Insurance M&A – a 2024 Outlook

Experts are calling it: 2024 looks like a good year for merger and acquisition (M&A) activity for the insurance industry. To make the most of this positive environment, buyers and sellers will be focusing on getting appropriate valuations, exploring a variety of financing options, and showing flexibility in creating purchase agreements. If you’re in the market to buy or sell, here’s what you should expect when working with a lender.

What’s the Agency Worth?

The sale price of an agency depends on many factors, primarily the calculated value of the business. Price and value, however, are not the same thing, as buyers may be willing to go above market value to gain specialty assets or technical expertise in the target agency. Conversely, the buyer may demand a discounted amount if the market is soft, and they face little competition.

Calculating value starts with looking at EBITDA (earnings before interest, taxes, depreciation, and amortization). To come up with a true market value, however, expenses that will not continue after the sale — such as for an owner’s vehicle or one-time costs for software — must be added back to the baseline EBITDA. Additionally, owner’s compensation must be adjusted to reflect the true market rate for the owner’s salary and benefits, i.e., what an employee at a comparable agency with similar responsibilities and seniority would be paid. This is necessary because owners often either overpay themselves or take zero compensation. The revised figure, used for valuation purposes, is the pro forma EBITDA.

A starting price is calculated by multiplying the pro forma EBITDA by a multiple. According to Merger & Acquisition Services, common multiples range from eight to 10x for agencies with EBITDA below $2 million to 12.5 to 14.5x for those with EBITDAs over $5 million.

How Can the Purchase Be Financed?

There are probably as many ways to finance an insurance agency purchase as there are agencies. The most basic is an all cash purchase, where the buyer pays the agreed upon price, often with the help of a business loan. While this is the simplest arrangement for the seller, it has notable drawbacks for the buyer. First, it doesn’t offer any guarantees regarding future performance of the business. In addition, if the buyer takes out an SBA loan, they may have to put their home up as collateral. Some specialty, non-SBA lenders, however, do not have this requirement.

Purchase arrangements that keep some of the seller’s skin in the game provide a level of protection to the buyer. A deal with an earnout provision rewards the seller with additional payments if the agency reaches established targets, giving them an incentive to sell the agency in a strong growth position. Earnouts can help get around different views on the value of the business.

Rolling over equity is another way to retain seller interest in the continuing success of the business. In this arrangement, the seller accepts a purchase price, but reinvests a portion of it back into the business. They may also retain a management or advisory role in addition to their equity stake.

Can Financing Be Flexible?

Absolutely. Some of the best deals — those that satisfy sellers and buyer alike — use a combination of financing tools. If the buyer is a publicly traded company, they may include stock as part of their offer, along with cash. Current M&A deals almost always contain an earnout component. In the past, earnouts were structured as a way to reach the base purchase price after the sale, but more recently they have been formatted as growth earnouts to produce additional value beyond the purchase price.

Many deals also contain some form of seller equity. The seller may hold a minority stake in the acquired company, with or without continuing managerial involvement. In addition, owners may be willing to provide a subordinated seller’s note, in which they receive a portion of the sales price up front, but accept continuing payments from the buyer for the balance. By accepting a portion of the risk, the seller has an incentive for the business to succeed.

Oftentimes in these arrangements, the seller continues on in a managerial or advisory role. Lenders for the buyer like these deals because they spread out the risk, and they have a protective effect on the agency’s cash flow, which is the collateral for the loan.

Potential agency buyers and sellers have a lot of options when it comes to financing an M&A deal. Working with lenders and valuation companies that understand the industry and its cash flows can make the process go more smoothly.