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2013 Q2

Second Quarter 2013

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Moratorium on Merger Activity Affecting the Value of Allstate Agencies

Moratorium (Noun – A temporary prohibition of an activity)

Moratorium might not be the most appropriate word to describe the Merger activity occurring in 2013, but I would say it is close enough for darts. Following the period of 2009-2012 where approval was granted to essentially any Outside Buyer whose business plan called for the purchase and merger of two, three or four geographically appropriate agencies, we were bound to see a slow-down in the number of approved merger transactions.

Instead of a gradual modification in policy regarding merger opportunities, we received an all-out slamming of the brakes with both feet as nationally we are seeing essentially no approval of merger requests. I’m bringing up this conversation not from a perspective of sour grapes (acquisition loans are down, but PPC LOAN is providing capital for other purposes and in other niches’), but from a true analytical perspective of how the elimination of a buy / sell option effects values.

I’ll cut to the chase – By essentially eliminating mergers, we have a narrower scope of transition options which is a negative for agency values. Less buying options = less interested buyers = less value. If you take a tool out of a carpenter’s tool box, you diminish his capability to build a house. Regardless of how often the tool is used or how essential the tool is to the overall creation of the house, the absence of any tool dilutes the value of the final product.

Who is Most Affected?

Sellers of small agencies are those most feeling the pain of not having the option of selling their agency to an Outside Buyer or an Existing Agency Owner as part of a merger transaction. The reason is simple – there are a good number of approved buyers who will not purchase a $1Million Earned Premium agency unless it is merged as part of a larger operation. Based on their personal lifestyle needs, or their career timeline, some buyers must instantly realize the cash flow benefits of an agency already at scale. Thus, the pool of potential buyers has shrunk for small agency sellers.

On the flipside, larger sized agencies are seeing greater demand for their agencies as the ability to reach scale through the purchase and merger of multiple low priced small sized agencies has been essentially eliminated as a competitor to those owners looking to sell their larger sized agency.

The New Opportunity for Small Agency Sellers

Recognizing small agencies need a boost to their cash flow to grow Allstate has expanded its Agency Development Bonus program to those purchasing an agency with $1.5Million in Premium or less. The attractiveness of the expansion of the ADB program to agency buyers has yet to fully materialize, but certainly it represents a significant positive to those who see organic growth to scale as a viable venture.

Were the 2009 – 2012 Mergers Judged Fairly?

We have all heard that Merger activity wasn’t as successful as some had hoped it would be. PPC LOAN financed hundreds upon hundreds of the merger transactions that occurred between 2009 and 2012 for Outside Buyers and Existing Agency Owners and in reviewing our customers post-acquisition CSRP reports, the performance could best be described as flat.

My initial thought was that mergers aren’t necessarily a recipe for success. But then I thought I would do a little research. I’d go back and look at the Smart Reports to analyze the performance of the agencies that were purchased as part of a merger and compare them to the buying agent’s performance after the purchase. Certainly, the quality of a seller’s book of business (or lack thereof) has some bearing on the new agent’s performance. Here is what my research uncovered about those who purchased and merged agencies:

Some of the worst performing books of business I have ever seen were sold as part of a merger transaction between 2009 and 2012. The general theme was that buyers would not purchase a poor performing agency by itself, but if an underperforming Book of Business could be bought at a discount and merged into another agency – why not give it a shot.
72% of Outside Buyers who merged agencies wrote more new business in their first year than all their sellers combined wrote the year prior to selling.
- Furthermore, 29% of these buying agents more than doubled the amount of new business written compared to their sellers.
On average Retention dropped a nominal 0.31%
In most instances the agencies being merged were less than $1,500,000 in Premium. Absent the current Agency Development Bonus program these agencies represented a business few approved buyers were willing to purchase as a stand-alone agency at the time.

I recognize my analysis is limited to just the performance of PPC LOAN’s customers and certainly analyzing new business and retention does not represent the full measurement of success. However, I do think the majority of those agents who utilized PPC LOAN for a merger loan were successful and I think they did a good job of “stopping the bleeding” of an agency that was shrinking – a not so easy task that cannot be overlooked. I further believe that a systematic and carefully executed approach to mergers could allow for more consistency in agency values over time and would avoid periods of ramped merger activity followed by periods of no merger activity.

