© Copyright 2004                               The Art of Merging by Norm Trainor The following is based on one of The Covenant Group's clients, Cam Onley. All of the names and telling details have been changed to preserve client privacy. Cam Onley was on the brink of a major breakthrough in his business. He was trying to finalize a merger that would mean access to a client base of 4000, but negotiations had reached an impasse. He worried that he was about to blow the deal of a lifetime. Cam became a life insurance advisor over twenty years ago, at the time working for a large insurer. After seven years, he and another agent, Stacey, left to start their own firm. According to Cam, joining with Stacey was the best thing he'd ever done. Their talents and skills were a perfect complement. Stacey was a prospecting genius and he was the closer. Together they built a thriving business, which now consistently generated over a million dollars in annual commission revenue. But Cam and Stacey envisioned a business five years down the road that generated five million annually. To make that happen they knew they needed a powerful growth strategy. Since merging their own businesses had worked for them in the past, they entertained the idea of another merger. For a few years they had referred the general insurance needs of their clients to a firm that specialized in property and casualty insurance. Though that P&C firm had its own life division, their expertise was limited in this area, and in return for the referrals from Cam and Stacey, the firm passed along any difficult or complex life cases. The relationship was a loose one, but it seemed to work for both parties. Merging with the life division of the P&C firm would give Cam and Stacey access to a massive client base, a move that would certainly put them in position to achieve their planned growth. When they broached the idea of the merger with Rick, the head of the P&C firm, Rick said he'd been thinking about the same thing. With the trend toward full service shops, Rick knew he had to do something about his life division in order to protect his client base. The discussion quickly turned to the structure of the deal. Everyone seemed to agree that splitting cases 50-50 was fair; the fact that Cam and Stacey would be doing most of the work would be offset by the access to Rick's client base of 4000. When the issue of ownership came up, Rick stated that he saw splitting that 50-50 as well. But this didn't sit well with Cam and Stacey, who didn't like the idea of handing over 50% of the business they'd spent the last thirteen years building, no matter how attractive Rick's client base. Unfortunately Rick wouldn't budge, and neither would Cam and Stacey. Over the next few weeks, each party continued to try to get the other to reconsider their position, but neither would. Rick was adamant that access to his 4000 clients was worth a 50% stake in the new business. Cam didn't want to give up on the deal; but he didn't want to sell his soul. Cam's story was a familiar one to me. Like many advisors, Cam and Stacey, and Rick as well, were all looking at the merger the wrong way. Resolving the negotiations wasn't a matter of simply coming up with percentages that everyone would agree to. A mindset shift was required for both parties. My first question to Cam was, "Why are you willing to giving up 50% of the commissions in the new business?" "Because we'd be getting access to 4000 clients." "And that would be worth 50%?" Cam nodded. "Cam," I asked, "what percentage of your revenue do you spend on marketing?" Cam wasn't sure. "50%?" I asked. Cam looked shocked. "God, noÖ.. 15%, maybe 20% tops." "That sounds about right. In fact, I like to use a rule of thumb algorithm for running a business that allocates revenue this way: 20% for the cost of marketing; 20% for administration; 40% for the cost of sale; and 20% for pre-tax profit. "Cam," I said, "advisors tend to apply a sales model to a business deal ñ it never works. Salespeople like to talk about splitting cases 50-50 because it seems fair. But 50-50 doesn't take into account all the other aspects of the business. Even if the parties do agree to a 50-50 split, problems are sure to arise down the road. If one party finds that they are doing all the work in terms of selling and administration, they're going to feel they're carrying the other party, and they'll resent the arrangement. "You should look at running the business according to an algorithm, where 20% is allocated to marketing. In which case, if the business was referred by the P&C firm, you'd pay the marketing portion of 20% as the referral fee. Whoever sells and services the client, gets 40%. 20% goes to administration, and the other 20% is the profit, which is split between the owners." Cam asked for my thoughts on the equity issue. I said, "Rick is trying to apply the typical sales model of 50-50, but this of course is not appropriate. We have to be careful about overweighing Rick's client base. As we've seen, the value of this client base will be accounted for by the marketing costs ñ or the referral fee of 20%. We need to recognize what each business brings to the table today; and one possible way of doing that is to look historically at the revenue." I asked Cam what the revenue was for his business compared to the life division of the P&C firm last year. "Our revenue was $1.2 million; theirs was $300K." "In that case, we're talking about an 80-20 split; not 50-50." Cam liked how I had framed things, but worried that Rick would still not budge. "Cam," I said, "the challenge is to get Rick to look at the merger in terms of a business model, not a sales model. I think that's possible." As it happened, Cam, Stacey and Rick and I ended up sitting together an industry function. The topic of the merger came up, and Rick asked for my thoughts. During the conversation, I asked Rick if he currently paid a referral fee for any business Cam or Stacey sent his way. He said no. I asked if he would be willing to, and he said of course. Then I asked how a 50% fee sounded. A look of shock crossed his face. I asked why that wasn't fair, and he filled me in on the various costs of running his business, such as administration and servicing. "So what would be fair," I asked. "20%?" Rick nodded. "I agree," I said. "As for the new entity; it's going to have the same business costs you just itemized for the P&C side." I then outlined the algorithm I had explained to Cam, and said, "Everyone needs to apply a business model to the new entity, and not look at it in terms of a sales model with a 50-50 split." With this new frame, Rick saw the value of his client base in terms of its contribution to the marketing of the business. And he now recognized more clearly the contribution Cam and Stacey would bring to the other aspects of the business: selling, servicing, and admin. Obviously a 50% split wasn't fair. He also saw that a 20% stake in the new entity was a fair recognition of what he brought to the table. To keep his life division competitive, Rick knew that he was better off have a smaller piece of a bigger pie than no pie at all. Clearly, Cam and Stacey's expertise and prestige in the marketplace was worth 80%. Both parties agreed to a deal where Cam and Stacey would own 80% of the new entity, and Rick 20%. Since Cam and Stacey were equal shareholders in their current business, each would own 40%. The new entity would run according to the algorithm, and a 20% cost of marketing referral fee would be paid whenever business was referred either from the P&C side to the life company, or vice versa. In its first year, the new entity generated $2 million in annual revenue, equivalent to an increase of over 30%. Furthermore, both parties were happy with an arrangement they considered fair. Lessons learned Cam, Stacey and Rick learned four important lessons about merging: When structuring a merger, both parties need to apply a sound business model, not a sales model A sound business model accounts for all the aspects of a business, not just selling and servicing A simple, but effective, algorithm for a business is: 20% cost of marketing, 40% cost of sale; 20% cost of administration; 20% pre-tax profit A client base is most appropriately valued in terms of its contribution to marketing, i.e., 20% Norm Trainor is the author of The 8 Best Practices of High-Performing Salespeople, a speaker and principal of The Covenant Group, a company that specializes in helping advisors build their practices. The Covenant group has worked with many of the world's largest financial institutions, including such firms as Swiss RE, CGNU in Hungary, Guardian, BMO and Clarica, helping their management and advisors create and sustain high performance by adopting a systems approach to practice development. The Covenant Group's proprietary practice development system, The 8 Best Practices of High-Performing Advisors Program, has been adopted by organizations around the world and is a leader in the industry. For further information, visit The Covenant Group's Web site at www.covenantgroup.com or email info@covenantgroup.com or call The Covenant Group at 416-304-1766.