M&As--thinking outside the box

Rough Notes, May 2003 by Di Stefano, Paul J

AGENCY FINANCIAL MANAGEMENT

Balancing the needs of both buyer and seller can be the key to a successful deal

everal weeks ago, I had an interesting conversation with an agency principal who had expressed interest in acquiring one of Harbor Capital's clients. This agency principal previously had completed a small number of acquisitions through direct negotiations with the seller but had not completed a transaction in which the seller was represented by an intermediary such as Harbor Capital. So he asked to be walked through our method for handling the acquisition process.

I was not particularly surprised at his request, since his question was reflective of concerns occasionally

expressed in the past by agency principals who incorrectly view the merger and acquisition process as a veritable auction when an intermediary is involved. I explained to him that as an experienced intermediary, Harbor Capital's view of the process is quite different. While maximizing shareholder value is certainly an important factor, it is by no means the only factor to be considered when consummating an agency transaction. Harbor Capital's philosophy in structuring viable deals is to begin the process by exposing our clients to the most viable opportunities. We then assist the client in weighing the pros and cons associated with each and then pursuing those that represent the most attractive operational fit with our client. Our experience would dictate that the opportunities with the clearest operational fit will also be among the most attractive financially. The ultimate deciding factor will be the best combination of operational fit and financial structure.

As one would imagine, in its role as merger and acquisition intermediary, Harbor Capital Advisors finds itself in a unique position to view first-hand the approach that potential acquirers utilize in pursuing agency acquisitions. Unfortunately, many would-be acquirers approach the process with a bit of tunnel vision. They make the mistake of attempting to structure the transaction solely from their own point of view in a way that attempts to insulate the acquiring agency from all financial risk. The reality is that successful negotiations should begin with the premise that both parties to the transaction must have their needs met. Successful acquirers think outside the box and thus are able to consummate transactions in large part because of efforts they make to meet the particular needs expressed by the seller. For that reason, it is of utmost importance to understand what the particular hot buttons are for the other side to the transaction. For example, those hot buttons may include some of the following: the security of a guaranteed transaction, capturing an upside potential in a work out structure, partnership in a larger agency with more resources as well as general perpetuation concerns.

An example of thinking outside the box is demonstrated in a recent Harbor Capital M&A assignment. This scenario involved two agency principals who, after considering their alternatives, decided to retain Harbor Capital to contact potential acquirers. One of the major issues that our client faced was a lack of markets. Due to the agency's size and location, several key markets had canceled agency agreements, thus impairing the agency's ability to write new business and forcing the agency to work through wholesalers at lower commission rates. An additional issue was related to the difference in age of the two principals and divergent personal wish lists and objectives. The older principal was open to two options: to work on a modified schedule or to depart after a transition. The younger principal wanted an infrastructure in which he could maximize his talents as a producer.

In discussions with our client, local agency competitors were ruled out as potential acquirers early in the process, so that a roll-in transaction would not be a consideration. The buyer would have to be a regional agency which desired to maintain our client's office location with the concession that account processing could be handled off site. Harbor Capital proceeded to open discussions on behalf of our client with four distinct agencies with varying business models, all of which had the potential to fit with the personal objectives of the seller.

I have attempted with the following summaries to give the reader an insight into the thinking behind the approaches taken by the four potential acquirers in structuring a transaction. In general, all four potential buyers would bring access to needed markets. More important, several of the potential acquirers clearly recognized and addressed the hot buttons of the selling principals.

Acquirer I took the approach that the age difference between the two principals dictated a different approach for each. The older

majority principal was offered a cash buyout while the younger minority partner was offered a partial buyout and a continuing but reduced equity stake in the agency. The rationale for the continuing equity stake for the producer was the ability of the acquirer to generate a substantial amount of new business by having the new location. The equity stake was attractive to the producer since it had the potential of growing in value quite dramatically over the next few years since the producer could easily capitalize on this new source of business.