Responsible use of debt is a great thing. Debt often allows your business to grow and thrive, and it can provide a lucrative exit in the future if you need one. But, like many things, you can have too much of a good thing. Too much debt is not good.
Here are my seven deadly sins of excessive debt for insurance agencies:
1.) Lust: Debt needing future growth for repayment.
If you have to sell new business just to cover your loan, you’ve compromised your future profits and working capital to reinvest into the agency. Additionally, what happens if you don’t sell enough to cover the debt? What will you do then?
2.) Gluttony: Debt > 2X commission revenue.
Here’s a simple test for agencies with standard and preferred books of business. For most agencies, cash flow becomes compromised when there is a debt load approaching two times commission revenue. Keep in mind commission revenue should exclude profit sharing or contingency. From a valuation perspective, debt greater than two times commission revenue–debt greater than the value of the agency–can put you under water. Specialty agencies and unique market niches can be an exception to this guideline.
3.) Greed: Overpaying for acquisitions.
You want a larger agency and an impressive revenue number. Getting emotionally committed to a deal can lead to a transaction that simply doesn’t flow cash. If you cannot afford it, the deal is not right for you. Be patient and disciplined.
4.) Sloth: Working capital debt for routine agency operations.
When an agency needs debt to fund day-to-day operations, that’s a problem. Your agency should be continuously cash flow positive. An appropriate working capital loan can bring cash to the agency for specific growth plans such as hiring a producer, upgrading technology or rolling out new marketing strategies. Working capital loan obligations need to be affordable based on the existing cash flow of the agency.
5.) Wrath: Using too much debt to buy out a partner at a grossly overvalued price.
Even great partnerships will sometimes run their course. One partner may reach a different point in his or her life, work ethic may change or there may be a personal difficulty between the two parties. If it’s no longer an equal partnership, anger ensues. Yes, buying out that partner–even at a premium–can be very positive long-term. However, don’t grossly overpay because the situation is emotionally-charged. Make a solid economic decision instead.
6.) Envy: Debt for personal use and toys. Just don’t do it.
Leveraging your business to provide cash for personal use is a path to destruction. Your agency is only truly successful if you’ve accounted for owner compensation and you’re still able to pay your employees, pay your bills and make a profit. Don’t use your business as a personal piggy bank.
7.) Pride: Don’t use debt to cover up family or employee incompetence and payroll.
Many of us don’t want to admit that a family member or employee involved in the business simply isn’t up to the task. It’s a point of pride with many owners that they have chosen employees and mentored them well. Using debt to cover cash flow strain due to staff problems will create a more significant problem down the road.
We will only offer you a loan if we believe you can pay the debt while maintaining business operations and if it will meet the needs of your agency. You’ll have a direct contact at Live Oak to guide you. Our industry relationships endure beyond the term of the loan.
For more information, contact me, Kelly Drouillard, at firstname.lastname@example.org or via phone at 913-980-7773.