Seven Steps To Buying Your Own Agency

by Mac Winston, CFP

Having spent the last nine years making over $100,000,000 in loans to service industry sector professionals for 100 percent or more of the purchase price of existing businesses, I have observed seven key steps that will ensure a smooth transition to ownership.

While acquiring or starting an agency of your own is a powerful dream, and one that can easily become a reality, a few words of caution are in order before we get started. First, you should beware of the allure of the sense of autonomy inherent in this dream. As any licensed insurance professional who has borrowed money to become an owner of an agency will report, there is no such thing as absolute independence, and as Bob Dillon sings, “you may serve the devil or you may serve the Lord but we all got to serve somebody.” Second, the dream of ownership can quickly turn into the nightmares of bankruptcy, overdrawn bank accounts, a disrupted family life, and mental depression when you decide to purchase or start an agency before you are ready. Therefore, working as a non-owner licensed selling agent for a year or two can be very valuable in terms of both sharpening trade skills and gaining first-hand knowledge as to the challenges, benefits, and drawbacks to ownership.

One last cautionary note: It has been generally observed that there is less risk in buying an existing agency than in starting one. Therefore, while there are many situations where a start-up makes good sense, you should thoroughly understand the challenges involved in each process before making a choice between purchasing verses starting an agency.

Now, assuming that you have decided to pursue the path of ownership through the acquisition of an existing agency, let’s go through the seven steps to success in buying your own agency.

Step 1 – Check Your Credit
The first step is to obtain a copy of your personal credit report. You may request a report, free of charge, each year, from one of the three major crediting reporting services: Equifax (800-759-5979), Trans Union (800-851-2674), and Experian (800-682-7654). You need to check the report carefully for derogatory credit notices that may impede your ability to borrow the money needed to purchase a practice. Most credit reports feature a credit rating called a “credit score” that ranks the credit profile of an individual borrower relative to the vast population of individual borrowers in the United States. Your credit score can be negatively or positively influenced by such factors as:

Late payments
delinquent accounts placed with a collection agency
The number of credit inquiries (i.e., the number of times a credit report on a particular individual has been ordered by prospective credit grantors during a given period of time)
The total balance of credit card or revolving credit available (it is wise to keep this below $35,000)
The total balance of revolving debt usage (this should be kept below $25,000)
The existence of bankruptcy during the last 10 years
The dollar amount and number of new debts incurred during the last 18 months
Any outstanding civil judgments
Disputed and unpaid city, state and/or federal taxes, etc.

If there are derogatory notices on your credit report, you should try to remove them by contacting the creditors in question or ask the credit reporting service to attach a written explanation, giving your side of the story, to the report. You might also wish to ask the applicable credit card companies to terminate unused accounts. These efforts can enhance your individual credit score and your chances of obtaining financing. To make sure that your actions to improve your score have been effective, go back to the credit-reporting agency and order a new report.

If you are unable to have derogatory notations removed and you feel you are in the right, you may want to seek assistance from an attorney. Alternatively, you can write a letter of explanation on the problematic credit issues to give to a prospective lender along with your completed loan application at a later date.

Step 2 – Select Your Market
The second step is to identify the market where you want to work and live. Most agents gravitate to the more heavily populated urban and closely linked suburban markets (e.g., the metropolitan areas of Chicago, Dallas, Atlanta, Denver, Phoenix, Los Angeles, Seattle, Houston and St. Louis). They do this to be close to family, high school or college friends, major entertainment and shopping centers, major airports, and the like. Smaller and rural markets are chosen less frequently. Agencies in these areas are not seen as attractive to some because they are “out there”…where there might be few of the most desirable characteristics of metropolitan areas.

Many small market agencies do, however, offer a significant “investment opportunity” not available in most urban and suburban agencies. The cash flow of insurance agencies generally improves (i.e., more money is made doing the same work), and the market value (or sales price) of insurance agencies generally declines as one moves away from urban centers. Cash flow improves because of reductions in rent and staff salary expense. Market value declines because there are fewer buyers for small market agencies. This gap between an agency’s economic value (i.e., the agency’s value as a generator of cash flow into the future) and its market value represents the “investment opportunity” that is not often available in urban and suburban agencies.

Step 3 – Get Help from a Agency Transition Facilitator
Unlike the businesses in the dental, veterinarian, accounting and other service sector niches, few insurance agencies are sold with the assistance of professional Agency Transition Facilitators. However, a serious buyer should get in touch with a professional experienced in identifying and negotiating a target purchase price, and navigating through the agency acquisition closing process. Professionals fitting this description are typically lawyers, accountants, specialized consultants and business brokers. They typically work in limited geographic areas where they have a unique familiarity and understanding of the local business market. As in the case of the author’s firm, some lenders have the ability to assist in the determination of value and acquisition financing structure (i.e. the use of cash equity vs. seller financing vs. third party financing).

