The following blog post was written by Kurt Fickling, IIANC’s Agency Valuation Specialist. In this ever changing economic climate it may pay to know what your agency is worth. Whether you are an agency owner or potential owner, an agency valuation will be necessary. Remember, the valuation will be the basis of the transaction. Kurt is there to assist our members with this! Click here to learn more.
If you are thinking of buying or merging with another insurance agency, due diligence must be performed, but what is due diligence?
Black’s Law Dictionary defines due diligence as “The diligence reasonably expected from, and ordinarily exercised by a person who seeks to satisfy or discharge an obligation.” When dealing with a merger or acquisition, Black’s goes on to say “A prospective buyer’s investigation and analysis of a target company. A failure to exercise due diligence may sometimes result in liability…”
Other definitions found from various sources and personal experience are “To uncover hidden risk in business relationships and human networks.” Or, “reasonable steps taken by a person to satisfy a legal requirement when in buying or selling.” And finally, “a comprehensive appraisal of a business undertaken by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential.”
When I value an insurance agency, there are 11 key components I look at, four of which concern due diligence in some manner. These are financial statements (Balance Sheet and Statement of Earnings and Expense), Company Markets, Producer Compensation Agreements and Errors and Omissions Experience. I have valued over 80 insurance agencies and have found in the vast majority of the information submitted to be accurate. However, I have also found some major shortcomings, and if due diligence had not been done, tremendous over-payments would have been made or other liabilities incurred that were not anticipated.
Here are some examples in my experience where due diligence has uncovered major discrepancies in the value of the agency.
- In one case while doing a valuation, I asked the primary producer in the agency if they were going to stay after the sale/merger with the buyer. The producer said no, they were going to take their book of business and start their own agency. The owner/aeller gave me a copy of a producer agreement that contained a two-year non-piracy, non-competition agreement. I then showed the agreement to the producer and discovered the signature was forged and the producer had no non-competition, non-piracy agreement. The producer left after the sale and took over 50% of the revenue in the first year.
- Another example: the CPA prepared the Balance Sheet and Statement of Earnings and Expense on a compiled basis. The Balance Sheet showed no payables other than minor insurance company payables. I went to the Secretary of State’s website and found two loans where UCC filings had been made and all of the assets of the agency were pledged for over $2 million of debt.
- In a third example, a potential buyer engaged me to value an agency for sale. The seller listed a number of insurance companies represented but I found discrepancies through the Insurance Company Producer Experience Sheets. Come to find out over 50% of the agency’s sales were brokered through another independent insurance agency and there was no agreement as to the ownership of the business. When asked if the brokering agency would release the customers, they said no, and this greatly reduced the value of the agency.
I could cite other examples where commission revenue is overstated, contingent income is overstated, expenses are understated, cash on hand is overstated, or payables are not listed or understated. All information needs to be verified. Once again, for the majority of valuations I have done, information has been accurately and fairly reported. However, over the years, I have found numerous misstatements or actual cover-ups that could have greatly affected the value of the agency. Due diligence must be performed, or you will not know what you are buying until it may be too late.