Merger & Acquisition (M&A) Trends Continue
There is no end in sight. How can our insurance industry keep the incredible pace of high-valued acquisitions happening? It feels like the tide needs to change, but yet the M&A national and regional brokerage firms and private equity money keeps flowing. Telemarketers are not giving up their daily badgering by phone, mail and email.
Independent insurance agents, especially those $10 million and less in revenues cannot compete with this acquisition pricing. They might be able to stretch and pay a retiree two times for their agency over five years, but besides going to the bank for a large down payment, usually 25 percent to 40 percent with most independents, they need to see the firm cash flow some of the purchase price, including the earn-out payments. In order to do so, there needs to be an earnings before interest, taxes and amortization (EBITA) of the seller of no less than 25 percent ,and hopefully even 30 percent or more.
If there is a 30 percent profit margin, the independents can pay six to seven times EBITA, and that equates to 1.80 to 2.10 times revenues. We never figure out pricing as a multiple of EBITA, we simply talk that way after EBITA calculations are made and valuation methods are applied, in order for our insurance owner/producer clients to understand what the pricing is, in their terms.
What we are seeing if a firm is profitable by at least 25 percent to 30 percent-plus, is revenue multiples in the 2.75 to 3.5 times range, usually offering some stock and an earn-out that can give them additional bonuses over two to three years. These earn-outs are usually a multiple of EBITDA and sometimes include the buyer’s stock. What we like even better and try to negotiate for is a revenue based earn-out. This is because we feel that if they are not on a revenue earn-out and the sellers cannot add people to grow the firm, because their EBITDA needs to grow. Often on an EBITA earn-out they cannot control the expenses assigned to them after the deal is closed. Many agencies today with EBITA earn-outs, don’t make these additional bonuses at all for those reasons, or if some accounts are lost.
Some buyers completely leave the sellers alone, some merely assist the seller and others completely change the complexities of the sellers. Sometimes the sellers don’t have to change their name ever.
Depending on the tolerance level of clients and whether they are agreeable or not, the latter is the first option of leaving you alone is usually the most sought after. However, some of these buyers have been known to completely change the operation, compensation of personnel and producers, perks, contracts, insurances and related benefits, automation, staffing, and market relations. One buyer today takes on all of your administrative duties, accounting (you lose your people), insurance benefits and retirement plans for a fixed expense charge, anywhere from 5 percent to 10 percent.
Those buyers that assist the seller sometimes allow the seller to have the higher commission rates and better contingents from the buyer, and that is added to the earn-out. Beware: Some might do this but don’t tell you that it is only for new business, not the whole book, which is a big difference.
Key nationals are all needing to grow, to keep their shareholders happy and to keep up with increasing costs, especially for staff. They also usually like to provide value-added services, free of charge to set themselves apart from the independents.
Multiples of EBITDA (if earn-outs are earned and the right EBITDA is in place) can range in the eight to 11 times EBITDA/pro forma profit ballpark. The very highest of multiples often appear in their letters of intent, to attract sellers, before due diligence has begun. If buyers are approached without a consultant representative, and encouraged not to use theirs, so avoid a second or third offer being made. After due diligence, the original offer in the letter of intent can often be a very different price and story. Once again, because most sellers are insurance salespersons and if the seller does not have their consultant to assist them, it is difficult to earn back the first promised numbers. Sellers don’t know how to do this and mistakes often are made in the way agency information is submitted. Often the buyers have hired third parties to do the due diligence work.
There is also often a big difference in value if stock is also offered. Some buyers determine their stock prices, without much clarity given to the seller as to where those values came from. Publicly traded national brokers without private equity money backing them is rare and only if so, one can look to the stock exchange for trading values for their stock.
If stock is offered (and it almost always is), it is best if it is optional as to the amount the seller has to take in the down payment or earn-out. It is also important if the stock can be sold back in a reasonable time, such as at retirement or at the end of the seller’s earn-out. Sometimes sellers have to hold the stock for a long time.
Some nationals require stock no matter what, and it’s rarely less than 10 percent to 25 percent of the down payment. Sometimes it has to be taken on the earn-out.
Some sellers want to tie in those perpetuation candidates they had hoped could buy them out. But these perpetuation candidates can’t compete with these prices, so the owner might give some of the stock down payment to those candidates to help tie them in for the future earn-out accomplishment and perpetuation of the book of business.
Then, the seller can retire and ease off into the sunset, without concern for those candidates leaving or how perpetuation of the book will happen.
Take this advice — don’t do it alone, get some help from an advisor, and know that all regional and national buyers know what they are doing, and most independent insurance agency owners don’t.
If an owner decides to sell, it is only done once. We believe the seller should get at least two offers and get to know the buyers, as they are all unique. Post-sale is also handled very differently over the years to come.
If you aren’t interested and want to internally perpetuate, get assistance on what the options are and how to best do it. A valuation is always needed with family members on internal sales.
Oak is the founder of Oak & Associates. Phone: 707-935-6565. Email: catoak@gmail.com