New Feature

It is a regular occurrence that I hear of a seller digging in their heels and wanting to only sell their agency for the exact multiple listed on the Allstate Agency Value Index even though their book is less than desirable and should likely garner a value below the average. I also hear stories of buyers looking to get a great deal on an outstanding book of business by refusing to pay more than the current Value Index Average. My statement to both these individuals is that the Value Index represents an average of a wide range of agency sales multiples. Some very high and some very low but none selling for exactly the average. I have added the new feature below to show the lowest price multiple paid in a quarter and the highest price multiple paid in a quarter – both to give perspective to what the comprises the average. Not all agencies are created equally and the wide range of prices below reflects this.

Agency Analysis by Size Group

$0 to $100,000 in New/Renewal Commission

PPC LOAN was not involved in the financing of any Agencies in this size group in the Second Quarter of 2013. Historically, 100% of the agencies analyzed in this size group were part of a merger transaction.

$100,000 to $200,000 in New/Renewal Commission

It was last reported that 44% of these sized agencies transitioned in the First Quarter of 2013 were part of a merger transaction. This was reported as a significant drop from 80% of these sized agencies being part of a merger acquisition during the Fourth Quarter of 2012. As the chart above shows the near absence of merger transaction has resulted in these agencies seeing a reduction in value from 2.15 times in the First Quarter to 1.99 times in the Second Quarter.

$200,000 to $300,000 in New/Renewal Commission

Agencies ranging from $200,000 to $300,000 in New and Renewal Commissions have historically been the most steady of all Size Groups, consistently maintaining a value multiple of 2.40 to 2.50 times over the past three years. During the Second Quarter of 2013 Agencies of this size have dipped to a multiple of 2.30. After a closer examination, this lower multiple may be an anomaly as there appears to be more than the usual “good deal” transactions that occurred in this size group during the Second Quarter.

It may also be the case that some buyers view purchasing a $2Million Premium Agency as less attractive due to the new opportunity to receive enhanced commission for purchasing a slightly smaller book at $1.5Million in Premium.

$300,000+ in New/Renewal Commission

Agencies in this size group realized an average multiple of 2.57 times in the Second Quarter of 2013, a decent increase from the 2.51 times realized in the First Quarter of 2013. Word on the street is that books in excess of $3Million in Premium are very scarce due in part to the inability to reach this size via merger of multiple small agencies.

Allstate Agency Price to 12MM Earned Premium Ratio (National Average)

