Buying or Selling an Intermediary Business – Where to begin?
This briefing outlines the steps involved in the purchase or sale of an intermediary business. No two deals are the same but there are common themes, as Eoin Caulfield of William Fry explains.
The trend towards consolidation in the intermediary sector has increased since 2008. Factors include the age profile of brokers nearing retirement and market changes such as a movement towards direct sales and the effect of the downturn. There is also a more intrusive approach from the Central Bank of Ireland and the overhead it brings.
Intermediaries are however often very profitable businesses with strong recurring revenue and relatively inert client lists. In a market seeking greater scale, sales of companies are increasing. But where does a buyer, looking to grow business through acquisition in the intermediary area, or an interested seller, begin?
This is a general guide outlining some main considerations in buying or selling an insurance intermediary company. Every deal is unique – different purchase price, different deal structure and different reasons supporting the decision. However, there are common themes.
Where do you begin?
The best place to start is to ask – why buy or why sell the business?
A buyer may have many reasons for seeking to acquire, all of which are ultimately commercial. The buyer will want to expand or gain critical mass or scale in a particular business line. Conversely, a seller’s reasons may be either commercial or non-commercial. Retirement may be around the corner or the feeling may just be that “now is a good time to sell”. Equally, the decision may be determined by the business, for example a desire to focus on a core insurance line and release value through a sale of the client list in other areas.
Asking these questions will help crystallise how best to structure the sale.
Deal Structure: Asset Purchase or Share Purchase?
Buying or selling businesses takes one of two forms which are quite different. Consideration must be given as to whether a transaction should be structured as a share purchase or an asset purchase.
If the deal is structured as a share purchase then the buyer will acquire the entire company including all of the assets and liabilities. However, in an asset purchase, the agreement is that the buyer and seller carve-out the individual assets and liabilities to be sold while the seller retains ownership of the company. In the case of an intermediary business, most of the value will be tied-up in the client list and a sale may involve transferring the list, and related assets and liabilities, to the buyer. For example, selling the personal lines business but retaining commercial lines. A variation of this is a “renewal rights” deal, where existing arrangements run-off with the existing company but it is agreed that, for the purchase price, renewals will be directed to the purchaser.
An issue in weighing up the pros and cons of an asset or share deal is what happens the proceeds of sale. In a share purchase, the proceeds of sale will be paid to the shareholders of the company. The shareholders will then be liable to capital gains tax if they made a gain on the sale. By contrast, in an asset purchase there are potentially two taxable events. The proceeds of sale are received by the company itself rather than its shareholders. Thus the intermediary company is the entity that will be taxed. If it then wishes to pass the proceeds to its shareholders, by way of dividend for example, there will be income tax payable this time by the shareholders on what they have received. This “double hit” sometimes mitigates against an asset sale. Stamp duty, a further tax to be paid, can also add to this although the differential has fallen away in recent years. Stamp duty is 1% of the purchase price, or currently 2% in relation to relevant assets in an asset sale. Not all assets attract stamp duty, but it includes goodwill and thus the value attaching to the client list.
What sort of preliminary agreements should be put in place?
Deals often start life on a handshake. However, when the buyer and the seller have the key principles of the deal agreed, it is common to record these in a document called a “Heads of Agreement”, “Heads of Terms” or “Memorandum of Understanding”. This is often the first involvement of the lawyer. The document is essentially a skeletal outline intended to ensure that the important points of the deal are agreed before devoting the time and cost to the negotiation of the purchase contracts. It will generally be non-legally binding, except for terms such as confidentiality and an agreement to negotiate exclusively with one another for a given period. The buyer will be given information about the intermediary’s business, including sensitive financial data and access to client details. Consequently, the seller will want to protect confidential information. Providing for a period of exclusivity is also a useful tool and ensures that for a stated period the seller will not try and sell the company elsewhere, giving time for a proper evaluation and sale process with the bidder.
What do you need to know about your target?
A buyer will now start its due diligence. Essentially, this is a process to allow a bidder “kick the tyres” on the business. Legal, financial and tax due diligence is a vital process, particularly if the buyer is purchasing the shares of the company, in which case they will inherit the entire company and both the “good” and the “bad”. The level of due diligence will depend on the nature of the target and there will be a risk/reward calculation as to how detailed it needs to be to get adequately comfortable. It would be usual to include professional advisors at this stage.
Although larger deals may involve a seller collating a “data room” and there can be other variations, it usually begins by way of a general due diligence checklist prepared by the buyer for completion by the seller. The end result of this information gathering exercise is to paint a complete picture of the business. The information obtained will highlight areas for focus during the negotiation process, as well as helping to firm-up on the price the buyer is willing to pay and the extent of the contractual comforts needed from the seller.
Documenting the sale
An asset purchase agreement or a share purchase agreement – there can be variations on what the agreement is called – will be used to document the deal. Because of timing, the purchase agreement is typically drafted while the due diligence process is underway. The purchase agreement will be the principal contractual document and traditionally (although not necessarily) it is drafted by the buyer. The reason it is drafted by the buyer is because it will contain lengthy “warranties” and indemnities and other key terms. The buyer will not wish to be undermined by losing drafting control. It will be accompanied by other documents, such as a deed of tax covenant (in regard to tax liabilities, usually handled with a stand-alone deed) and, for example, new employment contracts or services agreements.