Step 4 – Get Professionals on Your Team
Once the desired market has been identified and the desired agency located it is time to enter into an intent-to-purchase agreement. It is important to make sure that both the buyer and seller sign an intent-to-purchase agreement before time is wasted pursuing financing or any other industry specific approvals for a transaction that neither of the key parties have agreed in writing to even the most basic of terms (i.e. the purchase price, a target closing date, etc.). Before you sign an intent-to-purchase agreement, however, you should develop a relationship with an attorney and an accountant, as these are the professionals you will need to review such legal documentation and assist you with preliminary due diligence on the agency.

Step 5 – Obtain Insurance as Loan Collateral
Life insurance is necessary at this point because most financiers will require this type of coverage as collateral for their loans, and approval can take four to six weeks from the date of application. You will be able to deliver approved coverage as collateral to the lender more quickly if you submit an application for coverage and complete the insurance company’s medical exam in advance of your application for financing.

Life insurance is important because the death of an agency owner could result in a crushing burden to the agency at the worst possible time, and would most certainly represent a damaging blow to the deceased agent’s estate and family.

The most frequently used life insurance product for loan collateral is term life.

Step 6 – Arrange for Financing
Step six involves arranging the financing needed to purchase the agency. Business Brokers, consultants, accountants and attorneys usually can make recommendations of suitable lenders to consider.

Most lenders specializing in agency acquisition financing will fund up to a multiple of the annual commissions of the agency (my firm, PPCLOAN, typically provides financing up to 1.5 times total annual commissions—in instances where the buyer already owns a book of business this means financing up to the total of 1.5 times the combined commission total may be available). Lenders can vary widely in the length of the approval process, the interest rate and terms of the loan, and whether there are penalties for early repayment, so be sure to compare.

After you decide on a lender, obtain a loan application from them, complete it in its entirety and return it along with:

A copy of each of your personal tax returns for the last three years
A personal resume
Copies of the last three years’ tax returns and most recent interim operating statement for the selling agency and the buyer’s agency in situations where the buyer already owns a book of business
A statement of your annual living expense needs (if this is not included in the loan application form)
Information regarding the staffing of the agency(s), agency(s) location, etc.
A letter explaining any derogatory notations in your credit report
A three-year projection of revenues and expenses following the acquisition
A short narrative regarding your transition plans for the agency during the six to 12 months following the acquisition closing (this is one of the most important pieces of information you can provide because it will help the lending officer gauge the extent of your immediate income-generating potential, and business management skills/experience)

Once the lender makes you a financing offer, review it very carefully…all the way down to the fine print. You will want to look for two things in particular:

The Annual Percentage Rate (APR). The APR is a measure of the total costs of the financing offer. Such costs include the interest paid over the life of the loan, any fees paid, and any interest to be paid on interest as a result of having no payments or graduated payments during the first few months of the loan.
Penalties for Early Repayment. Many lenders will charge a penalty if the loan is repaid during the first few years of the loan or at any time prior to the scheduled maturity of the loan. It is not unusual for penalties of $30,000 to $40,000 to be levied on loans of as little as $150,000 in the event that they are repaid prior to maturity.

Another thing to check carefully is the amount of life insurance required as collateral (the amount of life insurance required is usually equal to the loan total).

The lending offer should include an amortization schedule depicting the monthly payments of principal and interest over the life of the loan. Review it and make sure that your monthly loan payment will leave you with sufficient funds to live on, given the anticipated cash flow of the agency (your accountant can be very helpful in determining this). An agency purchased within the typical market range of 2.15 to 2.5 times its historical annual commissions will support the repayment of acquisition debt in seven years while paying the owner a reasonable wage.

Step 7 – Negotiate the Purchase Agreement
So, you have accepted a financing offer. Now it’s time to team up with your accountant and attorney once again and complete the seventh step in this process: the negotiation of the purchase agreement with the seller of the agency. During this step, you should also make sure you purchase sufficient contents, liability, and errors and omissions insurance coverage for the agency. You should also make sure to negotiate distance and time oriented non-complete covenants that are not so punitive as to potentially impeach their effectiveness in court.

Once the purchase agreement is final, it’s on to the closing and, after that, celebrating the acquisition of your own agency! Don’t forget to retain a signed copy of all the documents involved and to store them in a safe and readily accessible place.

K.M. “Mac” Winston is President and Chief Lending Officer of PPC LOAN, a nationwide provider of bank financing to service sector professionals. He can be reached at 800-456-2779 and mac@ppcloan.com or visit PPC’s Web site at http://www.ppcloan.com/.