Well-financed Buyers Lead Today’s Agency Value Trends

Fair market value can be defined as the price that a willing buyer and a willing seller agree on for the price of a business. Naturally, there is a lot of room for negotiation based on the circumstances. However, fair market value is based on actual transaction data — real deals where money exchanges hands.

Today, there are two distinct tracks for agency value. There is the price that well-financed buyers can offer and the price that the typical agency can afford to pay. The key is to notice that the prices paid by well-financed buyers might not be an affordable price for the typical agency. It also seems that these two tracks are diverging over the past couple of years.

Well-Financed Buyers

The well-financed buyers would include national brokers, banks, credit unions and investment groups. Many of these buyers have been active with acquisitions for years and have a finely honed system.

Others are new to acquisitions or do it rarely and need to distinguish themselves in order to capture the attention of sellers. For these types of buyers, the rules for acquisitions are based on their ability to add revenue or just to get in the game and establish some locations or hubs.

The experienced buyers will have a target niche or location that they are looking to acquire. Or, perhaps they want to hire a high performing individual and need to buy an agency in order to do so. In these cases, these buyers are willing to pay top dollar to buy a specific agency, book of business or individual.

Banks and credit unions have been active in acquisitions for several years. Their goal is to divest their income stream through additional, but somewhat related services. The initial deal done by a bank is often called a “platform” acquisition. These agencies are fairly large and well-run. The seller will then become the person that runs the insurance division. In many of these deals the bank will “overpay” in order to capture these sellers first. Subsequent acquisitions are often done closer to a fair market value price.

Well-financed buyers during 2006 and 2007 were typically paying prices in the range of 1.5 to 2.0 times revenue (top line) or 6.0 to 8.0 times EBITDA (earnings before interest, taxes, depreciation and amortization, or bottom line).

In some cases, these were fixed prices. However, many deals had a large down payment with a retention or earn-out portion to the transaction.

It must be noted that well-financed buyers target specific types of agencies in specific locations. Not all agencies would attract the “high prices.” However, if a seller is in the right place at the right time, it can be rewarding.

During 2007 there were a few unique deals that went well over 2.5 times revenue by buyers wanting to pay a premium over fair market value for specific reasons.

Typical Agency Buyers

For the typical agency buying a book of business or an agency, the high prices paid by the well-financed buyer is not affordable. The typical agency does not have the cash available to pay cash for an acquisition, or afford a large down payment. Even if the buyer can get terms, if the price is too high, it will not cash flow. Ideally, the buyer will want the book of business to generate enough profit that it will cover the payments to the seller. This is what it means to cash flow.

The typical agency might be able to generate 20 percent to 25 percent in pro forma profits. A book of business or agencies that can be folded into an existing operation can generate 25 percent to 40 percent pro forma profits. One key is to have all the smaller commercial lines accounts handled by the service staff, so that producer compensation does not need to be paid.

So, if the price paid is 1.5 times revenue and the terms were payments over three years, the agency or book of business would need to generated a 50 percent profit margin in order to break even or cash flow over the three year period. Otherwise, the buyer will need to have funds available in order to pay the seller.

Since most book of businesses or agencies don’t generate a 50 percent profit margin, it makes the 1.5 to 2.0 or more multiple of revenue factor too high for the typical agency.

The well-financed buyers are targeting specific sellers and see either much better margins, they are willing to pay a premium for market share, or buy the talent that generated the book of business. Banks and investment groups pay a premium to jump into the acquisition game.

Summary

The current trend is that acquisitions are becoming the domain of the well-financed. Smaller agencies cannot afford to pay the fair market value in some markets. Internal acquisitions, if based on a fair market value would be very difficult to afford.

It is not clear how this trend will play out. Certainly, the very high prices paid can never cash flow for buyers. However, if the demand is there the trend will continue. The only question is, “Who will the buyers be in the future?” and “How long will the frenzy last?”

Topics Trends Agencies Profit Loss