$0 to $100,000

$100,001 to $200,000

$200,001 to $300,000

$300,001 and up

Simple Average

Low

High

2000
N/A
N/A
N/A
N/A

0.202

0.117
0.262

2001
N/A
N/A
N/A
N/A

0.209

0.133
0.311

2002
N/A
N/A
N/A
N/A

0.197

0.119
0.255

2003
N/A
N/A
N/A
N/A

0.199

0.147
0.254

2004
N/A
N/A
N/A
N/A

0.236

0.157
0.393

2005
N/A
N/A
N/A
N/A

0.259

0.175
0.398

2006
N/A
N/A
N/A
N/A

0.298

0.188
0.402

2007
2.37
2.65
2.92
3.01

2.96

1.21
4.56

2007
N/A
N/A
N/A
N/A

0.292

0.121
0.456

2008
2.32
2.41
2.74
3.13

2.71

1.45
4.06

2008
N/A
N/A
N/A
N/A

0.271

0.145
0.406

2009
2.14
2.35
2.50
2.78

2.46

0.82
3.97

2009
N/A
N/A
N/A
N/A

0.247

0.082
0.397

2010
N/A
N/A
N/A
N/A

0.24

0.106
0.353

2010 1st QTR
1.94
2.29
2.52
2.91

2.39

1.06
3.53

2010 2nd QTR
2
2.27
2.47
2.8

2.37

1.17
3.16

2010 3rd QTR
2.22
2.26
2.5
2.74

2.43

1.42
3.31

2010 4th QTR
1.94
2.33
2.49
2.76

2.41

1.95
3.28

2011 4th QTR

N/A

0.231

0.12

0.366

2011 1st QTR
1.78
2.36
2.49
2.73

2.47

1.2
3.57

2011 2nd QTR
1.99
2.37
2.41
2.53

2.33

1.2
3.66

2011 3rd QTR
1.89
2.16
2.45
2.7

2.25

1.5
3.66

2011 4th QTR
2.05
2.23
2.45
2.52

2.34

1.62
3.37

2012 4th QTR

N/A

0.229

0.127

0.336

2012 1st QTR
1.87
2.2
2.41
2.54

2.3

1.47
3.07

2012 2nd QTR
1.84
2.27
2.4
2.56

2.3

1.46
3.29

2012 3rd QTR
1.96
2.22
2.33
2.59

2.28

1.27
3.24

2012 4th QTR
2.14
2.21
2.43
2.55

2.39

1.53
3.36

2013 1st QTR
2.1
2.15
2.38
2.51

2.3

1.28
2.95

2013 2nd QTR
N/A
1.99
2.3
2.57

2.34

1.88
3.07

Use the arrows to see agency values over time.

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Allstate Agency Value Ratios

Agency Price to New/Renewal Commissions

Agency Price to Total Revenues

2007 1st QTR

2.95

2.37

2007 2nd QTR

2.74

2.39

2007 3rd QTR

2.75

2.35

2007 4th QTR

2.49

2.18

2008 1st QTR

2.95

2.38

2008 2nd QTR

2.74

2.39

2008 3rd QTR

2.75

2.35

2008 4th QTR

2.49

2.18

2009 1st QTR

2.65

2.28

2009 2nd QTR

2.5

2.22

2009 3rd QTR

2.42

2.17

2009 4th QTR

2.37

2.17

2010 1st QTR

2.39

2.08

2010 2nd QTR

2.37

2.09

2010 3rd QTR

2.43

2.13

2010 4th QTR

2.41

2.09

2011 1st QTR

2.47

2.18

2011 2nd QTR

2.33

2.05

2011 3rd QTR

2.25

2011 4th QTR

2.3

2.06

2012 1st QTR

2.3

2.02

2012 2nd QTR

2.32

2.05

2012 3rd QTR

2.28

2.05

2012 4th QTR

2.39

2.11

2013 1st QTR

2.3

2.06

2013 2nd QTR

2.33

2.11

Use the arrows to see agency values over time.

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Being the creator and author of the Allstate Agency Value Index has afforded me the opportunity to write countless articles and to travel on behalf of PPC LOAN to speak to both Allstate Management and the Agency force. In the process, I have learned of the issues often faced at loan closing, such as the restrictive covenant.

So, this quarter I have asked Tabitha Hughes to share her many years of experience in the area of non-competes. She has written an insightful article with many points to ponder when selling your Allstate business. We are pleased to share this information and hope it will help many of you in the near future.

Paul Clarke President PPC LOAN

Non-Competes Revisited

In closing loans for Allstate agents over the last 13 years, one of the biggest points of contention that comes up during the loan closing process is the restrictive covenant. Many buyers and sellers don't understand why a lender would care about their agreement. The reason is simple: Allstate's non-compete doesn't protect an agency buyer, and the lender has a vested interest in wanting the person to whom they are lending hundreds of thousands of dollars to be protected.

ALLSTATE IS NOT A PARTY TO YOUR PURCHASE AGREEMENT

Sometimes sellers are hesitant to sign a strong restrictive covenant because their R3001 Agreement with Allstate only stipulates that they not compete for one year and within one mile of their agency location. While this is true, they are not selling their agency back to Allstate (taking TPP). The agency buyer should remind the seller that while Allstate approves the transfer, the company is not a party to their purchase agreement, and the buyer is paying the seller a price for the agency that is higher than the TPP value Allstate would give them. In exchange for the higher price, the buyer is entitled to and should expect protection from competition by the seller. If after discussing these points, the seller continues to resist entering into a strong restrictive covenant, the buyer should investigate the seller's motivation behind this reluctance. As a general rule, sellers acting in good faith who have no intention of competing with their buyer also have no objection to signing a strong restrictive covenant.

