The Path to Growth for Smaller Agencies: Hire Producers Or Acquire Agencies?

I know a thing or two about helping agencies grow. In fact, I’ve helped hundreds of entrepreneurs create independent insurance agencies. From this experience, I’ve learned growth is a fairly straightforward proposition — at least from the early days up until the agency sees $500,000 to $1 million in revenue. Then, typically, the agency’s growth slows or stalls and owners begin to look for ways to regain momentum.

Often, principals become increasingly burdened with management responsibilities reducing time for personal production. While it may be rather easy to identify the reasons for the slump, the way out is often less clear.

Generally, principals who understand personal production drives revenue growth — but lack the time to do it themselves — think the answer is hiring employee producers. Others see buying other agencies or books of business as the best course of action. While the second option is typically not seriously considered due to misconceptions around price and the perceived work involved, the truth is either option can lead to agency growth. Owners need to look at the numbers to determine the best path for their agencies.

Strategy A: Hire Producers

On the surface, hiring a producer may not seem to require much capital. The agency simply pays the new employee commission only or a small salary plus commission, and hopes the new producer will break even quickly. Unfortunately, three flaws can be found in this thinking.

• If the agency hires someone and only pays commission, the agency isn’t making itself competitive with other agencies or industries that are willing to provide salary support. As a result, the agency ends up with the bottom of the barrel in terms of employee quality and capability. This can make the whole endeavor riskier and more failure prone.
• One of the benefits agencies offer to counterbalance this is a higher-than-standard commission split. While this can attract some candidates, it can often be a long-term mistake for the agency. If the agency targets average producer compensation at say 40% of agency commission rather than a more typical 30%, the difference is pulled from profits and eventually value. With agencies in this revenue category averaging 13% operating profit according to the Reagan Consulting 2021 Best Practices Study, that extra commission puts the agency in danger of growing top line while the bottom stays the same or shrinks. It also leaves the agency with no incremental profits to invest in the growth of the business in other ways.
• Smaller agencies that fund a new producer with salary support may face two other financial hurdles. Generally, not all producers become successful in paying for themselves and, as a result, agencies trying to grow this way find it difficult to make the return-on-investment work favor. Again, according to the study, the producer success rate for agencies of this size is only 58.2%.

Additionally, the measure of successful producer hiring and management called “Net Unvalidated Producer Payroll” is lower for smaller agencies than in other agency size categories. NUPP effectively measures the agency’s success in recruiting and managing producers. According to the Reagan study, smaller agencies reported an NUPP of 0.2% compared to 0.7% for agencies between $2.5 million and $5 million in revenue. It’s likely that larger agencies have higher NUPPs, and therefore lower risk, than smaller ones due to superior financing, training and management capabilities for sales teams.

For the small agency, while hiring producers to reverse a growth slump may seem simple and cost-effective, it can often deliver results quite the opposite.

Strategy B: Acquire Agencies

With a variety of studies pointing to the increasing rate of agency owner retirements as the baby boomer generation ages out of the work force, it’s obvious many agencies will sell in the coming years. Some will sell internally, but many will sell to external buyers. At the same time, producers who own their books of business are also reaching retirement age.

Many of these businesses and books may be too small to attract the attention of private equity backed or public agencies, but they can make excellent acquisition targets for smaller agencies.

Principals of smaller agencies who are trying to find a reliable method to grow their agencies into a larger revenue category can consider acquisitions as a smart path to growth — if they prepare properly.

Preparation should include:

• Managing their current agency to generate excellent profits with which to fund an acquisition. Agencies, in this size group, in the top quartile of the Reagan Study enjoy average sales velocity of just over 27%. These excess cash flows create the capital for acquisitions.
• Ensuring your agency operates as profitably as possible Constantly challenge expenses and production using benchmarking studies like the Reagan Best Practices Study.
• Developing a strong relationship with a lender, typically a community bank, in advance of needing to borrow. Community banks not only lend their own money but can often assist with Small Business Administration loans, which offer longer payment terms and lower interest rates.
• Identifying prospective acquisition candidates and developing a systematic and long-term program for courting them.

With good preparation, an agency can be in a position to make its first acquisition within three years. This is about the same period of time required to find out if a producer will work out or be a total loss.

Let’s say a $1 million revenue agency is producing 27% profit ($270,000) and has the opportunity to purchase a $500,000 revenue agency for 2.5 times revenue or $1.25 million. If the acquisition is purchased using an SBA 7(a) loan with a 25% down payment, 10-year term and 4.5% annual interest rate, the agency will need just over one year’s profits for the down payment ($312,500 divided by $270,000). With planning, this should be easy to do.

Generally, as agencies get larger, they are more profitable and the Best Practices Study bears this out. Assuming a new profit rate on $1.5 million in revenue, the first year profit post acquisition is $450,000, an increase of $180,000 while debt service on the loan is only $116,593. The result is that agency profits increased overall even while paying for the acquisition.

In this scenario, the agency did regain its growth trajectory and did so much more reliably than if it had hired producers.

Again, according to the study, the average smaller agency commercial lines producer brings in only $57,102 dollars in new business annually and ultimately has a book size of only $262,470. That means it takes two producers nearly five years to equal the revenue increase created by the one acquisition.

Risk vs. Reward

There are obviously risks in an acquisition and it does require time, effort and skill to do well. But when comparing growth by acquisition versus the hiring of producers, the typical decision to hire producers doesn’t always look like the obvious choice when you look at the numbers.

There is a growing opportunity to help the current generation of agency owners move into retirement while speeding the growth and improving the profitability of remaining smaller agencies. The math in every case is different but opening the mind to the possibilities seems like an excellent idea.