The value of an insurance agency can be as mythical andmysterious as sightings of the Loch Ness Monster. When you dig intoassumptions behind the numbers, the reasoning can be very murky andconfusing.

It doesn't have to be that way. A solid valuation should steeraway from anecdotal information and concentrate on true qualitymeasures that are the hallmark of a good service business.

Each year, WFG takes a look back at transactions from theprevious year, and evaluates any trends that may be emerging. Whatwe saw in 2005 was a transaction market focused on four keysegments.

Considering which segment the business fits into, as well as thestrength of its services within the proper category relative tocompetitors, 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, andis typically the type that commands the lowest purchase price. Youmight expect to see firms with less than $10 million in annualrevenue.

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 hardway) that such an acquisition must be assimilated into the largeroperation over time. After all, insurance work is a relationshipbusiness, and those relationships must be brought alongcarefully.

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

3. Agency selling to a bank with an existing insuranceplatform.

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

4. A platform agency selling to a bank.

Many banks entering the insurance market have begun by acquiringa platform agency–one that has a very strong brand name, awell-established territory, ample markets, a veteran staff and ascalable infrastructure. Often the bank will operate the agencyvirtually unchanged, but will attempt to drive new revenues throughcross-selling to existing banking customers.

Once you understand these four transaction types, you canconsider the commonly used “multiples of earnings” measure in amore meaningful way.

Actually, multiples of earnings is better stated as multiples ofEBITDA (Earnings Before Interest, Taxes, Depreciation andAmortization). This is essentially the “free cash flow” of anagency, and calculations often use the trailing 12-monthperiod.

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

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

First, of course, is supply and demand. The demand factor hasdefinitely decreased in the banking arena, for instance, becausemany larger banks have made their platform acquisitions. The vastmajority of bank transactions last year were second-tier or revenueacquisitions, which also resulted in lower valuations.

The supply of high-quality, high-producing agencies droppedthrough active consolidation in recent years, so such an agencywill still be more highly valued.

Demand has increased to a degree among public brokers due to theinvestigations by New York Attorney General Eliot Spitzer andothers on contingent commissions–removing such fees from theirrevenue structure has spurred public brokers to seek more growththrough acquisitions.

A second valuation factor is type of agency being sold. Employeebenefits agencies have been commanding significant valuationpremiums of late, as have true multiline agencies. The former has ahigher margin, while the latter is seen as having a morediversified risk profile.

Third is overall deal structure. We've seen a significant trendtoward the use of earn-outs–the “at-risk” component of the purchaseprice. While an earn-out will often increase valuation, it alsoresults in less cash at closing, and a shifting of risk from thebuyer to the seller. A greater percentage of the purchase price isincluded 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 canbe significant. Consider these elements:

o Distribution relationships.

An agency with solid, long-term contracts and good relationshipswith its carriers can use this factor to add a premium to itsoffering. The longer the contract terms, the better a bargainingchip this is, and exclusive distribution arrangements are obviouslymore lucrative.

o Operating model.

If the agency provides personalized, high-touch service, it willgenerally command a higher valuation multiple. The “boutique”approach often includes more repeat business, a well-developedmarket niche, a stellar reputation and higher-quality submissions.These can translate into lower-cost production and even betteraverage loss ratios and other financial metrics.

o Brand recognition.

Significant goodwill value is generated by a well-known brandname. Industry or communitywide recognition of company principalsgreatly adds to the cachet of an agency that is up for sale.

o Veteran team.

An agency with a well-rounded management team and veteranindustry professionals at every level presents very strongly in anacquisition. Such development speaks volumes about the agency'sstability and workplace value–both highly-desired factors by a newteam seeking a smooth transition.

Valuation, then, is not simply a number calculated by aspreadsheet template or a Web site engine. The factors to beconsidered–whether type of transaction, economics or businessprinciples–need to be individually weighed for each agency going onthe market.

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