Tag Archives: burand & associates

What Happens When an Agency Owner Dies?

I have unfortunately worked with the families, estates and partners of several agency owners who have passed away.  Most of the deaths occurred unexpectedly.  In all cases, the person who passed left the family, estate and partners with far more problems than necessary.  So, my question to you is this: If you passed away tomorrow, what problems would you leave behind?

One situation I absolutely dread is when I have to tell a family the agency is not worth anything near what the recently passed relative (usually the father) said it was worth.  Agency values are not what they once were. So, you may be telling your partners and loved ones that the agency is worth more than it really is, a practice that, while possibly innocent, is still cruel.

Get your agency valued using real world values so everyone’s expectations are realistic.  Put yourself in your family’s and partners’ shoes.  The income from the agency will be eliminated upon the sale.  Will the agency’s sale be enough to support their standard of living? 

You will uncover problems such as bad debt.  I have seen a number of agency owners die with sizeable accounts receivable that were quite old and totally uncollectible.  These debts may total 20 percent, 25 percent, even 30 percent of the agency’s commissions.  Even if an agency is worth some high multiple, those bad debts have to be deducted.

You will also find issues that you can address, sometimes rather easily. It’s horrible when a widow learns that her husband did not really own all the business on the books.  He always meant to get around to fixing his producers’ contracts but died before he did. As you get your agency valued, however, you can confront the issue and correct it. There have also been situations where all the important accounts are written by the deceased, and there is no one in the agency to take over those accounts.  Those key accounts most likely will not stay with the agency, so its value is not going to be what the estate may have thought.

Another example: keeping lousy books.  It is not imperative for an owner to keep good books and good data.  It is smart, and it is a good business practice, but it is not imperative.  However, if a person dies and the books are poor, the agency is not going to sell for full price.  Who will pay full price for an agency for which no one knows the true income and the true state of its balance sheet? 

Getting a valuation will force you to look at issues such as contracts and books—in time to fix any problems.

I know many readers are thinking these things never happen, but they do. How do you know you do not have similar issues if you have not had your agency valued by a competent appraiser? 

Two other issues to focus on:

Agency Ownership

Do you really own your agency?  I have seen a number of situations where the agency’s contracts were so poorly written that the agency did not clearly own the business on its books.  Maybe the owner knew this at one time and had forgotten because nothing bad had happened.  On a day-to-day basis, it didn’t really matter. But when the agency is being valued, especially when it is being valued because the owner has died, it does matter, and that is not when anyone wants to discover the problem. As more and more clusters develop and even age, this is going to be a bigger and bigger problem.

Buy-Sell Agreements

What happens when a person dies with a bad buy-sell agreement with his partner?  Unless luck and goodwill are in plentiful supply, nothing good happens.  The partner may have been the greatest, most unselfish person on earth, but is his or her family just as unselfish?  This is important because, at least for a time, the dead partner’s family will be partners, too.

For example, what happens when the surviving partner realizes the buy-sell agreement poorly defines value?  This may leave the door open for the dead partner’s estate to claim any amount of value. I have seen, more than once, claims of two times premiums!  It is not always that the other side is greedy; often, they are just uneducated about the insurance world. Combine that with grief and a feeling of immense vulnerability, and they may not want to settle for a reasonable value.

Another great example is where the agency’s balance sheet is poor and the estate’s trusted advisor discovers some rule of thumb that agencies are worth some multiple of commissions, but fails to understand that balance sheet deficits, especially trust ratio deficits, must be deducted.  If you have ever tried to buy out a partner at full price while the agency has a trust ratio deficit, you will know how difficult it is to make payroll and other payments.

The readers of this article have the opportunity to fix a wrong before the wrong occurs.  The pain survivors feel when a loved one or partner dies is already immense.  Why exacerbate it by leaving them a business in a mess?

What Is The Difference Between Intrinsic Value And Market Value Of Insurance Agencies?

I have been valuing insurance agencies for a long time. I have been valuing them using both the Intrinsic Value and Market Value methods most of the time. For anyone interested in reading a brilliant description of these two methods, I suggest reading the article, “Musings on Markets” (September 7, 2011), by Professor Aswath Damodaran of the NYU Stern School of Business.

Intrinsic value is usually determined using one of several versions of the discounted cash flows method (the exact definition of cash flow varies, but all are intrinsic). This method states a firm's value is determined by the firm's future expected cash flow, discounted for time and risk.

