AGENCY VALUE HINGES ON TRANSACTION TYPE, INTANGIBLES

The National Underwriter - Property & Casualty Edition
Author:  Steven S. Wevodau

The value of an insurance agency can be as mythical and mysterious as sightings of the Loch Ness Monster. When you dig into assumptions behind the numbers, the reasoning can be very murky and confusing.

It doesn’t have to be that way. A solid valuation should steer away from anecdotal information and concentrate on true quality measures that are the hallmark of a good service business.

Each year, WFG takes a look back at transactions from the previous year, and evaluates any trends that may be emerging. What we saw in 2005 was a transaction market focused on four key segments.

Considering which segment the business fits into, as well as the strength of its services within the proper category relative to competitors, will help you understand how to value an agency. Consider the differences among the four major categories:

1. Agency selling to another privately-held agency.

This is often called a “book of business” or “roll-up” sale, and is typically the type that commands the lowest purchase price. You might expect to see firms with less than $10 million in annual revenue.

2. Agency selling to a public broker.

Often, an agency will be targeted for acquisition by a large, public broker, who will then absorb its operations over time.

Most M&A-fueled brokerages have learned (sometimes the hard way) that such an acquisition must be assimilated into the larger operation over time. After all, insurance work is a relationship business, and those relationships must be brought along carefully.

The acquired agency may be quite large, and the valuation model applied to its operations would be similar to the model applied to public brokers.

3. Agency selling to a bank with an existing insurance platform.

Many banks today have made their “platform” acquisitions, and are already in the insurance business. They may be looking for second-tier acquisitions or revenue acquisitions. These transactions are similar in many ways to the second category in terms of integration and post-transaction activities.

4. A platform agency selling to a bank.

Many banks entering the insurance market have begun by acquiring a platform agency—one that has a very strong brand name, a well-established territory, ample markets, a veteran staff and a scalable infrastructure. Often the bank will operate the agency virtually unchanged, but will attempt to drive new revenues through cross-selling to existing banking customers.

Once you understand these four transaction types, you can consider the commonly used “multiples of earnings” measure in a more meaningful way.

Actually, multiples of earnings is better stated as multiples of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). This is essentially the “free cash flow” of an agency, and calculations often use the trailing 12-month period.

The accompanying table shows the range that we saw in 2005 for sales using a “multiples of earnings” factor by transaction type. Obviously, a sale of one small agency to another would not command a multiple similar to a sale of a platform agency to a bank. Understanding the type of transaction your agency is seeking will help you think more reasonably about its value.

Valuation Factors

Various factors will apply to agency sales falling under each of those four transaction types.

First, of course, is supply and demand. The demand factor has definitely decreased in the banking arena, for instance, because many larger banks have made their platform acquisitions. The vast majority of bank transactions last year were second-tier or revenue acquisitions, which also resulted in lower valuations.

The supply of high-quality, high-producing agencies dropped through active consolidation in recent years, so such an agency will still be more highly valued.

Demand has increased to a degree among public brokers due to the investigations by New York Attorney General Eliot Spitzer and others on contingent commissions—removing such fees from their revenue structure has spurred public brokers to seek more growth through acquisitions.

A second valuation factor is type of agency being sold. Employee benefits agencies have been commanding significant valuation premiums of late, as have true multi-line agencies. The former has a higher margin, while the latter is seen as having a more diversified risk profile.

Third is overall deal structure. We’ve seen a significant trend toward the use of earn-outs—the “at-risk” component of the purchase price. While an earn-out will often increase valuation, it also results in less cash at closing, and a shifting of risk from the buyer to the seller. A greater percentage of the purchase price is included in the earn-out as the multiple increases.

Added to those economic issues is the factor of intangibles. Insurance being a relationship business, the value of goodwill can be significant. Consider these elements:

• Distribution relationships.
An agency with solid, long-term contracts and good relationships with its carriers can use this factor to add a premium to its offering. The longer the contract terms, the better a bargaining chip this is, and exclusive distribution arrangements are obviously more lucrative.

• Operating model.
If the agency provides personalized, high-touch service, it will generally command a higher valuation multiple. The “boutique” approach often includes more repeat business, a well-developed market niche, a stellar reputation and higher-quality submissions. These can translate into lower-cost production and even better average loss ratios and other financial metrics.

• Brand recognition.
Significant goodwill value is generated by a well-known brand name. Industry or communitywide recognition of company principals greatly adds to the cachet of an agency that is up for sale.

• Veteran team.
An agency with a well-rounded management team and veteran industry professionals at every level presents very strongly in an acquisition. Such development speaks volumes about the agency’s stability and workplace value—both highly-desired factors by a new team seeking a smooth transition.

Conclusion

Valuation, then, is not simply a number calculated by a spreadsheet template or a Web site engine. The factors to be considered—whether type of transaction, economics or business principles—need to be individually weighed for each agency going on the market.

Qualitative criteria need to merge with quantitative measures to create a realistic, market-ready valuation. Only when such a careful approach is taken can the agency owner truly be considered a “willing seller,” and the prospective acquirer truly be a well-informed “willing buyer.”