Insurance agency acquisitions can be complicated transactions. There are many components to the deal often overlooked or forgotten by buyers and sellers. From A to Z, here are some typical terms defined that you may encounter when considering an acquisition. Understanding them may help the process run much smoother.
Asset Deal – In insurance agency acquisitions, an “asset deal” is a purchase agreement to buy the property of an agency. This would include all intangible assets such as a book of business, renewal rights, customer list, inforce and carrier contracts. Real property like computers and equipment are also included. Liabilities would generally not be included in an “asset deal.” Many times a “Newco” is created which is the new legal entity owned by the buyer acquiring the assets. The Newco must be licensed to conduct business. In contrast, a “stock deal” is the acquisition of the equity ownership of the agency. The seller’s legal entity remains intact and is now owned by a different party. There is no “Newco,” and the licenses of the business remain intact.
Buy Side – This refers to the advisory, business broker, or investment bank representation on behalf of the buyer. A buy side engagement hires this type of firm or individual to find acquisition targets working for the buyer or “buy side.”
Change-of-Control Provision – A provision in a contract that specifies the status of the contract when ownership (or control) changes. Consider this for contracts and agreements with the seller’s legal entity. Most important are carrier contracts and employee/producer non-compete agreements. Carriers need to approve new owners of the agency for the appointment and contract to remain in force. For non-competes, buyers should be sure the non-compete is still good post acquisition or require new non-competes be executed along with the closing of the acquisition.
Due Diligence – Research, actions and investigation that are standard for review, analysis and investigation of an agency of interest. Exploration includes assessing an agency’s value, evaluating management and determining purchase/sell price.
Earn Out – Typically stipulates that the original owners of an agency are paid for the sale of their business and are contractually obligated to stay with the company through a transition period. Achieving or exceeding a particular level of performance may earn the seller a much larger profit from the sale. The purchase price of most insurance agency acquisitions includes cash plus an earn out component.
FEIN – Federal Employer Identification Number that identifies your agency as a tax paying entity.
Goodwill – The value of a company’s brand name, solid customer base, good customer relations, employee relations and any other intangible assets that are not valued the same as buildings or equipment. A significant portion of the purchase price is allocated to Goodwill and eligible as a tax deduction (amortization) over time. Accounting and tax practices have changed, so be sure to consult your CPA.
Haircut – In computing the value of assets, a haircut is a percentage reduction from the stated value (e.g., book value or market value) to account for possible declines in value that may occur before assets can be purchased or liquidated.
Intangible Assets – An asset outside of a physical asset (e.g., building, real estate). Intangible assets include goodwill, patent rights, permits, copyrights, and licenses.
Joint & Several – An obligation or debt entered into by two or more borrowers, each of whom is liable for repaying the full amount of the debt in the event the other party(ies) are unable.
Key Life Insurance – Life insurance policies covering the principal persons in the business, e.g., owners, administrators.
Life Insurance Assignment – A conditional assignment appointing a lender as the primary beneficiary of a death benefit to use as collateral for a loan. If the borrower is unable to pay, the lender can cash in the life insurance policy and recover what is owed.
Management Buyout (MBO) – A financial transaction enabling an agency’s management or key employees to purchase the agency they manage.
Non-Disclosure Agreement (NDA) – A confidential agreement showing a relationship exists between the parties involved. This typically refers to information that is shared between parties but should not be made available to the general public.
Out-of-Trust – In agency bill operations, the agent receives cash from the customer for the premium and should deposit the cash in a separate trust account on behalf of the carrier. Such premium is then paid to the carrier (net of agency commission) at the regular monthly date. An unfortunate situation occurs when the agency has used trust cash (in reality carrier premiums) for expenses and did not have the funds to remit the premium fully due to the carrier. It may also be termed “advance commissions” meaning the agent paid themselves commissions in advance of selling the premium. An analysis of Cash + Accounts Receivable > Carrier Payable can identify if the agency is “out-of-trust.”
Producer Agreements – A fully-executed contract between an insurance agency owner and producer clearly outlining compensation, non-compete agreements and other matters of ownership and involvement.Have you read the Insurance Agency Acquisition Terms from A to Z? Learn more here! Click To Tweet
Quick Ratio – This measures a company’s ability to meet its short term obligations with its most liquid assets. For insurance agencies, it is an analysis to determine if the agency is “out of trust.”
Quick ratio = current assets (cash and equivalents + marketable securities + accounts receivable) / current liabilities (including amounts due carriers, commissions payable)
Reps and Warranties – Legalese for promises made by the seller in the purchase agreement that all issues, liabilities, and exposures have been disclosed to the buyer. Mistakes or misinformation in representations and warranties made by the seller or the agency in connection with a merger or acquisition can result in costly liabilities. Buyers may be faced with an inability to recover losses and sellers can be forced to give back a portion of the purchase price. Many times there is a “basket” for a nominal aggregate amount to cover minor bills that may arise post-closing that were inadvertently non-disclosed.
Seller Note – Seller financing to the purchaser. Typically, the seller will receive a cash amount at closing (combination of buyer cash and proceeds from financing). Additionally, the buyer may make installment payments over a specified time at an agreed-upon interest rate. Seller note is also known as seller carry or seller financing.
Transition Period – Transition periods can vary from a few months to a few years depending on how involved owners want to be. Making certain agreements are in place, employees are under contract, and everyone is comfortable is of utmost importance.
Unsecured Debt – A debt, typically a loan, not collateralized by any assets.
Valuation – Multiples of EBITDA (earnings before interest, taxes, depreciation and amortization) give a picture of an agency’s value. Valuation may also be expressed as a multiple of revenue.
Working Capital – In pure form, this is an agency’s current assets minus the current liabilities. If an agency’s current assets do not exceed its current liabilities, there may be financial trouble. In agency acquisitions, buyers should be sure there is enough working capital to cover payroll, rent, and expenses before the first commission payments. As a lender, we will provide working capital funds for the “on ramp” to transition the cash flows of the business to the new owners.
eXit – The private equity or investor exit. When an owner sells their business or sells ownership in an investment that has been made in the past. This is also known as a “liquidity event.”
YOY – Year-over-Year. Is an agency’s performance getting better or worse? This evaluation looks at two or more regular events to compare results at one period with those from another period (or series of time periods), on an annualized basis.
Zero Coupon – A debt security that doesn’t pay interest (a coupon) but is traded at a deep discount, presenting profit at maturity when the bond is exchanged for its full face value.