Today there is constant attention by those asking agency owners to think about selling or merging with them, so the owner can pursue his or her hopes, dreams and yes … retirement. We know because our clients keep telling us about these flirtations.
Potential buyers are competing with each other for those few sellers. This competition has led sellers to push the limits on not only what they are willing to pay, but also what they are willing to say. Some buyers have developed creative terms that led to inaccurate hype about what the actual dollars the seller actually receives at the end.
This has resulted in a self-fulfilling condition. As a result of the price hype and the number of solicitations sellers receive, many sellers hold out for that perfect deal, because everyone “knows” that is what the going rate is (but is it really?). This belief has created a real upward pressure on value for agencies.
Truth or fiction
From a purely financial standpoint, agency value has not gone up in the past few years. Profitability is a major component of value and because of the soft market, profitability has even dropped for some agencies.
Astute buyers know the math. They also know that most sellers of independent agencies are anxious to tell their friends when they do sell or merge, that they got “one of those great deals” because the multiples being tossed about sound too good to be true.
That is because in many cases the deals described are too good to be true. Many owners are not financially oriented and choose to think that what they hear or see, is what they get. It is not that those who hear the anecdotal stories don’t understand the terms or what a retention deal is; they do. It is more that a buyer and seller are going to promote the high end potential, not the low end, in order to make themselves look good.
The word on the street is also at best incomplete, if not wrong. There are many facts behind the numbers that are not disclosed.
For example, one national broker approached about 50 independent agencies in Northern California to try to get these firms to sell. They tried to get attention of potential sellers by telling them they pay an above average price. However what was left out of the initial discussion was that it is based on sustainable profits. In this case, sustainable profits do not include contingents. The buyer would also tack on a large home office overhead charge, which affects the bottom line. This is important since most buyers calculate the value based on bottom line profitability not top line income.
Keep in mind that there is agency value, there are terms to the deal and there are actual proceeds. The dollars a seller can actually put in their pocket is impacted more on the terms of a deal then the value assigned to it. If it is not a cash deal, promises made to a seller about a potential price will be based on, if and only if, certain things happen.
In a recent case, one seller received and accepted what they thought was a great offer. The potential price was broadcasted on the street as 1.75 times revenue. Half of that price was cash up front the rest contingent upon reaching growth targets–sustained growth of 15 percent per year. Unfortunately for this seller, the marketplace turned and the firm actually had negative growth. Thus, the seller basically got half of what the word on the street said they sold for.
When the hype is real
When a buyer, such as a bank is buying a “platform agency” the price is usually paid at a high premium. Often a substantial down payment is made, then the remainder is often paid over three to seven years. For these rare deals, sellers are expected to find other agencies to buy and fold into their operations. They become the insurance branch of the bank, so part of the premium is based on their future efforts in building a viable insurance department for the buyer.
Keep in mind that many of the “platform deals” were done in the middle of the hard market. Buyers projected 15 percent to 25 percent growth rates for several years into the future.
To properly evaluate deals by national brokers or banks/financial institutions, one must take into account the terms based on expected revenue growth or profit growth. The analysis should also factor in what is excluded as revenue and what is added as expenses.
For these deals, the seller might get 6.5 times pro forma EBITDA based on sustained growth over several years. When growth is taken out and overhead expenses removed and contingent added back, these deals end up looking like a plan vanilla 5.0 to 5.5 times EBITDA or 1.25 to 1.50 times revenue deal. So, know how earnings are calculated.
The key for any seller is to realize that the word on the street is not often accurate and that a good deal should not be turned down because it does not reach what they heard “Joe down the street” sold for. Make sure that you do your homework. A sale or merger should only have to be done once. Tax considerations need to be well thought out for both parties and can significantly impact what a seller receives. Remember that there is value and there are dollars in the pocket and they are not the same.
Bill Schoeffler and Catherine Oak are partners at Oak & Associates. The firm specializes in financial and management consulting for independent insurance agents and brokers. They can be reached at (707) 935-6565, by e-mail at: email@example.com, or visit www.oakandassociates.com.