Here are just a few real world examples (even if incredulous ones) of how, by not hiring a true professional, agency owners have lost -- a lot:
An agency owner was short $1 million in trust monies but did not think the shortage should be counted against his value. His comment was, "I have heard agencies are being sold for 2X and no one says anything about the balance sheet or trust monies." Of course, he was correct that no one ever talks about the balance sheet or trust monies, but intelligent buyers ALWAYS consider them. The lack of discussion around balance sheets is a real disservice to people who want to sell their agencies on their own, and it causes them a lot of difficulty.
In this case, the seller kept accusing buyers of taking advantage of him by deducting the shortage from the price. No one would buy the agency then and somehow word got out regarding his issues. It did not end well.
Two other factors play into these situations:
1.) Some buyers will pay full price even with the shortage. Some do so because they do not know what they are doing. They hear 2X and never look at the balance sheet too. They way over pay in these cases. They are ignorant or egotistic. The balance sheet matters in valuations. Really!
2.) Some buyers, believe it or not, purposely ignore the balance sheet to make them feel better about overpaying. In this case, they are buying for psychological purposes, not good business reasons.
$1.9 million shortage including the complete disappearance of trust monies. This situation was similar to the prior except the buyer always ignored the balance sheet in previous acquisitions and their lack of professionalism and knowledge had never bitten them. They knew more than me when I suggested they improve their due diligence. They advised they knew what they were doing because they had bought "many" agencies.
Never confuse luck and ability like they did. In an interesting study of Wall Street stock pickers, using statistical rules for randomness, the number of stock pickers that outperform the market for years is exactly the number of stock pickers that should outperform the market on a pure random luck basis. For example, on a random basis, around 10 firms should outperform the market over a long time. They will be hailed as geniuses but it really is luck. Someone might buy many agencies without proper due diligence and get lucky many times, but do not confuse luck and ability because luck goes both directions, with a vengeance.
Paying for contingencies known to not being paid for several future years. I always get the question whether the buyer should pay for contingencies. The questioner should first ascertain if the contingencies will be received in known situations. For example, if you are buying the agency on December 31 and the contingency results are dialed in, why would someone not pay for them or exclude them from the deal and let the seller keep them?
On the other hand, if a known catastrophe claim will wipe out next year's contingency, why pay for that? Using averages does not always adequately address this either. Instead, do the hard work and analyze the situation rather than trying to take short cuts.
A true story of when contingencies should not be counted, at least in their entirety, includes when it is highly probable a carrier is going to cut their contingency bonuses. This is not always predictable but often it is. I lost a client a few years ago when I cut their value because I was so certain their key carrier was going to issue a new contingency contract with a large reduction. The carrier did cut their agencies' contingencies soon after.
On the other hand, some agencies are excellent at managing their contingencies and deserve an even higher value. In summary, contingencies need to be thought through.
The effects of a down payment are often inadequately considered. For example, "If I pay three times but include a large down payment, it makes it a better deal, right?" Wrong. The price is still three times regardless. The time value of money versus the interest rate, etc., may make a difference but by and large, the quality of the deal needs to be assessed on a Net Present Value basis. One might use an IRR basis or some other similar basis too. If you do not know how to make these kinds of calculations, my suggestion is to hire someone who does because not knowing how to do this means you are almost certainly risking losing far more money than you understand. It is though, of course, your money to lose.
A common, and potentially extremely expensive mistake for families is not knowing that families really are not allowed to do their own valuations when transferring businesses to their heirs and other family members. The IRS basically prohibits this practice. Failure to comply with the IRS is often a fun experience for masochists but I'm not sure anyone else enjoys it. The IRS basically requires families to hire highly qualified third-party business appraisers.
This brings me to another aspect of business valuations and that is: not only are do-it-yourself valuations bad ideas without the proper education, but quite a few so called "experts" really are not that expert. This includes the attorneys who think they can do valuations when they write buy/sell agreements. Here are some examples that apply to attorneys and some valuation "experts":
I read a buy/sell agreement that used "Fair Value" and "Fair Market Value" interchangeably. These terms are not interchangeable in most legal venues. Each has a distinct legal meaning in most situations. The resulting differences in value using each term can be huge. Neither is inherently right or wrong. Both have their place and it is imperative that the correct definition be used in the right situation and the appraiser and even attorney knows the difference.
I find many, maybe most, people doing valuations in the insurance industry do not know the difference. They know part of the difference between Fair Value and Fair Market Value but not the entire legal difference resulting in some horribly wrong appraisals. I think this may also be a building issue for some kinds of loans and private equity, but that is another story and those firms should be smart enough to protect themselves. I am not sure all are.
I have seen multiple CPAs use the wrong amortization schedules for acquisitions this year. The goodwill amortization rule has been in place for 25 or so years now, but while they are CPA's, they are not always experts in this field.
These lists are only for friendly deals. When one party has vastly superior knowledge over the other, the stakes get even higher for someone trying to manage a valuation themselves or has hired someone local who does not specialize in the industry. Of course, saving a few thousand while risking hundreds of thousands or millions may make sense to you. On the other hand, if this strategy does not make sense to you, hire a professional to assist you in your agency’s valuation.
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.