Mergers and acquisitions continue to be a popular growth strategy in the insurance industry. It’s also gaining popularity as an exit strategy for agency owners who can’t find someone to take over their business. But the process isn’t always an easy one – especially for first-time buyers and sellers.
In Part 1 of this series, we looked at the preparation that both buyers and sellers need to do before embarking on an M&A activity. We also explored how sellers can pitch their business opportunities to potential buyers. Now it’s time to tackle one of the most dreaded aspects of deal-making: due diligence.
Keep in mind that every deal has its own quirks and challenges, so it’s difficult to talk specifics. Hopefully, this information will help you avoid some of the common pitfalls that can delay or derail a deal.
Phase 3: Due Diligence
While preparation can make the due diligence process easier, it is a time-consuming, often nerve-wracking process – especially for first-time sellers. Having relative strangers examine and question every strategic decision can feel intrusive. Try not to take any questions personally. It’s also important to keep in mind that despite the best prep, there are still likely to be some surprises. It’s truly astonishing what insignificant (to you) points a potential buyer or seller will get hung up on!
One way to make the due diligence process easier is to share some of the responsibilities with your team. Of course, this means letting them in on the “secret” if you haven’t already done so. When and how to break this news to your team is often a point of contention. Some M&A experts advocate for full disclosure – at least to employees with expertise in the areas under review. Others, perhaps most, emphasize the need for close security to avoid complicating negotiations or triggering employees to renegotiate their terms of employment. (Look for an article on this subject in the near future.)
Everyone participating in the due diligence process needs to speak honestly but put their best foot forward. Now is not the time to air old grievances or corporate dirty laundry. Also, as you work through the due diligence, try to keep integration questions from leading the conversations off track. This can happen when buyer and seller are a great fit; they become excited about future possibilities. Work the process and don’t get ahead of yourselves!
Exactly what due diligence will cover depends on the parties involved, the nature of the business, and the structure of the deal. A colleague of mine wryly adds, and how many lawyers are involved.
Generally, however, prepare to discuss the following:
Corporate Financials
This discussion will likely be VERY in-depth. Potential buyers need to understand how money moves through the business, from capitalization through accounting procedures to disbursements. In this time of economic uncertainty, sellers should expect greater attention to corporate debt and “dubious” client or vendor accounts.
Ownership and Governance
Potential buyers need to understand stakeholders in the company under consideration and what their expectations for the future are. Expect a close review of the legal documents governing the business structure, ownership participation, issued securities (if any), corporate decision-making, etc. This is also a good opportunity for sellers to talk about management styles and workplace culture.
Company Operations
Potential buyers need a clear picture of what has made the business successful in the past. This typically begins with an overview of the business’s value proposition, market positioning, and business development strategy. Then, the conversation is likely to move on to an in-depth review of key business processes and corporate policies and procedures, including the employee handbook. If there are performance improvement initiatives in place, sellers should explain the goals and methodologies involved. A review of the business’s “supply chain” and vendor relationship is also appropriate. Sellers should also expect questions about the impact of COVID-19 on the business and be able to explain mitigation measures.
Employees and Contractors
We often say that a company’s biggest asset is its people. As part of the M&A process, prospective buyers will want a detailed census of current employees and contractors that includes contracts/terms of employment, job descriptions, salaries and other compensation, benefits packages, etc. Sellers should also prepare to discuss the retention prospects for team members – especially those in key roles. There’s also usually a review of hiring and retention procedures. Sellers need to ask if buyers want current employees to undergo background checks and/or drug screenings and if so, determine who will be responsible for coordinating and funding these evaluations.
Tangible and Intangible Assets
Depending on the nature of the business, this may be a fairly brief conversation or an extremely in-depth one. Generally, buyers want to understand the various assets that will transfer as part of the sale. This can include tangible assets, such as real estate holdings and office equipment, and intangible assets, such as intellectual property. Sellers need to be able to explain how they reached the valuation of such assets. An in-depth review of the agency’s book of business may take place at this time or later as part of a broader conversation about client acquisition and retention.
