Ten years ago, the upper end of the valuation range fortop-performing agencies was 1.5 times revenue. Today the upper endhas increased to 2.0 times revenue, and even occasionally higher.Why have agency values, expressed as a multiple of revenue,increased in many cases by 33 percent or more?

There are two basic reasons agency values have increased sodramatically:

o Demand for agency acquisitions is stronger than it has everbeen, due to the all-time high number of public brokers, banks andothers competing for acquisitions.

o Driven by increases in employee productivity, many agenciesare far more profitable today than they were a decade ago.

Last month, Bobby Reagan addressed the issue of “demand foracquisitions” in an article in this “Final Say” spot, headlined:“Supply and Demand Trumps Any Negative M&A Factors” (see NU,June 20, page 26).

The bottom line on the “demand” side is that in 1994, a tinynumber of publicly traded acquirers competed for agencyacquisitions. Over the past decade the number of publicly tradedacquirers has exploded nearly tenfold!

This is important because publicly traded acquirers frequentlyhave a competitive advantage in doing acquisitions–their capitalbase is often much stronger than that of privately held acquirers.The increase in agency values is not surprising given the recordnumber of well-equipped acquirers competing for acquisitions.

Nevertheless, while acquisition demand frequently grabs theheadlines, it is only part of the reason why values have escalatedso dramatically. We would argue that an equally important driver ofgrowth in agency values over the past decade has been the stunningimprovement in agency profitability.

Many have forgotten how bleak the world looked for agency ownersa decade ago. The viability of the independent agent distributionmodel was in doubt. The Wall Street Journal, in a front-pagearticle in 1995, captured the concerns of the day by quoting oneindustry observer who argued that insurance agents were “thebuggy-whip makers” of the late 20th century.

In fact, it was a crisis in agency values that led to the jointdevelopment of the Best Practices Study by the IndependentInsurance Agents of America (now the Independent Insurance Agents& Brokers of America) and Reagan Consulting in 1993.

The time-honored benchmark for agency valuation of 1.5 timesannual revenue was in a state of serious decline, due to weakagency profits and slow revenue growth. The typical agency's valuehad fallen closer to 1.0 times revenue, with only the highestquality agencies worth 1.5 times. The Best Practices Study wascreated to be a tool to help agency owners reverse the downwardtrend.

We take great satisfaction in the belief that the Best PracticesStudy has contributed to the progress that has been made in agencyperformance over the past decade.

A comparison between the 1994 and 2004 studies provides astunning picture of how much improvement has actually occurred. Toillustrate this progress, some key performance benchmarks for the$2.5-to-$5.0 million revenue study group are provided in theaccompanying table.

From a valuation standpoint, the dramatic increase in agencyvalues makes sense when we see that pro forma EBITDA–the mostimportant variable in determining agency value–has increased from17.8 percent to 29.5 percent of agency revenue over the pastdecade.

(“EBITDA” is Earnings Before Interest, Taxes, Depreciation andAmortization. In the Best Practices Study, Pro Forma EBITDA iscalculated by taking reported EBITDA and adding to it owner bonusesand perks.)

In trying to understand why agency values have increased, oneneeds to look no further than the increase in EBITDA to 29.5percent of revenue. Why? Because agency buyers (whether they areemployees or an outside third party) determine an agency's valuebased on its expected future profits. Generally speaking, thehigher the expected future profits, the higher the value.

Why has EBITDA increased so dramatically? It's all aboutemployee productivity. Top performers over the past decade haveincreased their revenue per employee from $73,563 in 1994 to$136,369 in 2004–an increase of over 85 percent. The implicationsof this are staggering.

Consider that a $3.7 million revenue agency in 1994 needed 50employees to operate. Today, that same agency needs only 27. Thisis not your father's agency!

This increase in employee productivity has fueled expensereductions nearly across the board, since nearly all of aninsurance agency's expenses are head-count related.

As just one example, occupancy expense (that is, rent andutilities) for Best Practices agencies in 1994 averaged 6.3 percentof revenue. Those agencies needed a lot of space for those 50employees!

By 2004, the figure had dropped to 3.6 percent of revenue. Thatmeans for our hypothetical $3.7 million revenue agency, occupancyexpense has decreased by $100,000. And it isn't just occupancyexpense–telephone, postage, office supplies, equipmentcosts–they've all decreased.

One might be tempted to feel sorry for the 27 employees–afterall, they are the ones upon whom the burden of juicing up profitshas fallen, right?

Well, yes and no. Certainly their efforts have driven theincrease in profitability, but they have been compensated well forthe effort. The fact is the vast majority of the savings derivedfrom carrying a lower number of employees has been reinvested inthose who remain.

A statistic might help–the average compensation per employee hasrisen by 72.3 percent since 1994. The total compensation dollarshaven't changed much–they've simply been spread over a smaller, butmore productive group of employees.

What are the implications of this going forward?

Unleashing employee productivity has been a key driver of agencyvalue growth over the past decade, and will continue to be so. Doesyour agency have a strategy for increasing productivity?

In our experience, it all starts with your producers. If you'vedeveloped a sales culture in which your producers are relentlesslybuilding (not simply maintaining) their portfolio of customers,then employee productivity will inevitably follow, and growth inyour agency's value won't be far behind.

Kevin Stipe is a senior vice president and principal of ReaganConsulting Inc., an Atlanta-based management consulting firm thatdeveloped and produces the “IIABA Best Practices Study,” which maybe accessed free of charge at www.reaganconsulting.com.Mr. Stipe may be reached at 404-233-5545, or by e-mail [email protected].

Flag: By The Numbers

Head: Agency Values On The Rise

The number of employees a top-performing agency needs to operateefficiently has fallen nearly by half, sending the average revenueper worker–and the agency's value–soaring.

Quotebox, with mug:

“The increase in employee productivity has fueled expensereductions nearly across the board, since nearly all of aninsurance agency's expenses are head-count related.”

Kevin Stipe