Preparing to Sell the Agency
There seems to be an insatiable frenzy of agency acquisitions for many years now, with private equity firms and publicly traded brokers taking the lion’s share. These well-funded buyers are paying a premium well over what a local peer independent agency could afford to pay.
Keep in mind that these well-funded buyers pay top dollar only to agencies in the right location, with a great book of business and high profit margins.
For those agencies that miss the mark as a highly desirable agency, there are steps one can take to improve the business in order to attract these well qualified buyers and their deep pockets.
The key to receiving a great deal is superb preparation before you step into the market place. Jumping in without doing your homework is a poor strategy when the stakes are high – namely the owner’s life’s work. Preparing the business for sale or merger is not an overnight process. It can take months, if not years, of planning to maximize the bar-gaining position and the return on equity.
The best way to accomplish this is to address weaknesses and capitalize on strengths before presenting the business for sale or merger. Always assume that any potential buyer will do a thorough job of due diligence, which will ultimately uncover weaknesses. Proper planning will identify current problem areas and help determine how to fix them and/or treat them in discussions with buyers or merger candidates.
Control the Narrative
Create an agency profile that accurately describes the firm and highlights its strengths. This document is used as a platform to allow potential buyers to understand the unique features of the seller. It will save both parties a lot of time.
The first section of the profile should contain a thumbnail sketch of the operational fundamentals of the agency. There needs to be a brief history of the firm and the background of the principals and key personnel. An organizational chart should be in place and should show the positions, salaries and start dates of all employees. All producers’ books of business should be displayed with compensation. Are there contracts, vesting? All should be described.
An overview of the book of business should be written and a description of any specialties/programs. A breakdown of the book by line of business is also helpful. The profile should also have a breakdown of the top 10 insurance carriers, loss ratios, contingent history and type of business placed with each carrier.
Factors Affecting Value
The value of any business typically depends on two things – the future profits of the business and the risks associated with such profits continuing. The key drivers for profits in an insurance agency are total personnel costs, which typically range between 50 percent and 70 percent of revenue. Employee productivity, headcount and compensation plans are what determines the bulk of personnel costs.
The typical profit margin for most firms, when owners’ compensation and perks are normalized, is around 15 percent to 20 percent. Highly valued firms have profit margins between 25 percent and 40 percent. If the agency has a low profit margin, then the value will be low since buyers typically determine value based on a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization).
The major risk factors when valuing an insurance agency are the mix of business (personal lines, commercial lines, benefits/health, life, etc.), the book of business (industry, size of accounts, concentration, policy types, etc.), access and quality of markets, quality of staff, nature of the client relationships (best if they are not all personal friends), retention rates and sales growth. These risk factors determine the multiple used when calculating value. The lower the risk, the higher the value.
Third-Party Pro Forma
In most cases, financial statements of privately held companies are designed to minimize taxable income in any given year. Most firms show very little profit on un-adjusted statements. Here is where the seller or seller’s consultant needs to control the narrative. It is advisable to reconstruct financial statements to show the buyer the adjusted pro forma financial performance, which directly affects value.
When recasting income statements, owners will find that most adjustments fall into one of the following categories:
The value of any business typically depends on two things – the future profits of the business and the risks associated with such profits continuing.
Getting in Shape to Sell
Much like a house, a business will sell at a higher price if everything is neat, organized and in working order. Here are a few tips:
Obtain Professional Help
One of the first things that a seller should do is obtain a realistic idea of what the business is worth from an objective, outside source. A professional valuation creates a basis for evaluating a buyer’s offer and helps determine what the seller can expect to net from the sale.
A good appraiser will also provide practical insight into the strengths and weaknesses of the strategic, financial and operational aspects of the business. They should clearly state the real value drivers of the firm, so the seller can make the needed adjustments to improve the business value. It is best to hire an appraiser that specializes in the insurance industry to get the most meaningful analysis of the agency and its value.
In addition to a valuation expert, sellers should seek out the advice from financial planners for their personal needs, a qualified tax advisor, legal advice to review contracts and agreements and an expert M&A consultant to represent them. The M&A advisor can help prepare both the business and the owners for the sale process. Specifically, the sellers’ representative can:
A Final Thought
These are all things to think about in the sale and merger process. Selling a business can be hard emotionally, but if approached properly it will also be seamless and rewarding. The key is to keep in mind the buyer is looking at purchasing cash flow and it is not a direct judgment on the seller’s business or insurance skills.
This is also a great exercise to go through even if you are not ready to sell. It just so happens that the things buyers are interested in also happen to be what makes an agency successful.