Acquisitions - signed, sealed and delivered

Mergers and acquisitions are nothing new in the insurance sector, but there is probably more focus on the issue now than there has been at any time in the past. It is open to debate whether this is because of Financial Services Authority regulation and all that it entails, or perhaps due to the emergence of a number of national chains. However, one thing seems certain. Selling a business or buying another is something that most brokers will consider at some stage.

In a recent Professional Broking sentiment survey, more than 30% of brokers said that they were looking to acquire, but only 3% said that they were considering selling. Perhaps this says something about the success and the ambitious nature of PB readers, or perhaps it is truly representative of the industry. In any case, prospective buyers should not lose heart.

It is often the case that many brokers that enter into discussions are we not officially up for sale but are interested in finding out about the firm's plans and what acquisition might mean for them.

Acquisition interest

It is perhaps not surprising that 30% of brokers declared an interest in making an acquisition. There is a realisation that scale is increasingly important, bringing with it economies of scale and cementing access to markets.

To flourish in today's commercial market and provide a meaningful service to SME clients, many smaller brokers seem to believe that they need to be managing a gross written premium of £10m or above. For many, that realisation leads them to buying others, or being bought themselves. Interestingly, those firms that have reached the £10m mark often see their next step as £30m, raising all sorts of questions regarding just how big is 'big enough'.

Achieving what is desired or perceived to be critical mass - or not being able to achieve it - is not the only driver for the sale of a business, however. Other reasons may include the need to raise capital to buy out a director or partner wishing to retire, the desire to 'bank' a sale at today's prices and the opportunity to benefit from an orderly withdrawal and take maximum advantage of taper relief from taxation.

Whether buying or selling, the same principles apply. Potential partners should be scrutinised against whatever success criteria are set. A purchaser should beware of going out shopping for a box of chocolates and returning with a packet of biscuits.

Sellers should remember that not all potential purchasers are the same; often business models are different and each may have a different rationale for wanting to purchase your business - make sure that their plans fit with your aspirations. Some investigative work at this stage may avoid future disappointment.

It is recommended to any broker contemplating selling their business that the soul searching takes place before sitting down with any potential buyers. Approach this option with a positive mindset and, most importantly, be honest with yourself.

Be clear about what your options are and why selling your business is your favoured strategy. Consider how a sale would impact each partner or director and what their individual aspirations are. Consider what you want from the future; will you be staying on with the business? If so, for how long? Continuity in the management is often important for a purchaser, and you may be able to negotiate a reducing involvement over a couple of years, if that suits both parties. Assuming you are staying, consider how you and your team will fit with the new organisation.

Clearly, assessing the value of a business is the fulcrum of any acquisition and is likely to be the area in which most negotiation will take place.

Would-be buyers should bear in mind that they cannot buy customers: purchasers can only buy access to them, so assess the value of a business realistically from the outset.

From the buyer's perspective, never underestimate the risk involved in making a success of your acquisition. Many brokerages, especially smaller ones, are light on planning and forecasting, leaving potential purchasers to make their own judgements based on their skills and experience. Add to this the softening market, the possible effects of Spitzer on contingent commissions and the yet-to-be-quantified cost of regulation and it should be clear to all that simply making acquisitions is no guarantee of success.

In order to generate real value from an acquisition it will be necessary to attend to the fundamentals of the business - customer satisfaction, income generation and cost control. If the potential acquisition helps the overall business in any or all of these areas then there is the potential for success. If not, then the motives for making a purchase must be scrutinised more closely.

None of the above should detract from the fact that sellers typically want to extract the maximum price for their business and buyers usually want to pay as little as they can get away with. The mechanisms for physically valuing the business vary, but typically are expressed as multiples of either income or profit.

While negotiation is of course part of the process, all parties should recognise that the visible costs of conducting negotiations and involving professionals such as accountants and solicitors are too high to be ignored.

It is also crucial to avoid underestimation of the management time required in the sale/purchase process and beware of taking your eye off the ball.

If there is any doubt in your mind about proceeding, whether as a buyer or as a seller, it is important to resolve that doubt before a commitment is made to the other party.

It is a subjective business for both vendor and buyer and the value of a business can be significantly affected by elements such as physical location, the existence of a profitable scheme or the quality of the management team as long as key players can be contracted to continue in the business.

Cultural fit

Given that the management team intends to continue in the business, it is critical that it sells to a buyer with an approach to business that is similar to its own. The cultural fit is all important, but this does not necessarily require an unrealistic relationship with no disagreements whatsoever; it should at least involve a common set of values and a shared view on how to go about resolving differences.

Do not make the mistake of thinking this is only important to the seller; from a purchaser's point of view it is essential to bring new people into the fold who share the existing vision for the future and do not waste time and energy attempting to stand in the way of progress.

Understanding how a potential buyer will be funding the purchase may offer an insight into their plans. Usually purchasers make acquisitions in order to see their investment yield positive growth, whether through economies of scale or the creation of critical mass. However, the timing of expected returns may be shorter in some cases than in others and it would be wise to understand the implications of this from the outset.

Once the broad outline of a sale has been agreed, it is usual for a process of due diligence to be undertaken in order to ensure that the buyer understands precisely what they are potentially committing to buy.

It is important for both parties to be open and upfront in the due-diligence process. In particular, the buyer needs to be upfront about what information will be required and how the business will work as part of their organisation.

It is advisable that vendors are honest from the start. There is little point in hiding something that will later emerge as a problem to the acquired business and will sour relations with the new partners or scupper the sale at the final hurdle.

It is vital also for sellers, as well as buyers, to choose their advisers wisely. This is especially important for smaller brokers, to whom the cost of legal and financial advice may represent a significant outlay.

A natural tendency may be to use small, local advisers to reduce cost.

Often, though, this proves to be a false economy as smaller adviser firms may not have the experience or expertise and costs may rise as a result and can needlessly delay to the process.

As a vendor, the due-diligence process may highlight to staff that something is going on and a view must be taken on how this is handled. Clearly, confidentiality is important as the deal is obviously not finalised at this stage. It is equally important to ensure that staff do not panic or become suspicious of management motives. Most people take the view that confidentiality is the overriding concern and choose not to inform staff until the deal is signed and sealed. In any event, it is wise to discuss the issue of communication with staff, and to discuss the market and the press with the purchaser and agree a way forward.

An acquisition is not a step to be taken lightly by either party and, clearly, reason and logic have to play a major part in the decision. However, going to the extreme of being hard-headed and detached may not always produce the best result either.

When the necessary processes have been undertaken, there are some other points worth considering. Some of the best advice, as a buyer or a seller, is not to shy away from initial feelings. If, on first impression, there are uncomfortable feelings about a potential buyer or vendor and there are nagging doubts about whether the relationship would work, trust instinct and walk away, however good a deal the acquisition might seem otherwise.

Similarly, if the due diligence has been completed and you feel at ease with the new partners and can imagine working together into the future, then take the plunge and sign the contract. The relationship about to be entered into will hopefully last for many years and be greatly beneficial for all involved.