Steve Wevodau

LESSONS LEARNED FROM PAST ACQUISITIONS

National Underwriter - Property & Casualty Edition, June 2003 - Authors:  Robert J. Lieblein and Steve Wevodau

 

While we cannot predict with certainty the problems that will arise in future M&A transactions, past agency acquisitions provide valuable lessons regarding common pitfalls to avoid. Many great agencies have been built through successful acquisitions, but many struggled because of failed or poor acquisitions. While many agency owners start off with good intentions during their acquisition process, history has taught us some simple, yet valuable insights as to why acquisitions fail.  The following article identifies some fairly basic mistakes frequently made during the acquisition process that often result in significant costs that take years to recover from. 

Acquisition Strategy

To complete a successful acquisition, a buyer must develop a comprehensive acquisition strategy.  While all successful strategies need to provide for flexibility, you need to identify the best fit and what to look for in an acquisition target.  Taking the time to do this in advance can save significant time and money in the future and provide the template and guiding principle for strategy.  The acquisition strategy should include such basic items such as industry sector, location of target, strategic fit, corporate culture, financial criteria (e.g. commission revenue production, loss ratios, retention rates, gross profit, earnings, etc.), management strength, geographic markets, transaction structure (e.g. total price, notes, earn outs, etc.) and how the deal will be funded. 

Pricing Rationale

Buyers must be prepared to discuss and explain their pricing rationale. The buyer’s ability to effectively communicate and negotiate based on a sound financial model is often a key factor in moving past pricing stalemates. Arguing higher versus lower is a no-win situation.  Be prepared to provide a broad market and regional comparison with current pricing to help support your valuation rationale.  Discuss issues such as working capital and capital expenditures or additional investment requirements and whether they impact the purchase price.  Therefore, be prepared and do your homework so that you can effectively articulate your pricing rationale and deal structure. 

Flexible and Creative

To maximize the probability that a transaction will be successful, buyers need to be flexible and creative when developing alternative deal structures. Alternative structures often allow both parties to reach a better deal and move much of the focus away from a zero-sum pricing argument.  Both parties in acquisition negotiations often overuse the term “win-win.”  But the ability to be flexible and creative often results in a deal price and structure that is “fair and reasonable” to both parties. 

Due Diligence

The most common shortfall in the acquisitions process is inadequate due diligence. When buyers are asked how time was spent during the acquisition process, you will generally find that much more time is spent negotiating the deal versus time spent conducting due diligence.  Many post-closing surprises could have been avoided had the buyer performed better due diligence procedures.  Due diligence takes on many forms but at a minimum, should include comprehensive financial, operational and legal reviews. At a minimum, your due diligence team should have representatives from senior management, operations, accounting/finance and legal along with experienced M&A advisors.  Professional advisors can assist you in developing detailed due diligence checklists that help ensure that all areas are properly analyzed.  

Professional Advisors

Too many buyers make the costly mistake of not engaging experienced and qualified professional advisors. These include attorneys, accountants, and investment bankers. Buyers fail to realize that the cost of professional advisors is minimal compared to the cost of a failed or poorly executed acquisition.  Acquisition expertise is not part of the core competency of most agency owners and is not something they do everyday. Professional advisors provide the critical expertise and market knowledge that is invaluable in helping a buyer complete a successful acquisition.  In the long run, the cost of advisors, including any costs incurred for acquisitions that are not completed, may be the best investment a buyer can make.  At the end of the day, the objective is to do the right acquisition at the right price and terms.  Remember the old saying, “penny wise, pound foolish” – do not make this mistake when it comes to dealing with professional advisors. 

Walk Away

There is often a tendency for buyers to become emotionally involved with a deal as time, energy and money are invested. Not every transaction should be completed, and many buyers would be better served if they would walk away from the opportunity.  Often a buyer is financially stronger in the long run by not doing the deal.  This cost is not measured just by the cost of the acquisition but by the on-going financial and intangible costs that can far exceed the capital investment of a transaction.  Keeping an objective view of the possible acquisition and remembering what the key criteria is for doing the acquisition is critical.   

Motive

Many buyers spend too much time and energy speculating what the seller’s motivation is for selling, it really isn’t that important.  What is important for the buyer to understand is what the impact on the agency after the transaction is completed and the seller exits the agency really is.  Most sellers will tell you that they will stay after the acquisition is completed but reality changes after time.  Whether it is 6-months, 1-year, or some other time frame, buyers need to understand the impact on the agency, if and when the seller exits the agency.  Relationships with customers, carriers, and most importantly employees, need to be understood and strategies need to be put in place to minimize the disruption of the agency once the owner exits. 

Buying is Selling

A buyer often has the mentality that if they offer the highest price they will be the successful party.  Taking such a view violates one of the most basic principles of negotiation strategy, and that is, buying is selling.  A major non-financial concern for a seller is to find the “right” buyer and how the buyer will treat employees once the acquisition is completed.  A buyer should never lose sight of the importance of being thoughtful and respectful during the acquisition process.  

Seller’s Advisors

Sellers hire professional advisors because they realize, that while they may be very good at running an agency, selling their company is not something they do every day. Buyer’s need to recognize the role of a seller’s advisors and make sure they deal directly with the advisors and not attempt to cut them out of the process.  An underutilized strategy is for the buyer to pay the advisors a fee as part of the purchase price.  Buyers need to recognize that advisor fees are part of the overall “transaction price” regardless who pays the fee.  A buyer may reap significant “goodwill” by offering to pay the advisors fee, which may result in the difference between a successful and failed acquisition.  Remember, buying is selling! 

Nothing Will Change

Buyers often make the mistake of telling the seller that nothing will change after the acquisition.  While the buyer may think that such a promise may help in getting the deal completed, sellers often know that change will occur.  Nobody likes change but when properly communicated, positive results can happen from change.  Be candid with the seller and tell him of the changes that you expect to make both short and long term.  In addition, obtain input from the seller regarding your intentions.  Getting the seller’s feedback and having them part of the decision process goes a long way in getting “buy in” and helping with the integration process.   

The Deal is Done

Everybody remembers the excitement of closing the deal and thinking the deal is done.  Remember Time Warner and AOL at closing and all the great things that were going to happen.  While closing the deal is a milestone and one should be congratulated on completing the acquisition, the reality is that this is the easy part.  An acquisition is two-parts:  closing the deal and integrating the deal.  Unfortunately, the integration aspect of the acquisition process is the most difficult one.  Most acquisitions fail, not because of the price paid, but because of the failure to properly integrate the organization financially, operationally and from a management standpoint.  The single biggest mistake one can make is thinking the deal is done at closing. 

Careful planning and strategy before you embark on your acquisition approach will greatly enhance your chances for success.  Adhering to the basic concepts discussed above will help any buyer implement a successful acquisition strategy and avoid the many costly pitfalls that other buyers have encountered.