OBSTACLES THAT CAN BLOCK AN AGENCY SALE
Di Stefano, Paul J
Managing the roles of attorneys and accountants is crucial
As Yogi Berra succinctly said, “It ain’t over till it’s over.” This quote can easily be applied to agency transfer of ownership transactions. As a group, agency principals tend to be an optimistic lot, and when it comes to transactions involving the sale of their agency, that optimism tends to take over. A typical scenario goes something like this: The parties to the transaction have reached broad agreement on terms, and the selling agency principal assumes that the balance of the process consists of details that can be easily handled by the agency’s accountant and attorney.
Our hands-on experience with agency transactions severely challenges that rosy assumption, because our organization is well aware of the complexities of the process surrounding the sale of an agency. That process invariably leads to unpleasant surprises if the participants have not been properly prepared. Compounding that problem is that these unpleasant surprises are likely to raise their ugly heads right at the time the deal is expected to close-creating concern, apprehension and gnashing of teeth.
How can agency principals avoid these unpleasant last-minute surprises? A full understanding of how the ownership transfer process works is critical because in many cases, the selling of an agency represents the liquidation of one of the agency principal’s greatest assets.
Term sheets and letters of intent
In most cases, once an agreement in principle has been reached, a term sheet or letter of intent will be executed. The difference between a term sheet and a letter of intent is the level of detail involved, as well as the fact that a letter of intent will be signed by both parties whereas a term sheet in most cases will not be executed. Both of these documents are important because they can help prevent misunderstandings with regard to the terms initially agreed to.
While a term sheet spells out terms such as purchase price and payment terms, as well as whether the transaction will be a stock or asset deal, a letter of intent is much more comprehensive. For example, the letter of intent addresses requirements for non-compete agreements and compensation arrangements, as well as a standstill agreement. At times, letters of intent become so detailed that both parties, after signing one, agree to proceed to the actual purchase and sale agreement. One reason for this is that the attorneys for one or both sides want to be sure that, since both parties are signing the letter of intent, it incorporates all the provisions of the purchase agreement. This tends to be overkill unless the letter of intent contains a standstill provision, since letters of intent are typically nonbinding.
Sellers should understand that many buyers will quickly put out an offer, even when it may be based on marginal information regarding the selling agency, because they know that when they get to the due diligence stage, they can restructure the offer to reflect their findings. This comes under the saying: “If it sounds too good to be true, it probably is.” In these cases, many of the problems that arise late in the process can be attributed to the lack of information given to the buyer. When representing a client, Harbor Capital goes to great lengths to construct an in-depth acquisition profile regarding the details of the seller’s operations. To put that document together, our professionals delve into all aspects of the agency’s operations. That enables us to understand the areas that need to be addressed in order to ensure a smooth closing.
The role of accountants and attorneys
It quickly becomes obvious that managing the involvement of an agency’s accountants and attorneys is an important part of the process. One of the first considerations is whether the agency’s financial statements will pass a financial due diligence. We have seen cases where initial discussions go well and a deal is agreed to in principle, but it falls apart during the accounting due diligence. The fact is that, typically, the agency’s outside accountant is not rendering audited financial statements but rather preparing what is called a reviewed or compiled statement. While many agency principals may not be aware of this, these reports-especially a compilation-are little more than a typed version of the agency’s trial balances. We have found that since most outside accountants do not formally audit the agency’s financial statements, many have limited knowledge of the agency’s business model.
An example: We were recently called in to consult on an agency sale that was far down the line. The agency’s outside accountant was having difficulty with some questionable balance sheet transactions that occurred over a number of years and had not been addressed earlier in the process. Unfortunately, the financial problem was uncovered by the buyer’s accountant during due diligence, and the seller had to both explain how the problem occurred and come up with an acceptable resolution. Because the deal was being structured as a stock purchase, this issue could easily create an obstacle to closing the transaction.
The decision to bring in an experienced financial advisor at the eleventh hour was, at best, a stopgap measure. Agency principals must keep in mind that their deal may be in jeopardy once the acquirer’s financial team has uncovered problems that should have been addressed or disclosed by the seller earlier in the process.
In another client assignment, we were advised by our client, a seller, that a previous deal had fallen apart due to unacceptable contractual language. It turned out that the purchase and sale agreement drafted by the buyer’s attorney contained such onerous warranties and representation clauses that our client had walked away from the deal. Our client explained that even after the buyer came back and offered to change the provisions, he had been so turned off by the way things were handled that he refused to reopen the discussions. In retrospect, part of the problem seemed to be that the seller’s attorney had not advised his client about what to expect in terms of the complexity of the documents; thus the seller to some extent may have overreacted upon reviewing the initial documents.
In other cases, a deal may become bogged down if the seller’s attorney decides that his role is to renegotiate the deal on behalf of the client even after terms have already been agreed to. Many times the agency principal incorrectly believes that this proaction will ultimately inure to his benefit, whereas the opposite is often true, with many deals falling apart because of an attempted renegotiation.
While we have discussed the ancillary problems that can create obstacles to a closing, we should back up for a moment and focus on the deal process itself and how the general lack of experience in deal making can leave a seller in a poor negotiating position. A prime example is sellers who choose to represent themselves. They negotiate what they believe to be a comprehensive deal and find themselves suddenly being presented with issues that were not contemplated when negotiating the deal-such as escrow and related rights of offset or whether the deal would qualify for capital gains treatment.
At Harbor Capital we liken our role in the deal-making process to that of an orchestra leader who keeps all sections playing harmoniously together. Even in cases where the seller has been approached and has agreed to financial terms, representation by a professional financial intermediary such as Harbor Capital can prove invaluable to agency principals. An experienced intermediary will anticipate all the elements of the closing process, including the managing of the agency’s accountant and attorney, and will leave no stone unturned in coordinating a seamless closing.
By Paul J. Si Stefano, CPA, CPCU
Paul J. Di Stefano, CPA, CPCU, is the managing director of Harbor Capital Advisors, Inc., a national financial and management consulting firm that offers services to the insurance industry. Services include agency appraisals, merger and acquisition representation, and strategic and management consulting. Harbor Capital Advisors, Inc., can be reached in New York at (800) 858-2732 and its Web site can be visited at www.harborcapitaladvisors.com.
Copyright Rough Notes Co., Inc. Jul 2004
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