Technology
Although it’s a tangible asset, a business’s information systems deserve a close review of their own. Sellers should provide a detailed map of hardware, software, and telecommunications systems. If the agency management and/or customer relationship management software has been significantly customized, that information should be disclosed during the due diligence process – especially if the buyer plans to integrate those systems with others they already control. There also needs to be a frank discussion of the business’ cyber and network security protocols as well as a review of past breaches and response measures. If there are pending or possible claims or litigation related to a breach, this should also be disclosed.
Insurance
Sellers need to prepare to disclose the ongoing costs of insurance benefits for employees as well as for “administrative” coverages for the business as a whole: workers’ compensation, E&O, etc. Savvy buyers will expect an analysis of past claims/loss history and a heads-up about any pending claims.
Regulatory, Tax, and Legal Status
This is an area that often gets short shrift, in my opinion. Insurance is a highly regulated industry – a fact often not fully appreciated by investors coming from other sections. Seller and buyer need to have a frank conversation about the agency’s regulatory status and history, including past and pending audits, administrative actions, arbitrations, etc. Buyers also need to inquire about the tax status of the organization, especially any liens or outstanding tax obligations. It’s also appropriate to discuss other legal issues as such as past or pending litigation and labor law compliance during these discussions. Finally, any known environmental issues or conditions need to be disclosed.
Clients
A key conversation concerns the business’ methods for acquiring and retaining clients, and the costs involved. This conversation will likely involve a detailed analysis of past and project revenue per client, as well as a discussion of the circumstances surrounding any significant lost clients. There will also be a review of all “standard” client contracts and any addendum, exceptions, etc.
Depending on the complexity of the business, the discussion of clients may include a review of marketing and sales processes. These talks would include opportunity sourcing methods, marketing strategies, advertising campaigns, sales projections, and pricing strategies.
Having a detailed project tracker – even if it’s just a shared spreadsheet – can go a long way toward keeping the due diligence (and the M&A process as a whole) on track. You’ll also want to have a way to securely share documents among the parties involved in the discussions. Another sanity-saving tip when it comes to document sharing: if you update a document, be sure to remove any older, less complete versions. Nothing creates greater confusion than two people referencing two different versions of the “same” document! Live document sharing software can help avoid this issue, as well as allow multiple parties to work with a document simultaneously.
Phase 4: Making the Sale
Once the seller provides the requested information and the buyer reviews it, it’s time to get down to negotiating. This can be a fairly straightforward matter if both parties largely agreed on the business’s valuation or a long back-and-forth of offers and counter-offers. If more than one potential deal is under consideration, sellers should be sure that they are comparing “apples to apples.” Once terms are settled, it’s time to bring in the lawyers – if they haven’t been a part of the process all along.
At this point, it’s also time to plan how the seller will tell their clients and any employees still in the dark about the sale. This needs to be a mutual decision between the seller and buyer, one that respects both parties’ needs for confidentiality. If there are individuals that the seller suspects may react negatively to the news, they may need to be notified privately slightly prior to the public announcement.
This is also the time to create a transition team that will lead the company through the integration process. Ideally, such a team includes representatives from both organizations. The former owner of the agency should NOT be a part of this team if they are not remaining with the new organization in some capacity. Even then, having the “old boss” play a key role can undermine the ability of new owners and leaders to build their own relationships with employees and clients.
Next Steps
Once the ink on the contracts is dry and the checks clear, many M&A participants breathe a deep sigh of relief and say, Thank goodness THAT’s over! In fact, the most difficult step of the process still lies ahead. No matter how similar two companies are in goals, values, and culture, bringing them together into a single, smoothly-running entity is a challenge. We’ll take a look at ways to help facilitate the process in the final installment of this series. See you soon!