Referral agreements based on a handshake (or verbal contracts, or anything informal) are quite common in the insurance broker industry. Many brokers don’t see the point of taking the time and energy to formalize agreements between noncompeting “friends.” After all, if there is a falling out between brokers, don’t the referrals just stop? Is there really any need to spend time drawing up contracts or making things official? Can’t you just trust that the deal will go through? In reality, it’s rarely that simple.
The challenges of informal agreements
Handshake agreements can become an issue for brokers who are reevaluating their capital structure. Most capital providers and strategic partners will not finalize a relationship with brokers that have outstanding agreements with no formal documentation. Capital providers and strategic partners will often require brokers to formalize any referral agreements or other arrangements prior to finalizing a partnership. This may cause a costly delay in closing on a partnership or getting access to capital.
Another problem with informal agreements usually arises when things go south between noncompeting businesses who are sharing a relationship with a client. It’s at that point the question comes up as to who owns the business that was referred? Is it the broker who placed the business or the broker who referred the business? If it is the broker who placed the business, how long is the referring broker entitled to compensation or commission splits? It’s rare to find alignment between brokers on these issues when the time comes to dissolve or formalize these handshake agreements.
When to get formal
Formalizing a handshake agreement is each party’s “insurance policy” against any significant change within the business or for when things aren’t going well. The best time to formalize an agreement is at the onset – when both parties are excited about the mutual benefits of the relationship. The second-best time to formalize an agreement is now – when things are still going well. Don’t wait for there to be tension or a sudden need to formalize an agreement. Avoiding an official arrangement can lead to disputes, and in some cases, can even prevent or delay a desired change in capital structure.
Tips for formalizing
Part of the challenge with informal agreements is that they can be misinterpreted, incomplete, or lacking in detail. Here are a few key items to consider when formalizing an agreement:
- Ownership: Clearly outline who owns the business and the responsibilities of each broker when it comes to servicing the account.
- Compensation/commission splits: Clearly outline commission splits and referral fees for both brokers and define payment terms.
- Agreement term & termination: Clearly define the term of the agreement and the steps to be taken to renew or terminate the agreement.
Because insurance brokerage business deals often happen between trusted, familiar colleagues, it’s not surprising that formal agreements fall to the back burner. However, it’s important to validate agreements to ensure both parties are aligned and on the same page. Kicking the can down the road could result in costly disputes and future business delays.
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