Valuing, or benchmarking an agency's worth is typically done for one of three primary reasons:
(1) to determine market value in preparation for an acquisition or merger;
(2) for resolving true ownership value for purposes of changing equity positions whether it be for a buyout, succession planning, ownership disputes, or to introduce a new partner; or
(3) for the owner's edification of what the current market value of his operation may be.
Certainly, there are other reasons to obtain a valuation but those set forth touch on the primary goals behind obtaining and understand the agency's worth.
Generally, valuations should be a careful blending of actuarial, micro and macro economics, core finance, and business principals rolled up into one analysis. Often times, many of the aforementioned principles are omitted and not carefully evaluated during the assessment of the agency's value. There are many experts who offer valuations, but few clearly understand the dynamics that need to be included when working within the insurance industry.
Agents and agencies, being service providers, offer countless intangible value. Intangibles will almost always far outweigh the tangibles of any agency which is why determining value becomes such an art form. Assessing intangible value is more subjective and requires insight from professionals who clearly understand the variables and dynamics of the insurance industry. Generalists, who will value anything from automobile dealerships and manufacturers to hospitals and retailers, sometimes lack the true insight of a niche business that is constantly evolving. They simply want to employ the science aspect of valuation to the agency without a real understanding of what our industry involves.
Valuation experts will typically employ one or two different methodologies when assessing many businesses. The most common are: (1) capitalization of earnings, which is determined by generally applying a multiple to a normalized earnings figure to develop the value; and (2) discounted future earnings, which uses a present value of future years earnings. Many times, the valuation professional will use both methods to determine ranges. They will typically obtain industry data from a publication, use treasury and inflationary indices, guess at future growth rates, and drop their numbers into a spreadsheet which spits out a valuation report. These types of reports obviously lack true insight of the industry, specific market trends, and do not bring true agency value to the forefront. Owners are mislead and sometimes, when negotiating a sale of their life's work, are misinformed. You cannot and should not ever trust your agency's value just to a calculating engine that measures risk free discount rates, U. S. Treasury rates, or any other publication of indices that serve as the underlying calculator of value. This reduces your hard work to a commodity. This is not to say that the published indices are not important, but that there must be much more contemplated in a valuation. Agency owners should always be leery of web sites or valuation companies that allow you to drop key numbers into their spreadsheets which in turn delivers a result on the spot. This treats the value of your agency as if it is in a large pool of homogeneous businesses. Every agency is different and should be assessed in a way that captures its unique characteristics. The quick and dirty valuations always cost less money, but in the long run, they leave the agency owner misinformed. If this type of valuation is used as a negotiating tool, or for guidance, it may potentially result in the owner(s) leaving money on the table in some way.
We should broaden our understanding of true value indicators for the current agency owner. Value can be broken out into two separate categories: economic value and goodwill value.
Economic value uses true quantifiable dollars in the assessment. The result is that there is always a determined dollar value ascribed to a particular revenue stream, contract or property. .Goodwill value is intangible and therefore, more subjective but still critical to the agency's worth. Set forth are some primary examples of economic and goodwill key value indicators of an agency:
Recurring Revenue - This is a critical element that should be compiled and included as part of the valuation. An assessment of the in-force business by policy year, estimated retention or persistency and future commission streams are a must. They clearly demonstrate liquidation or annuity value to the agency owner(s).
Distribution Relationships - This generally refers to exclusive, long-term distribution contracts to capture production from a particular regional or national source. While this can also be considered a goodwill value indicator, economic worth is a value that can be ascribed to the contract. Note that acquirers will typically pay a higher multiple for an exclusive distribution relationship because it presents potential synergy value to them and they should provide higher consideration for the contract. The longer the term of the contract, the greater the value to the agency owner.
Aggregation of Production and Agency Compensation Agreements - An agency's ability to achieve the highest level of production based compensation, or contingent commission, certainly adds value. From the economic perspective, this could enhance a potential acquirer's portfolio of carrier relationships, particularly if the agency possesses a unique carrier relationship that provides top level compensation. This can sometimes create enormous synergistic value to the market and needs to be taken into consideration.
Operating Proficiency and Profitability - An agency's ability to provide scalability, operating proficiency, and overall return on revenues are key economic value creators. An evaluation of pending inventory, placed cases, or premium by headcount are key metrics that can add value if the result reflects consistent proficiency. Also, a business that demonstrates ability to fluidly work with the ebbs and flows of case traffic by appropriately deploying processing personnel, can really add increased value. It is equally critical to have seasoned personnel that can work in a potentially caustic environment. If an agency possesses the ability to be able to grow quickly, manage its workflow efficiently, and returns profitability on a per unit basis, significant worth is added to the business. Finally, an agency that has demonstrated above industry average loss experience and possesses a well underwritten book of business presents itself as a much more attractive prospect in the market. This is a key element that adds economic value to many prospective buyers and should be contemplated in the analysis.
