Financing the Future of the Independent Agency System

By Insurance Journal

How to Approach a Lender about Perpetuation Plans

Independent agency owners put a lot of effort into formulating perpetuation plans for their insurance agency. Now it’s time to execute the plan. And that may require some additional financial resources. Fortunately, there has never been a better time to realize the maximum value of independent agencies. Not only are lending rates and capital gains tax rates still at historic lows, but specialized lenders are willing to recognize the true value of books of business thereby unlocking more potential capital.

To seize these advantages independent agency owners need to be savvy about what lenders will expect from them-and about what they can and should expect from a lender.

What lenders expect from agencies
Well-crafted perpetuation plan. One of the first things any lender will evaluate is the soundness of a perpetuation plan. It should be designed as a win-win for both the selling generation and the successor generation. On one hand, the plan should allow sellers to achieve their retirement goals of reaping a solid return on the many good years they’ve invested in the business. On the other hand, the plan should enable the successor generation to achieve its business goal of purchasing a growing agency that has many good years yet to come.

So before approaching a lender, review the agency’s plan to ensure it addresses such key elements as: 1) does the price make sense for both parties and does it represent fairly the enterprise value of the agency; 2) how taxes will be minimized for the seller; 3) how control will be passed on to the succession team; 3) how the buy/sell agreement for the new owners is funded; and 4) how the agency proposes to finance the plan.

Adequate collateral. Of course, all lenders factor a business’ collateral into their loan decisions. But not all lenders define “collateral” the same way. Traditional banks typically require hard collateral and tangible assets to justify business loans. The problem is, insurance agencies rarely have significant tangible assets. So, when a traditional bank scans three-years’ worth of financial statements, they may not see any business assets of loan-worthy value. This may require putting up a house or other personal collateral. But specialized lenders who truly understand the workings of insurance agencies will define “collateral” more broadly by taking into account the history of the agency, the relative stability of its cash flow, the strength of its client relationships, and the ongoing potential of its book of business.

Valuation. As stated before, most traditional banks have trouble understanding the value of an independent agency. Expert lenders understand the full potential represented by an agency’s book of business. In evaluating an agency’s borrowing potential, lenders should look at the mix of business, cash flow and efficiency of operations to see how likely that agency can continue to generate consistent commissions from their existing client base.

Mix of business. An agency’s mix of business is often just as important as its volume of business. The more diverse the book-across agency clients, business lines and insurance carriers-the more favorably specialized lenders will view that book. Typically, stronger agencies are those agencies that aren’t overly dependent on one carrier or a small group of clients.

Cash flow. Lenders will also want to quantify an agency’s cash flow. Insurance agencies often have more reliable cash flows than other mid-sized businesses. Why? For starters, they don’t have to “reinvent” themselves every year, since they deliver a service that individual and business customers depend on year in, year out. Secondly, they are able to generate predictable cash flow from ongoing commission revenue.

Efficient operations. The key to maximizing the value of an independent agency is to efficiently reinvest in the business while minimizing unneeded expenses. Lenders who understand the insurance industry will be eager to lend to agencies that have been diligent in running their operations efficiently. Those are the agencies that will truly be able to command a premium when it comes time for valuation and sale.

What agencies can expect
Industry knowledge. The better the lender understands the nuances of the independent agency, the more likely the lender will understand the true value the agency represents.

Expert consultation. A good deal should offer more than a good rate. It should also come with proper structure and exceptional service. The advice and guidance of a qualified consultant or lender can be essential to identifying opportunities and avoiding costly errors. Some banks attempt to attract customers by touting their understanding of the business owner’s industry. But in the banking world, insurance expertise is difficult to find, yet essential to seek.

Flexible solutions. Cookie-cutter lending approaches rarely work for any business; they certainly never fly with insurance agencies. Agency entrepreneurs should look for lenders who can be fair and disciplined in their analysis-yet flexible and creative in their solutions.

Why move forward now
A convergence of conditions makes this an ideal time to move forward with perpetuation financing plans. While the Federal Reserve is likely to gradually ratchet rates up in the coming months, interest rates remain at historic lows. Although set to revert back in 2009 or possibly sooner given political developments, the capital gains tax rate is still at the reduced level of 15 percent. Despite the cyclicality of hard and soft markets, the insurance industry is generating steam. And although most traditional banks haven’t made the leap, specialized lenders are ready, willing and able to serve the distinctive needs of the independent insurance agent.

So don’t miss out on this opportunity to realize the value of the agency without having to sell out to an acquiring bank or to a competing agency. The key is to find a lender that can understand the agency’s real needs.