Don’t sell your agency short by underestimating its worth
When your agency’s perpetuation plan is carried out, an agency valuation will help set a purchase price. But finding out your agency’s worth now can help you make decisions that will put your company in a stronger position well before the current owners decide it’s time to move on.
“Value” isn’t just a multiple of commissions
Some agency owners simply multiply their commission revenues by a set factor to determine their agency’s value. While this method is simple and inexpensive, it ignores the agency’s ability to generate cash and other key factors that reflect your agency’s true worth, explains Rick Wittmann, marketing financial services manager.
Most in-depth agency valuation methods start with determining the agency’s future earnings potential. Your prior year-end income statement is a good starting point. Each income and expense item should then be adjusted for anticipated future events. For example, adjust your commission income for anticipated revenue increases resulting from market share gains, anticipated carrier rate increases, retention rate changes, etc. Future expenses should figure anticipated increases in salaries and benefits, cost reductions due to higher productivity, agency consolidations, etc. Based on these projected figures, create a cash flow forecast. A five-year forecast is most common.
Next, you can adjust each future year’s earnings in current year dollars using a process called discounting. The discounted future years’ earnings are added up to obtain the present value of future cash flows.
“An agency’s value is determined by its ability to generate earnings, and one of an agency’s best earnings indicators is its ability to produce cash,” Wittmann says.
More than money
Next, don’t forget to include factors that may not have a dollar value on the surface. Relationships with carriers, the makeup of your book of business, stable customer relationships, operating efficiency, management experience, and other factors all have an impact on agency value and must be factored in. If your agency is lacking in any of these areas, that’s a good focal point for building long-term value.
An agency that has solid relationships with its carriers, especially if it’s attained elite status with one carrier, has greater value than an agency with many carriers but no solid lead company.
Agencies that concentrate their business with a few large accounts will not be as valuable as an agency that has a well-diversified book with no accounts representing a large percentage of the total business. Wittmann notes that as a best practices goal, no single account should represent more than 5 percent of an agency’s total revenue or the largest 10 accounts more than 17 percent. In addition, an agency with above average loss experience and a well-underwritten book has a higher market value.
Agencies with restrictive covenants, which prevent producers from taking agency customers with them when they leave the company, will have a higher value.
A demonstrated ability to recruit, train and retain employees is important to a successful operation, as well as best practices, cost-effective technology, high productivity and building tangible net worth – all which boost your agency’s worth.
”While sometimes hard to quantify, collectively these factors have much more importance than many agency owners realize,” Wittmann says.
Definitions
Perpetuation plan: A plan to transfer agency ownership, either to agency employees or a third party.
Agency valuation: The determination of an agency’s fair market value, accomplished by value tests based on the firm’s earning capacity.
Cash flow forecast: A statement that includes the sources and uses of funds for a number of years. Generally, it includes income statement items and is then adjusted for any noncash items (e.g. depreciation, amortization) and taxes.
Tangible net worth: An internal cash reservoir used to fund future growth.
Terminal value: A factor used to represent the discounted value of all cash flows after a point in time (five years in our example) after which they can’t be forecasted with reasonable accuracy.
For more information please contact Anne M. Smith.