M&A Realities Demand Organic Growth

Given the need for growth and the challenges associated with organic expansion in today's market, many independent agencies are venturing into the merger and acquisition marketplace to acquire growth–most frequently with frustrating and unsuccessful results.

The reality is the vast majority of independent agency buyers are effectively priced out of the M&A market at this time. How has this happened?

The first factor affecting agency values is basic supply and demand. Supply is down, demand is up–all things being equal, this raises the cost of agencies being marketed.

The supply of high-quality insurance agencies available for sale is greatly diminished after an extended buying frenzy on the part of banks, national brokers, private-equity groups and large regional independents.

Many of those who remain independent have made a conscious decision to do so (with an eye for internal perpetuation) and are simply not for sale.

Demand, on the other hand, remains very, very strong. In 1994, there were only three national agency buyers with significant acquisition activity. Last year, we were able to identify over 30 buyers (including regional banks) competing for deals.

That's great news if you're a seller, but not so great if you're competing for a limited supply of agencies available for purchase.

Another issue materially affecting agency purchase values involves recent valuations for the national brokers. At the end of 2005, a sample of publicly traded insurance brokers (Hub, Brown and Brown, HRH, Gallagher and Willis) had market values that averaged almost 12-times pretax cash-flow (or EBITDA–Earnings Before Interest, Taxes, Depreciation and Amortization). This means that, on average, every dollar of EBITDA for this group of brokers translated into $12 of value in their own stock values.

Compare this to the average independent agency, whose value (assuming it's perpetuating internally) typically ranges from 5.5-to-6.5 times EBITDA. If the investment community rewards the public brokers with double-digit valuations for each dollar of acquired EBITDA, why wouldn't they stretch and pay a premium to get the right deal done?

If I pay a seven-to-eight multiple for a dollar of EBITDA, and my own valuation goes up by a multiple of 11 or 12 times for that same acquired dollar of EBITDA, I'll take that deal all day long.

Unfortunately, this acquisition arbitrage opportunity does not exist for a privately held buyer. If you buy an agency whose actual economic value is simply the same 5.5-to-6.5 times EBITDA that your agency is probably worth, and you pay seven-to-eight times EBITDA to get the deal done, guess what? Your own agency value was just diluted. You were better off before you did the deal.

If you have to pay seven-to-eight times EBITDA to get an asset worth 5.5-to-6.5 times EBITDA, is that typically going to be a smart decision? Unfortunately, seller expectations, which reflect the higher multiples, make it very tough for independent agents to get deals done at reasonable prices.

The lesson is that for most independent agents and brokers, now is not the time to try to compete for agency purchases.

If organic growth is anemic and acquired growth is too pricy, where does this leave the average independent agency? Back to the basics–build on your ability to sell more insurance, and focus on the development of a significant sales culture.

If you're wondering whether your agency has a sales culture, or even what a sales culture looks like, the 2006 "Best Practices Study" (available at www.reaganconsulting.com) provides some interesting benchmarks for you to consider.

The accompanying tables summarize new business results, by line of insurance, for validated (mature) producers for each of the Best Practices revenue categories, for average agencies and the top 25 percent. How does your agency compare?

To improve your existing sales culture, invest in the tools and resources that will enable your own producers to generate Best Practices-like (or better) new business results. In addition, continue to invest heavily in the hiring and development of new, young producers.

On that point, another interesting trend involves producer recruitment. In the 2003 "Best Practices Study," roughly 10 percent of new producer hires identified were from outside the insurance industry. In 2006, this percentage jumped to over one-third.

Increasingly, agencies are seeking out sales talent from other industries. The old adage, "it's easier to teach a good salesperson insurance than it is to teach a good insurance person to sell," is beginning to have a real impact on our industry's recruiting practices.

An increasing number of agencies, recognizing their limited ability to develop production talent, are targeting their recruiting efforts on companies with reputations for developing high-quality technical sales people (Xerox, P&G, Coke, Northwest Mutual, etc.).

Given the annuity-nature of producer compensation and the quality-of-life upgrade our industry generally provides, many salespeople with ever-increasing sales quotas and ever-shrinking territories are finding good homes in the independent insurance agency world.

Growth is essential to agency health, but for the average independent agency today, acquired growth is probably neither wise nor viable.

Although not nearly as sexy or exciting as "doing deals," the basic blocking and tackling activities associated with developing and enhancing a successful sales organization remain the best means to success as an independent agent today.