Valuation & Terms of Small Books of Business

We get many calls about valuing small books of business and if it is worth it to do a valuation. The seller may know what he/she wants, and the buyer may not want to spend a lot of money and needs some good advice.

Usually on a small deal, like under $150,000, a fair market valuation does not make sense. Instead, we usually do an Opinion of Value if a book of business is under $500,000 in commissions or less.

Deal Example Math

Let’s say you are looking at a $200,000 book to buy, mainly personal and commercial lines accounts.

You are looking at expenses to put in a CSR for like $36,000 plus benefits of 15% (or $5,400), and then your time at renewal and maybe a call or two. Then let’s pay the owner or a producer 20% ($40,000) plus 15% benefits ($6,000) and then throw in another $25,000 in miscellaneous expenses, like phone, accounting, rent, automation, etc. This totals $112,400.

So, now we have $87,600 in profit on a $200,000 book–that’s 43.8% profit.

Valuing the Book

If you use a 6-times multiple of 43.8% profit, that is 2.6-times commissions, or in dollars a $200,000 book is then $525,600. If you give them 30% down, that is $157,680. Then you still owe $367,920. You turn that amount that you still owe, which is 70% of the money, into a percentage for the next three years. That 70% divided by three years is 23.3%. And with an earn-out you don’t pay interest. That way you can tell them no matter what comes in, you will give them 23.3% of the money. So, then you are paying on retention and are protected, as if only $175,000 comes in.

Ask us to send you the spreadsheet of a pro forma for this little book, and then to be astute you value it based on the bottom line. Then use perhaps a 6-times pro forma pretax multiple times profit, not the top line.

Two-times commission is usually a minimum for any size book today.

Typical Terms

In general, typical terms with an independent agency (not regional or national broker) are usually 20% to 50% down and the balance on an earn-out, which means paying a percentage of what you still owe for each year based on what renews. The first year is paid by the down payment, so the buyer doesn’t start paying until the beginning of the second year and then can pay monthly, quarterly, or annually. With an older seller, the buyer usually has three years or less to pay this off.

The multiple varies between usually 5.0 for a riskier book with a higher profit to 7.0 multiple of cash flow or profit. On this book example, a 6-times profit is used because the profit was high at 43.8%. The profit range is usually 15% to 30% today.

Letter of Intent

A letter of intent (LOI) that each party signs before a purchase agreement is drafted by an attorney is helpful. An LOI may help the attorney to assist the seller or buyer with the Purchase Agreement. (Note: I can send a sample LOI that will not suffice as a legal agreement but can save a lot of the attorney’s time and is in layman’s language.)

Contingent Buy-Sell with Retiring Principals

A contingent buy-sell agreement can be put in place to set up a deal with producers that are not ready to let go yet but want back-up. This puts the price in writing in case something happens to the seller so that valuation is not done after a death or disability and protects the seller from a fire sale. The buyer is screened well, and both parties agree they are a good “fit” and want this to be done in the future. (Note: I can send a sample agreement to amend and use, but it should be reviewed by an attorney.)