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Agency Valuation with a Loss of Market

Author: VU Faculty

Two things are going on in the insurance marketplace. First, agencies are continuing to be bought and sold. Second, carriers are abandoning some agencies or even lines of insurance in some states. What happens when both of these come together? For example, you're buying an agency and learn that it's losing an important market. How does that affect its value? Here's how....

 

Ask an Expert Question..."I am buying another agency's personal lines book of business. We have agreed to pay $700,000 for $400,000 of revenue. Terms are $100,000 down and balance over 6 years @ 8% interest.

"It has come to our attention that one of the carriers common to both of us is terminating the seller's contract due to lack of production and loss ratio. Buyer also represents this company but company will not reconsider termination for buyer or any other agent. This book represents 17.5% ($70,000) of the total purchased revenue.

"Do you think the purchase price should be reduced due to the the pending book transfer expense and possible transfer problems and, if so, how do you put a value on same? Thanks."

Ask an Expert Answers...Without a market of this size, there's no doubt that either the value is reduced and/or the expense of the sale has been increased. We ran this by our valuation gurus and got the responses below.

 

Faculty response...
This sounds like a simple communications problem! You say that their only reason for termination is lack of production. I assume you are in good stead with this company, thereby eliminating the issue of lack of production, right? If that is the case, the worst case scenario for you is rewriting the policies into your code instead of the original agent's. The best case scenario is that the company simply converts from their producer code to yours. If there's something we don't know, these suggestions may not work.

Faculty response...
Has the contract been signed? That would be my first question. If so, then hopefully you did business with an understanding seller. If not, it is probably time to step back, take a good hard look and get into really doing "due diligence." Like most buyers and sellers, people get caught up in the moment of the "DEAL" and forget good business decisions. Without even looking at the entire situation, this is a very, very rich deal. Good for the seller, not so good for the buyer.

Faculty response...
If possible, the deal should be restructured. However, if the contract has been signed, and depending on how the contract reads, the buyer may be out of luck. This is a good example of why professional assistance should be obtained when doing acquisitions because the consultant would have probably made sure the quality of the book was considered in the purchase price and made the deal made contingent on obtaining all the company contracts.

If the final contract has not been signed, the renegotiation may hinge on the letter of intent. Hopefully it contains a "material adverse change" clause which would automatically open the door for a renegotiation or an end to the acquisition, as warranted. If the letter of intent does not include such a clause, then renegotiation depends on what it does say.

How the price is renegotiated depends on the above. If at all possible, complete due diligence should be undertaken (to avoid any other surprises) and a new price developed based on the findings. The due diligence will also enable the buyer to explain to the seller why they can no longer justify as high a price. This approach is more likely to be successful than simply stating they want a lower price due to other potential but unknown and unidentified problems.

If this is not possible, a simple way is to use the same multiple to which the parties have already agreed, 1.75 times revenue, and apply it to the remaining revenues and otherwise use the same terms. At this multiple, the buyer might also consider changing the terms so the price is retention-based rather than fixed.

Faculty response...
When structuring a buy/sell arrangement, it's important to have contingency provisions for things like this and many others that can (and have) come up to throw a wrench into things. Aside from the issue of whether the deal itself is a good one, this is a good example of what can go wrong and why it's important to use an experienced consultant to assist you in structuring a deal that looks out for your interests. Unfortunately, too often egos or the desire to save a few bucks results in agents that negotiate their own buy/sell deals getting burned.

Here are three other articles that discuss this issue:
 

•  12 Reasons YOU Should NOT Sell Your Agency

•  Boilerplate Answers

•  Why and How to Hire a Consultant

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