Value versus Price

By | September 7, 2009

Understanding Agency Value and the Sale Price Correlation


When it comes to anything in life, there is value and there is sale price. Value is a theoretical term that has different meaning based on the underlying assumptions. The sale price is the cold hard reality of an actual transaction. Value and sale price are related, but any correlation is variable and not fixed.

What is Value?

Professional appraisers will use one of several standards of value when appraising a business. These include Fair Market Value, Fair Value, Strategic Value, Book Value, and Liquidation Value, with the most commonly used standard being Fair Market Value.

Fair Market Value has a very specific definition, which include a hypothetical buyer and hypothetical seller who both know all the facts and neither is under any compulsion to buy or sell. What Fair Market Value boils down to for a business is the value that an unbiased investor would place for it in comparison to any other investment vehicle. Publicly traded stocks are a good representation of Fair Market Value.

In practical terms, Fair Market Value for any business is derived from an analysis of the specific business itself, general trends in the marketplace and the economy and with a comparison of that business to transactional data from other businesses known to have sold. This is essentially the method that is also used to appraise houses.

The Sale Price

The sale price (not the asking price) is just one single transaction, so it does not represent market value, but it can reflect marketing trends or conditions. The sale price is what a specific buyer pays to a specific seller. It is the “value” two parties placed on that single entity based on their specific circumstances.

Some sellers are more interested in a quick or easy transaction, so they might accept a lower price. In contrast, some buyers might feel an urge to close a deal, so they might overpay on their first transaction.

In many cases, the seller might have something of value that a specific buyer will pay a premium to obtain, while other buyers will not see the sale value. Classic examples of why a buyer will pay a premium include a unique market contract, a large market share in a specific niche, a desired location or a talented producer.

The actual price can get complicated when terms are introduced. Typically, buyers will make a down payment and then pay the balance based on some type of earn-out over a period of years. If the earn-out formula includes a retention or growth piece, the final total amount paid to the seller could significantly fluctuate.

In general, sellers want a high price that is fixed and paid as soon as possible. Buyers want a lower price, with a small deposit and the balance paid over time with cash flow from the business and based on retention of the business.

Price and terms are the negotiated point between the parties. Price and terms are not Fair Market Value, however, Fair Market Value is often used as a launch platform where negotiations begin. An old adage is “your price and my terms or your terms and my price.”

Sellers Market

The current market place has had some significant changes in the past few years. Hitting a plateau around 2005, large buyers like banks and publicly traded brokers reportedly paid top dollars for many agencies for the next three years. These actual transactions drove up the value for comparable agencies. The problem in the marketplace was that not all agencies fit the high price acquisition model used by these buyers, but most sellers still felt that was an indication of their value.

However, enough of these less desirable sellers held out for higher prices and it became a self-fulfilling prophecy. It was a strong seller’s market for many years up to the middle of 2008. Because sellers were demanding high prices, and which often occurred, the smaller buyer — i.e. other privately held agencies — were not significant players during this time period. Usually, an acquisition has to cash flow for the smaller buyer, and a 2.0 (or more) times revenue price is difficult to cash flow.

When banks ran into trouble in the fall of 2008 and the economy got weak, the whole landscape started to change. Many banks stopped being active with acquisitions and some actually became sellers. National brokers still continued with acquisitions, perhaps to maintain growth in a soft market, but at a more conservative pace and with less lucrative terms for the seller. The small buyer is now a viable player. Sellers can still find qualified buyers, but most likely not at the same price and terms in the recent past.

Current Trends

Many buyers today have become educated and look at the bottom line when valuing a business. Although price can be converted to a multiple of top line revenue, it is usually determined from earning before interest, taxes, depreciation and amortization (EBITDA). Transactions are more in the 5.5 to 6.5 times EBITDA range with much less above 7.0 when compared to 2005 through early 2008.

Buyers are also lowering the fixed price portion while paying more on an earn-out basis.

In the heyday of 2005-2008, some well-financed buyers were offering to some sellers a fixed price component from 75 percent to 100 percent of the total price of the deals. Now the trend is more toward 50 percent of the price being fixed and the balance paid as an earn-out over three or four years.

Small buyers still cannot compete with large buyers in the design of affordable acquisition terms to sellers because they typically don’t have the same access to cash. Many peer-to-peer transactions include only 25 percent to 35 percent down, with the balance paid over three to five years, based on retention of the business.

Buyers are also getting picky, so if the agency is not well-run, then the price will drop significantly. Since cash is tight, the deal needs to make financial sense from the beginning. If a major overhaul is needed, then perhaps the time, energy and money should be spent on developing organic growth.

What is Next?

The market is getting harder and the economy will eventually improve, so this means there will be a swing back to higher value, right? The answer is no, not so fast.

Typically, in any market, when a big shakeup occurs, old players leave and new players enter; then a new paradigm is created.

The new players are investment groups and they are looking at the insurance industry strictly from a cold analytical approach. If they become a major force replacing banks, then prices will stay the same or even drop a bit despite the favorable conditions for the independent agent.

Then there is the 800-pound gorilla called the federal government.

If any “public option” scheme for health care develops, then commissions from employee benefits might soon be a thing of the past.

There is also a push to federal regulation of the insurance industry, and who knows what that could mean for the independent agent.

Bottom Line

What does this mean specifically for you and your agency? Well, there is the current value trend and then there is the price you will sell it for. It is important to know the current trends (in agency value, the economy, the industry, etc.) and then position yourself to maximize the equity in your business. A well-run business will always attract top dollars from a buyer, so run your business like you are ready to sell it, now.

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Insurance Journal West September 7, 2009
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