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  • Writer's pictureChris Burand

Agency Valuation Expectations

(And if the process sounds easy, you've chosen the wrong appraiser/business broker)

One of the most dreaded emails/phone calls I get is from an agency owner, usually of a small agency, that has been led to think agency appraisals are simple. Agency appraisals are indeed simple when they are wrong. I know immediately the owner is going to be frustrated with me when I am simply trying to protect him and his agency from their own shortcomings. Some appraisers will gladly take advantage of these agency owners.

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If you want your valuation done correctly, expect to provide a lot of data, proof that data is correct, questioning, providing revised data, and sometimes having to research why your data is incorrect. Also expect a lot of work, frustration, and wondering why this or that is important since you've run your agency successfully for decades without ever looking at that data.

When you sell your agency or transfer it to family members or employees, the buyers need to know what they are buying. A major mistake many agency owners, especially small agency owners make, is not understanding who the buyer is. The "buyer" when transferring to family or employees is the IRS. The IRS wants to make sure the price is correct so they get their fair share of taxes. When you do this deal, the deal is between you, the buyer, and the IRS. Don't forget this. The IRS demands the transfer happen at Fair Market Value, per their rules beginning with Revenue Ruling 59-60. Agency owners often tell me, "My father didn't follow any rules and I want to do it the same way." If the transfer happened prior to 1959, then a different set of rules might have applied, but subsequently, he was supposed to follow RR 59-60. The fact that he didn't and his accountant was an accomplice, is neither here nor there.

At this point, some agency owners advise they want to comply. Others though really want to keep it simple, even if it means violating the rules. They cannot seem to accept the reality that these rules truly exist. If you want to take your chances, go for it and ignore the appraisal completely. If you’re going to violate one section of the regulations, you might as well violate multiple sections.

I hate being the first person to advise them of these 60+ year old rules. These rules are not quite as old as the Ten Commandments, but they've existed for the entire careers of virtually everyone in the insurance industry. These rules were written just after the first complete homeowners policy was created, whereas before, a liability policy had to be matched to a property policy.

If you are selling your agency, buyers are going to demand verification of what they are buying. It's true that some buyers don't know what they're doing, and more often they are hiring consulting firms to do the due diligence and some of these firms are failing. But most are capable. They are going to demand proof your data is correct. A "trick" some use is to pretend they don't have any issues with your data until nearly closing, or even at closing. Then they drop the price materially based on the seller's poor data, and the seller cannot back out.

I had one agent ask me recently if it was really necessary to determine why the agency's tax returns did not match their internal financials. The buyer needs to know if they are buying the revenue and profit on the tax return or the revenue and profit on the financial statements. The buyer needs to know if the liabilities on the tax returns are real or fictitious. The buyer needs to know if the agency has 1,000 clients or 2,000 clients (not truly knowing how many clients the agency has is an endemic problem).

100% of agency owners tell me they have good to high quality data. Few have high enough quality data at first glance. For example, if you do not have an exact customer count by division (personal lines, commercial lines, etc. and by customer, NOT policy), you don't have good enough data.

Quality data is an especially acute problem for small agencies who are using QuickBooks for their accounting. QuickBooks is generic and insurance agency accounting is unique, especially relative to agency bill business. To date, and I've reviewed hundreds of agencies' financials, not one single agency using QuickBooks had adequate accounting. Agency owners are always upset when I point out their accounting inadequacies. Sometimes they want to shoot the messenger and wonder, reasonably, why their accountant has not said anything. The accountant is probably a generalist and does not know the accounting is inadequate. The data is good enough for them to file taxes and that’s all they have been charged with doing.

From my perspective in looking out for agents, QuickBooks should be prohibited unless the agency is going to spend a ton of time configuring it specific to insurance agency accounting needs and practices. Off the shelf, it's inadequate. It is a shame that sellers of agency management systems lacking integrated accounting modules do not advise on this reality.

Not all appraisers will press for the details either. In sales, the salesperson never wants to create barriers to a sale. In selling insurance, an agent might not give the insured all the details upfront because if they did, the insured would go elsewhere. Some appraisers do not tell agency owners all the details upfront either, and maybe never, so they get the deal. I saw a letter from an appraiser telling a small agency owner she did not need a full appraisal because the agency was too small. The price the appraiser charged was full price though.

Sometimes the appraisal is cheap and easy because the appraisal is really a business broker in disguise. They don't really care about the appraisal fee. They want the business broker fee.

Shortcuts are only in your favor if you get lucky that you are not audited, the buyer does not contest your data (probably due to their ignorance), and no lawsuits ensue. I have been involved in several valuation disputes where someone took shortcuts. Whether it was the IRS, a buyer, or an upset partner, they will find the shortcuts and hold them against you. Sometimes with family, the next generation goes along with mom and dad, but they resent the shortcuts for the rest of their lives because they realize with more care, the deal could have been much fairer for all involved.

Larger agencies sometimes, though definitely not always, have officers that are experienced and educated in these matters, so they are better prepared. They know what to expect and understand the work involved in a quality appraisal. I feel for small agency owners who wear all the hats, who do not have experience or education in business appraisals and valuations, and who do not know their accounting/data is poor. They are getting by and do not understand that an appraisal has nothing to do with whether the agency is getting by. The appraisal is a report card from the perspective of the buyer, the disgruntled partner, the divorcing spouse, and the IRS. It's their rules that apply, not your rules.

Something state insurance associations and carriers could do for their agencies, especially the small ones, is to hold entire programs simply on what to expect when having a quality valuation completed.


NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.

None of the materials in this article should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.

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