In theory, market value also emphasizes cash flow. However, my experience is that most practitioners, especially when applied by agency owners but also some consultants, so inadequately account for cash flow and the risk that something will go wrong so that for all practical purposes, cash flows are disregarded. This makes market value agency appraisals purely speculative. Sometimes the result is an under valuation. More often the result is a value exceeding reasonability. Sometimes market value and intrinsic value are materially the same. After all, a broken clock is correct twice a day and 730 times a year. Most people would say being right 730 times a year is an awesome record.

A good example is the real estate boom and bust. The intrinsic value of the real estate never supported the market value. Many analysts and promoters became quite innovative in their development of “intrinsic” metrics that supported the market values, but the basic cash flow never supported the market value. The real estate investment only made sense if one could flip the investment at an adequately higher price before the market crashed.

The same force occurred in the market for insurance agencies. Very few agencies have an intrinsic value exceeding two times today or five years ago or ten years ago. If a business appraiser or a business broker sees someone who wants to believe an agency is worth more, the list of rationalizations, justifications, fictitious economies of scale, insightful product diversification strategies, and capital plays (interesting since capital is arguably free in some forms today) are infinite. If someone shoots holes in all these arguments, then ultimately the business broker will play their ultimate card: “We're so much smarter that we can make this work.”

The fact is the intrinsic value did not justify the price paid by many agency buyers five years ago. The strategies that caused the buyers to believe the values were justified were mirages of wishful thinking. The market was overheated and for whatever reasons, if buyers wanted to be in it, they had to pay a high price. There is and was nothing else to it.

The fascinating difference between intrinsic and market value for insurance agencies is that the intrinsic value should remain in a rather narrow band because:

1. Profitability in a well-managed agency is stable. By well-managed, I am excluding firms that are 100% or more dependent upon contingencies for their profits. In these agencies, profitability will vary wildly depending on their contingencies. Otherwise, expenses do not vary much year-to-year in well-managed agencies and therefore, profitability is stable.

2. Sustainable growth is humble. When you read about an agency growing 10% to 25% annually, ask, “How many annuals?” In other words, how long have they truly achieved such significant growth? Also, what risks are they taking? The Property & Casualty industry grows at approximately the same rate as the U.S. economy because the Property & Casualty industry insures America's economy. That rate is approximately 3% annually.

The Property & Casualty industry is not a growth industry and it has not been one for decades. To pretend otherwise is like an older model choosing the right makeup, the right lighting, and the optimum angle to look ten years younger. In fact, the evidence is strong that firms who grow multiple times faster than average have a higher than normal probability of cheating. Often the cheating is not malevolent, but it is still cheating.

3. Risk is comparatively moderate. The insurance agency business is one of the least risky businesses. It may feel risky, but compared to most other businesses, it is quite safe.

These three factors combine to create periodic value fluctuations, but within a rather narrow band on an intrinsic basis. This is why owning an agency is a great business in tough times while maybe less appealing in great times. So why is the fluctuation so much more on a market value basis? Speculators. The speculators may be banks, brokers, private equity, other agencies, but they are speculating. This creates some issues because speculators use market value plus twenty percent or so for their values. They have a tendency to build price without adequate regard for supporting cash flow or risk. This is why a boom takes years to build and the resulting bust can take just a few weeks.

The fact that speculators pay too little attention to cash flow and risk has two significant consequences. The first is that speculators value good agencies and bad agencies too similarly. The result is they pay too much for bad agencies and sometimes fail to purchase the best agencies because they're not willing to pay an adequate premium for quality. Now, some really smart speculators have learned that certain kinds of supposedly bad agencies do not actually have post acquisition bad results. One should not confuse these two situations.

The second consequence is when inadequate attention is paid to cash flow and risk upon acquisition, speculators eventually cannot or do not pay enough attention to building the people and systems necessary for organic growth. This is readily apparent in some brokers' results today.

Whether you should or should not emphasize market value over intrinsic value depends on your position and the market cycle. As a seller in good times, the market value will usually be your best deal because this industry has blessed sellers with an infinite supply of irrational buyers. Their numbers grow and constrict with the seasons, but rarely are they in short supply for long. The only exception to this is the really good agency. A market value may rarely adequately capture the true value of these agencies' cash flows and risk. Internal perpetuation is almost always the best course for maximizing their value.

If you are a buyer, a brutally honest intrinsic valuation is the best way to manage your risk. Market value should be entirely secondary. Always remember that no acquisition is better than a bad acquisition and since roughly every study ever done shows that 75% of acquisitions are failures when truly tested, this rule is worth cementing in your brain. The exception is that if the buyer has such a bad situation that a bad acquisition can hide their current dilemma, then maybe make the bad acquisition.