Now, What's My Agency Worth?

There are two types of people we see in conducting agency valuations–reactive clients and proactive clients.

A reactive client is one who reacts to an event and views an agency valuation as a necessary evil. This client calls upon the consultant for one of three reasons:

o A buy-sell agreement is invoked, or a partner is negotiating a buyout.

o An agency principal is going through a divorce.

o The valuation is requested for estate planning purposes.

In each of these scenarios, the agency principal is reacting to an outside event that has prompted an independent third-party valuation.

The proactive client, on the other hand, is one who seeks to use a business valuation as an important tool to manage the agency. Understanding not only what the valuation of an agency is, but also what the drivers of that valuation are, can be extremely empowering for an agency principal.

You can be assured that the chief executive officer of any publicly-traded insurance brokerage firm is well aware of the impact any business decision can have on their company's value. Yet, in my experience, the principals of private brokerage firms rarely take into consideration how their business decisions impact their agency's value.

In fact, many owners of privately-held agencies do not even think about valuation until they decide to exit their operation. By then, it may be too late.

Fortunately, some agency owners are more proactive than others.

For example, we were recently engaged by the principals of a West Coast property-casualty broker who requested an in-depth valuation of their agency which had annual revenues of roughly $5 million. The principals wanted to exit the operation in five-to-seven years, and wanted to make sure that any business decisions made today would have a positive impact on the agency's value.

To make that determination, they first needed to understand the value of the agency in today's market and the drivers of that value.

After extensive analysis, we determined that the agency was worth approximately $6.7 million–a valuation the principals found extremely disappointing. They knew a competitor who had sold his agency–also with $5 million in revenue–for two-times revenue, and felt their agency was a much more attractive operation.

Although using revenue multiples as a rule of thumb is useful, agency owners need to realize that rules of thumb are exactly that–rules of thumb. Each agency has its own set of unique value-drivers that ultimately determine its individual valuation.

We explained to the principals, in this example, that the most acquisitive brokers in the industry–and the most likely third-party buyer for their agency–would rely more heavily on the firm's EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) than on revenues. However, when calculating the agency's EBITDA, the financials first needed to be recast as if the firm were run by a public insurance broker.

The most common adjustments would be found in compensation expense (particularly those of the principals), sale expense, occupancy expense, benefits expense and insurance expense. However, to truly determine the recast EBITDA, each income statement line item would need to be carefully analyzed and adjusted.

In this agency's case, their adjusted EBITDA was 20 percent of revenue, so although they may have had the same revenue as their competitor, it was likely that the EBITDA margins of the two agencies were vastly different. Even if the agencies had identical revenues and EBITDA margins, there were other variables that could account for vastly different valuations.

The other variables include: geography or location of agency; culture; producer base, which covers the number of producers, their ages, specializations and compensation; lines of business; markets; client base; and business mix.

When the above variables are considered along with an agency's revenues and EBITDA, you then have your recipe for value.

After our analysis, the disappointed principals were able to quickly grasp the issues that drove the value of their agency. With our help, the principals developed a strategic business plan with a primary focus on creating agency value.

Their goal was to bring the agency's value from its current estimate of $6.7 million to over $11 million by the time the principals would exit. We estimated that by improving the EBITDA margin by 10 percentage points (to bring the margin up to 30 percent), we would add close to $3 million to value.

Combining that with a 4 percent top-line growth over a five-year period, as well as a sustained effort to optimize each of the other value-drivers mentioned above, the expectation was that the principal's goal of achieving an $11 million valuation by the time they wanted to exit was very realistic.

By being proactive and using valuation as a management and planning tool, the principals now had a road map to increase the value of their agency by more than 64 percent by the time they planned to exit.

This made the time invested in the analysis–and into improving the operation based on that analysis–one of the best investments they ever made.