic; it would be easy for a buyer to hide accounts to avoid paying on them. Unless the parties have a long history between them, it is unreasonable to think that the seller should trust the other party to be forthright. Everyone in the business knows someone that sold with a retention-clause and was swindled by a buyer. I know of one very egregious case in particular involving a buyer that owns a large regional agency.
3) The seller typically loses control of how the clients are serviced post-closing. Some agents/agencies are very service-oriented, while others are production-oriented. This is a common cultural difference between smaller agencies and larger ones. The servicing may have been overseen by the seller previously, but then gets handed off to an already-overloaded CSR to avoid distracting the buyer’s management and sales staff.
4) It is tedious and costly to track/verify policies every month. The buyers typically say that they will code the seller’s policies in their management system and provide monthly statements for verification. If the transaction includes say 1,000 policies, then the parties will be tracking roughly 83 policies per month. The seller will need to cross-reference the management system report against many pages of carrier commission statements. Initially this may go well but as the months progress the seller has moved on to whatever new stage of life they intended to and the process of verifying monthly payments becomes a nuisance.
I understand that deals are being done that include retention-clauses. In some cases it may be justified, such as with a small book of business being relocated that has a low retention rate. But I would wager that in the vast majority of such transactions it is simply accepted by the seller because they are only negotiating with one buyer and that buyer has convinced them that it is the norm when it is not. If you are in discussions with a buyer that is attempting to sell you on a retention-clause, put the deal on hold and get a second opinion from someone that knows the marketplace for buying and selling agencies. The deal may be good depending on the guaranteed amount, but an agency owner should never bear the greatest risk when selling their agency.