Technology - The use of technology can be a two-edged sword. Value is created when an agency is able to deploy an efficient, cost effective, systematic approach to its operations. Value is further enhanced when proprietary or unique applications such as web technology, application order taking, status, rating or underwriting is used. These add enhancement to the company. It is important to note that companies who pour money down a hole for technology and have serious development burn rates and no return on their investment are extremely difficult to add value to. Many companies who followed the dot-com parade and built their own technology infrastructure cannot get additional value without clear representation that they have something very unique, it provides economic value, and/or that it enhances their business in some way. Unfortunately, many owners fall prey to the "hire" rather than "acquire" technology and are still paying the price.
Internal Growth Rate - Historical growth rates are also important at adding value. If the agency management can navigate through market cycles and demonstrate the ability to continuously add new business through new products, carriers and distribution, this adds significant value to the company. Trending is very important and if an agency can weather the storms of the market, they reap the additional value.
Product margins - Another key issue is the net retention of the agency on a per unit basis. What is the agency receiving in gross compensation and what is it paying to its distribution to acquire the revenue? This is an assessment that can make a big difference particularly when an acquirer is assessing the company. If the agency is rapidly adding new distribution and demonstrating top-line growth through aggressively paying compensation, value may actually be detracted. This presents a scenario where an acquirer will be forced to lower compensation paid to producers in order to level the playing field on net retained commission, post transaction. The acquirer will certainly view this as a high risk move. Acquirers are typically leery of agencies that pay the lion's share of compensation out to producers and survive on razor thin margins and inferior service. The best model is one that demonstrates good fluid growth through unmatched service.
Company Structure - Believe it or not, this is also a key factor. Sub Chapter S corporations, partnerships and limited partnerships present greater financial benefit to the acquiring market. Traditional C corporations, because of tax implications of a stock purchase, may adversely affect the market value of an agency. Essentially, acquirers typically have to forego the deduction of amortization on a C corporation so that they seller can gain capital gains treatment. There are numerous tax rules that surround this issue which can be better determined by a tax specialist.
Product Diversity or Niche - While this may seem to be contradictory, economic value is added if an agency is residing solidly within a particular niche. Especially if there are proprietary product offerings or they have a form of exclusive right to certain distribution channels or carriers. Also, an agency that has a broad product offering may demonstrate the ability to be counter-cyclical or at least be able to ride out market downturns due to their diversity. This enables them to spread market risk throughout numerous products and carrier relationships. Agencies that are entirely commodity-based and reside in easily accessed markets generally hold the least value.
Operating Model - An agency that demonstrates a boutique environment, or one that provides "high touch" service, always gets greater valuation consideration. This clearly denotes more repeat business, greater penetration among producers, better product submissions, and accolades from carriers and other industry professionals. The translation is always lower marketing costs, better underwriting results, and better financial metrics within the agency.
Concentration of Production - This is always a big value deflator and also depends on the size of the agency. Value is discounted when agency production is heavily weighted toward one particular carrier or comes from a few sources. This presents a risk whereby the agency could sustain significant economic damage through departure of one production source or through the cancellation of a carrier contract. A single production or manufacturing source should never represent more than 25 percent of an agency's net operating revenue.
Brand Name Recognition - An agency who has an industry name presents a great deal of goodwill value. If the agency is easily identified within the industry based on its name or that of its principals, this really solidifies its presence as a stalwart. Agency owners or management that is viewed as industry luminaries and is recognized throughout the industry further bolsters goodwill value.
Management depth within an agency is another key value factor. All key areas of agency operations that are represented with industry professionals present very significant value. All of these intangibles translate into one key point; the agency is well grounded, stable, and possesses real going concern value.
These indicators represent a portion of those areas that need to be brought forth when considering the value of an agency. Never trust a web site, calculating engine or spreadsheet template to draw out the substantiated value of your business. An insurance agency can be a gold mine of value that should not be reduced to the level of an automobile appraisal. Agency owners and principals, many of whom have spent a lifetime building their companies, should only trust experienced industry professionals who take the time to clearly understand all of the operating facets of the business and can draw out or optimize the value of the business.