“Warranties” are the contractual comfort the selling shareholders or other connected persons give to a buyer. They comprise a list of statements on all facets of the business which are legally relied upon for the purposes of parting with the purchase money. Warranties are a large part of the purchase agreement and tend to be a key focus in the negotiations. If a buyer subsequently finds something is untrue, the warranties are intended to give a right to sue the warrantors within a given time period (e.g. 1-3 years, but longer for tax) to recoup any loss. A seller will seek to impose limits on warranties such as capping the aggregate liability that might arise on a warranty claim.
Clearly no company is perfect. A disclosure letter is therefore used to qualify the warranties given. A lot of attention will be given to crafting a disclosure letter to ensure a buyer cannot subsequently claim there was no knowledge of a matter which ultimately gives rise to a loss, and which therefore should properly have been taken into account in negotiating the purchase price.
Structuring the purchase price and deal
The structuring of the payment of the purchase price (often called the “consideration”) will be foremost in the mind of any seller. Ideally, a seller will want to maximise the price and get a full cash payment immediately upon completion. The reality however is that there will often be a trade-off.
Deferred consideration is a commonly used device in insurance deals. A buyer will be wary of handing over the entire consideration when renewals or key clients or employees may be flighty. There may also be a fear something could give rise to a warranty claim, meaning the buyer will have to look for money from the sellers which is already spent. Deferring some of the payment is therefore a common solution.
The amount deferred will often be calculated based on the future financial performance of the target company as well as other factors such as retention by the business of its key staff, for example, leading to payments against agreed targets over the next two to three years. This is commonly called “earn-out”. Similarly, there may be an amount lodged to a third party bank account to be released after a given duration, for example, assuming no unforeseen loss events have arisen. There will be practical considerations to bear in mind in any deferred consideration arrangements. These need careful negotiation to ensure there is no dispute as the payment dates are reached.
Other approaches to ensure the value of a business transfers intact may be used in tandem with deferred consideration. For example, a purchase agreement will often include a non-competition covenant that the seller will no longer engage in the same business after the sale. Similarly, there will be a covenant not to solicit employees or clients.
Gap between signing and completion?
Signing a deal nowadays is, unfortunately, not the end of the story. In the regulated financial services area, it is the norm that there will be a gap between signing the purchase agreement and when “completion” occurs. Often this will be something like one to two months.
Parties will be anxious to contract so that they can start a dialogue with the Central Bank of Ireland and potentially other affected stakeholders. Pre-conditions to this end will be included in the purchase agreement. While most insurance intermediaries are regulated under the European Communities (Insurance Mediation) Regulations – which do not necessarily require an advance regulatory consent – the Central Bank of Ireland’s new fitness and probity regime can only really be properly embarked upon when the agreement is signed. If there is to be a change in any “pre-approval controlled functions” it will need a confirmation from the regulator. This includes roles such as directorships, which typically change when a buyer acquires a company. An Investment Intermediaries Act authorisation may also require a non-objection confirmation from the Central Bank of Ireland.
Separate from regulatory conditions, there may be a need to obtain other change of control consents. Agency or other distribution arrangements with underwriters usually involve a contract that gives an ability to terminate if prior approval is not obtained. These will be intrinsic to the value of the deal and therefore need careful management along with, for example, banking arrangements. Other areas, such as IT platforms, often also need the consent of the technology provider who may sometimes insist on a fee.
What happens on completion
The time for the champagne finally approaches and completion of the transaction is imminent.
At the time of signing of the purchase agreement all that occurred was to contract to buy and sell with effect from a later date once the agreed conditions, such as regulatory clearances, were fulfilled. The other paperwork now falls into place as the transaction “completes”.
Depending on whether the deal was structured as an asset purchase or a share purchase, the following non-exhaustive list sets out some of the documents that will be handed over by the seller to the buyer on completion, allowing the buyer to make the payment of the purchase price (or relevant initial element)
- Stock transfer forms (a short statutory form document which legally transfers shares)
- Disclosure letter, deed of tax covenant, employee contracts and other ancillary documents
- Memorandum and articles of association of the company
- Letters of resignation of the directors, secretary and/or auditor
- Statutory registers and minute books
- Company seal
- Certificate of incorporation
- Certificates of registration issued by the Central Bank of Ireland
- Title documents to any properties
- Releases of bank security
- Bank mandates
A board meeting will be held by the target company. This meeting will approve a number of items such as the stock transfer forms, the resignations of the directors, company secretary and auditors as well as other documents (e.g. if it is an asset sale). Following the meeting and exchange of documents, the buyer will formally release the purchase price to the seller.
The focus then moves to tidy-up items, such as payment of stamp duty to the Revenue Commissioners (within 30 days of the deal), as well as notifications of completion to the Central Bank of Ireland and the making of filings at the Companies Registration Office.
Eoin Caulfield is a Partner in the William Fry Insurance Unit, one of Ireland’s largest dedicated practices in this area. He has been involved in many M&A insurance deals acting both on the buy and sell side and representing intermediaries and underwriters. He can be contacted at 01-639 5192, email [email protected] or website www.williamfry.ie