Exit Strategy Required To Make Sure Agencies Can Sell Firm In Any Market

To state the obvious, the marketplace for agency sales has changed dramatically over the past nine months or so. Simply stated, the merger and acquisition activity over the past three years was not sustainable, driven in large part by strong public broker market valuations, easy credit, private equity activity and institutional acquisitions.

In 2008, as money and credit tightened, M&A activity slowed and a perfect storm had arisen:

o Credit markets became frozen or inaccessible to many.

o Valuation multiples suffered.

o The soft market continued.

o Uncertainty and capital conservation ruled the day.

For most agency owners, the value of their agency represents a significant part of their financial assets, and more importantly, that value is a significant source of income after their retirement from the agency. What's an owner to do to realize that value?

If many of the variables influencing an owner's decision to sell are out of their control–soft market, capital availability, economic conditions–then it is critical an owner create a viable exit strategy that addresses the conditions they can control.

Establishing an exit strategy is a process that develops a plan. It is more road map and guide than it is a strict indicator of behavior. It is in a word a live document, evolving and changing as circumstances change. The logical steps of an exit plan process are:

o Define your financial and retirement objectives.

o Understand the value of your agency and its value drivers.

o Develop alternative scenarios–sale, internal transition, intergenerational transfer.

o Plan for the unknown and develop contingencies plans.

After developing an exit strategy, the next step is execution.

The initial phase in executing that strategy is developing an understanding of, and articulating your objectives. This means asking the following questions:

o When do you want to leave your agency?

o How much will you need in retirement?

o How much is your agency worth today?

o How do I want to transfer my agency?

In many cases, the last question may be the most problematic, as the conflict between an internal transition and sale of the agency is the thorniest issue facing many agency owners today. Because of this, it is essential for producers to understand their agency's value and its value drivers.

Often agency owners and deal makers express agency value as a multiple of revenues or a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). These multiples represent transactions and as such are a guide to the determination of value.

They do not, however, determine value for the agency. The individual characteristics of the agency do that.

There is a formula that can be used to determine how value is determined. As the accompanying graphic shows, it comes down to: Value equals the level of sustainable (S) and transferable (T) cash flow (CF), times a market multiple (M).

Variables that influence the sustainability and transferability of cash flow are, for example:

o Historical cash flow levels

o Strength of the management and sales team

o The ability to generate organic growth

o Risk assumed

As you may guess, risk comes in many flavors–clients, producers, carrier concentration, governance and non-competes, for example.

It is also important you recognize that value and valuation are not stagnant concepts–they are dynamic and change as conditions evolve. Using a third-party, independent valuation adviser is critical to gaining an accurate understanding of the market value of your agency as well as identifying the value drivers for your firm.

Because of the uncertainty in the current economic downturn, many owners will be postponing any decision on a sale. Whether it is a sale that is contemplated or an internal transition, concentrating on increasing agency value by organic growth and improved margins is critical to the future of the agency. Developing alternative sales avenues and internal perpetuation routes can provide flexibility as conditions change.

In producing an exit plan, producers must plan for the unknown, and there are three concepts they must keep in mind.

o First, owners have no one to turn to but themselves.

o Second, agency owners need to consider the firm's future, which can be the most difficult part of this exercise.

Taking steps to ensure the agency can continue if you are not there, ensuring buy-sell agreements are updated and funded, protecting agency assets with non-piracy agreements and employment agreements are among the many risks faced by owners that need to be addressed for the plan to work.

o Third, the agency-owner must successfully execute the plan.

While it is very important to adhere to the plan that has been developed, it is just as important to revisit and revise that plan as situations change and evolve.

The secret to overcoming adversity and succeeding at executing a successful exit strategy is to improvise, adapt and overcome.

Edward Pratesi is managing director of Brentmore Valuation Advisors LLC, in Farmington, Conn., a property and casualty agency valuation and consulting firm. He can be contacted at Edp@BrentmoreAdvisors.com.