Solving the Merger and Acquisition Puzzle
By Catherine Oak, CIC, AAI and Bill Schoeffler
Merger and acquisition activity is still going strong. There are still a number of firms combining
today for many reasons. The "urge-to-merge or acquire" is often based on satisfying market
volume requirements. A successful combination goes way beyond having the same markets. The
goal in any transaction should be to create not just a bigger firm but also a better firm.
Before the final agreement is hammered out, there is a lot of groundwork that must be covered to
see if the deal makes sense. A merger or acquisition is in trouble from the beginning if only the
immediate needs of the parties are addressed. A successful transaction requires long term vision
and looking at all the pieces of the puzzle. The following is a list of some of the major pieces to
the M&A puzzle.
1. Compatibility of Owners
The first step to a successful merger or acquisition is to determine whether the owners will be
compatible. The best way to understand compatibility is to compare a business combination to a
marriage. A long lasting and good marriage will be preceded by an effective exploration of each
other during the dating period. Business combinations and marriages fail when the parties ignore
or downplay compatibility conflicts. It is typical human nature to think that things will work out,
so sticky topics are sometimes not discussed.
The key is whether or not the owners will get along as partners, not socially. The business
personality "fit" between owners is key. They need to be of similar mindset regarding their
business philosophies, goals for the firm, when they want to retire and how the firm will be
perpetuated, who should manage what based on the owners' best talents, etc. We know that if
the owners get along well and there is harmony at the top, the employees will be much happier
and things will click in the operation.
Each owner in each firm should make a list of their own personal goals and wish lists for their
future. The list needs to include: compensation expectations, the management and sales role they
want, perks they expect, the hours they want to work and vision for the future of the firm.
If the owners are nearing retirement age, they should also be very specific about: when they
expect to retire; what future duties they want to have; what price they expect for their stock and
what "perks" they expect to continue to receive until they fully retire (i.e. an office, car, health
insurance, T&E expenses, etc.).
If the owners want to internally perpetuate, their expectations for their buy-out need to be realistic
in relation to the cash flow available from the firm's activities.
2. Complementary Strengths and Weaknesses
Each party should make two lists. The first list is the owner's own personal major strengths and
weaknesses and a second list of strengths and weaknesses for their firm. These lists should then
be exchanged with the other party or parties.
The goal is to see if each party will complement the other by minimizing weaknesses and
maximizing strengths. It may be very apparent from such an analysis that the combination may
just make each party's weaknesses worse and/or will not help improve the problems each firm
faces.
3.Business Philosophies
If two firms' operations are set up too differently, a business combination may not work. The
organizational structure of a firm often reflects the philosophies of management and the talents
available of the individuals employed.
One firm may be a sales organization and another may be mainly a service organization. However,
the two firms together may make a great combination, if the new entity can take the best of both
firms and utilize this in the best interest in the new entity.
The variety of operational structures a firm may have include; one firm may believe in having a
small commercial accounts unit that services and sells all accounts under a certain size versus
having all CSRs handle small accounts. Another may believe in centralization of the
marketing/placement function versus everyone doing their own marketing. Still another firm may
believe that the producers should handle the majority of the servicing of accounts versus hiring
qualified technical CSRs to support producers so they can have time for new sales.
The philosophies on these issues need to be discussed, explored and agreement reached as to
how the combined entity would be operated.
4. Book of Business and Market Analysis
Each party needs to develop a good profile of their firm's markets and book of business. This
topic usually invokes the most discussion since they are often the reason for the business
combination.
The market analysis starts off with a list of the top ten insurance companies represented by each
firm. A good analysis of each firm's book of business would include answers to the following
questions:
What split does each firm have by line of business?
What is the average size of account by line of business?
What target markets, areas of expertise and specialties do the producers in each entity have?
How well developed are the existing accounts written by each firm?
What is the attrition rate of the accounts by line of business?
What classes of business are the top ten commercial accounts and how much volume do they represent?
Is there much non-owned or brokered business that may affect markets represented?
The best combination would be firms that compliment each other, rather than having just more of
the same. This analysis will also be the foundation in determining the sales growth potential of
the new entity.
5. Compensation, Perks and Contracts
Comparing the current compensation packages for employees, producers and owners of each firm
is important. It is often difficult to change compensation plans, especially for key employees
(such as owners, producers or managers), without adversely affecting their desire to stay in the
new entity.
On the other hand it is also difficult to have one entity support two very different compensation
plans for owners, producers, key managers or salary differences for employees having similar
jobs. It is imperative to resolve any differences in advance of the final decision to combine.
Each firm should also share the contracts that are signed by the partners, producers and other
employees in the firm. The new entity should come to an agreement as to what the standard
contracts will look like that will need to be signed by producers and all employees.
6. Financial Practices
It is very important to look at the financial operation of each party. The financial ratios should be
calculated to see how they compare to each other.
Also, some owners run a tight ship and are frugal on perks to owners. Other owners may take as
much as they can from the organization to avoid tax and maximize their daily return rather than
investing back into the organization and retaining earnings for future needs. Collections of each
entity should also be discussed to see if there are concerns with the practices of the firm and the
habits of the customers.
7. Terms and Structure of the Transaction or Combination
The last piece of the puzzle is price and terms. It doesn't make sense to negotiate on value if the
parties cannot agree on all the other issues. All sides need to make sure that the value agreed is
fair to everyone. If one person feels shortchanged, then the deal will be poisoned for everyone.
With a merger, there are usually no terms or tax consequences. The key issue is what is the value
of each firm, so each party knows how much stock they deserve in the new entity. Adjustments
to compensation or profit sharing can be made to equalize stock among the new owners, if
desired.
With an acquisition, typical terms today are 10%-25% down with the remainder paid over three to
ten years with 7%-8% interest. Sometimes a deal is done solely or partially on retention to avoid
some of the risk of the purchase. Sellers rarely want a retention deal; a compromise is often
struck. If purchasing a "C" corporation, there can be real concern on the part of the seller to
avoid paying double taxes in an asset sale. Creativity or a stock purchase is necessary. Always
seek out profession tax and legal advice to ensure that the deal is done properly.
Summary
Information needs to be identified and communicated honestly and openly. Often during these
discussions, all participants learn something new about themselves, not just the other party. It
often helps to have a professional third party assist with this process. A disinterested
professional will direct the discussion to the important issues and bypass the minor problems that
may distract the group.
Keep in mind that a business combination is like a marriage. Owners that put the effort into
reviewing all the positives and negatives with their potential business partners will find that they
have fewer problems downstream. If the "urge-to-merge or acquire" is acted upon after a
complete analysis of these key areas, they will not only be bigger, but better!
Oak & Associates can assist you with this process. Call us at #707-935-6565 for more information.
