Q: I am looking into buying a medium sized insurance brokerage that specializes in auto insurance. The current owner is very much involved in the business. He knows all of the clients personally, and even has many of them as friends and social acquaintances. Also, his name is the name of the company. Needless to say I would like to keep him on for a very lengthy transition period. What thoughts do you have on structuring an earnout in a situation like this? I want to keep him motivated, but don’t want to give away all of my future upside.

A: This is a common predicament in personal service businesses.

Clearly, if the seller is “the business” you’ll want to consider all of the ramifications that will come once he walks out the door. An earnout may be an option for you however, I am not 100% certain what it is that you expect to have the seller “earn” when in fact you’re looking more to having a deal whereby the business will continue at current levels at least. For example, an earnout makes sense in some of these situations:

• There is a high degree of customer concentration.
• The business has been trending downward or upward very aggressively in recent periods.
• The seller has just obtained or is anticipating new revenue that will dramatically increase the business and he/she wants to get paid for it but there’s no current financial proof to substantiate their belief of how much new business will be generated.
• A single contract or component to the business may be up for renewal in the near future (i.e. expiring lease).

In the situation you cite, I think that having a proper deal in place that adequately protects you after the closing to ensure that there’s a smooth transition is what you need. Furthermore, there are no real customer concentration issues or matters that one would usually tie to an earnout.

Here are things to consider:

• You absolutely must have a substantial seller note in place.
• The multiple paid for these type of businesses will tend to be at the lower end of the spectrum.
• The non-compete needs to be at least three years and if possible should prevent him from being in any related business whose prospects are current insurance clients although this may be a little harder to enforce.
• While I understand that you’ll want his involvement for the longest period possible, it may be more of a window dressing scenario so that during the transaction clients understand he is still involved. However, if he has a lot of personal relationships as you point out, then surely these clients will be aware of the sale. My concern here is that I sense you are not fully confident in the business being able to carry on once the owner leaves.

• Lastly, in the insurance business the different types of specialties will have various degrees of the importance of the personal relationship between the seller and their clients.

  As an example, in agencies that specialize in life or health insurance, the relationship between the agent and the clients is crucial. In the auto insurance business, while the relationship is important it is less so.