WHY DOES IT MATTER?

Steve purchased an Allstate agency from Greg and paid him $500,000 at closing. Steve didn't hire an attorney to draft a formal purchase agreement - they simply signed Allstate's required transfer documents. Greg didn't discuss his future plans in detail with Steve; he only mentioned he was going to pursue another business venture. A few months after closing, Steve discovers the other venture is an independent agency just a few miles away from his newly acquired agency. Greg has a great new Yellow Pages ad, website, and nicely appointed office he purchased with the funds from his agency sale to Steve. Greg is also contacting his former customers, and Steve begins to lose business. Steve is angry and wants to sue Greg, but he has no legal recourse because he doesn't have a written contract stipulating Greg could not compete with him. Steve is left to repair the damage done to the agency on his own, as well as repay the $500,000 loan he secured to purchase it.

DUE DILIGENCE

Most agency buyers don't have Steve's bad experience, but the potential damage a seller can do to a buyer's agency is a serious risk, and buyers have a responsibility to conduct their own due diligence prior to completing an agency purchase. Buyers should speak with their sellers early in the negotiation process to determine their future plans, engage an experienced agency transition consultant, and have an attorney familiar with Allstate agency purchases (or at the very least small business acquisitions) draft a purchase agreement with an appropriate, enforceable restrictive covenant. With an adequate restrictive covenant, a buyer can sue for damages and recoup some of their lost investment. Furthermore, sellers are less likely to violate a written contract.

ENFORCEABILITY OF RESTRICTIVE COVENANTS

Often, a seller's resistance to signing a restrictive covenant, as well as a buyer's resistance to pushing the issue, is due to the preconceived notion that they are unenforceable. Contrary to popular belief, restrictive covenants are generally enforceable when the purchase of a business is involved, as long as they are reasonable. Restrictions against competition and solicitation that would normally not be enforceable in an employer/employee situation are often allowable when those restrictions are bought and paid for as part of an agency purchase. In an acquisition, the restrictive covenant is considered an intangible asset and can be given a value, just like the goodwill the covenant protects has value. This is necessary for the ongoing success of the business, as a breach of the covenant by the seller could cause irreparable damage to the buyer's agency. Thus, agency buyers can justify asking for a strong restrictive covenant in order to protect themselves and the health of their business from interference by the seller.

THE SCOPE OF RESTRICITVE COVENANTS

Your attorney can help decide what types of restrictive covenant terms are reasonable for your specific situation, but most address:

1. Non-Competition

a) What the seller and/or its representatives are specifically prohibited from doing - such as owning another agency, being employed by another agency, or being in any way involved with a business similar to the one that is being sold. b) The time period over which the restrictions will be in place. c) The geographic area for which the restrictions will be in place.

2. Non-Solicitation

a) Direct or indirect solicitation of the customers transferred to the buyer. b) Direct or indirect solicitation of former employees of the seller that are being retained by the buyer. c) Direct or indirect solicitation of any key referral sources.

3. Confidential information

a) Disclosure of customer lists or other confidential information to 3rd parties.

4. Damages

a) Monetary amounts the buyer can recover. b) Injunctive relief (such as a cease and desist order).

THINGS TO CONSIDER

Some things you may want to consider when having your attorney draft your restrictive covenant:

1. Who has potential harm my agency?

a) Seller/Key Agent. b) Seller's spouse or other family member(s). c) Key Agency employees.

2. How could this person harm my agency?

a) Directly taking agency customers. b) Taking customers through other individuals/companies. c) Taking key agency employees. d) Competing in my market area and interfering with my ability to write new business.

PROTECTING YOUR INVESTMENT

The above lists address just a few things that a restrictive covenant can cover. Not all agency purchases are the same, and not all restrictive covenants should be the same either. There may be a key agency employee that has the "real" customer relationships. Will you restrictive covenant cover that? Every buyer should seek the counsel of an experienced business attorney when purchasing an agency. An attorney can give advice and draft an agreement that is appropriate for your unique agency purchase and protect your valuable investment.