Much has been written on how to value and organize your agency, as well as how to maximize profits and value. One of the topics that rarely is addressed is how to prepare your agency in anticipation of an approach from an agency consolidator with strong financial backing. This issue is becoming increasingly important because new consolidation plays are being formed all the time. In addition, agencies that already have been acquired by a consolidator are further consolidating on a regional and local basis. Consolidators also can include banks, which have a strategy to acquire significant levels of fee income.
How may times have you told a confidant or spouse that some day you want to sell your insurance agency and get two plus times your agency's top line? If that's your goal, you had better start planning now since it takes time and hard work to obtain a premium price for an agency when an approach comes from a consolidator. A first step is to look at the agency's bottom line or pre-tax income. Does your bottom line generate a 20% pre-tax margin after pro forma market fair value owner compensation and benefits? From our experience, consolidators focus on the bottom line since the cash flows are, in effect, what they are buying.
Please don't ever assume that the agency's top line is more important than the bottom line. Real top line growth is real organic sales growth and does not include acquisitions, contingents, or book rollover overrides. Consistent revenue growth is a great indicator of the health of your agency. It's easy, of course, from a standpoint of window dressing, to cut expenses to enhance the bottom line; but that will show enhanced financial results for only a short period of time. Consolidators realize that when the reality sets in, the agency won't be able to sustain that level of profitability.
Most agency principals know how to make the agency grow and achieve an attractive level of profitability. A good exercise is to look back historically and determine what your agency revenues were 10 years ago and compare that to what are they are today. After you get over your surprise, look back again and think how you generated that growth. Was it from existing client referrals, seminar speaking, or referrals from bankers, lawyers and/or accountants? Probably one or all of the above. Most principals know intuitively that their best client acquisition prospects come from their own clients. When was the last time you asked a client for a referral? It's so easy most agents have forgotten to ask.
From a consolidator's perspective, top line growth is the greatest determining factor as to the price that it is willing to pay. The second is the mix of clients and companies the agency represents; the third is account persistency and the last is profitability, since it is determined from all of the above. Just look at what stock market investors are rewarding today: growth! Companies with exceptional growth receive the big multiples on revenue or profitability.
Starting the planning process with regard to initiating growth today is important in positioning the agency for the ultimate sale. Agency principals should be prepared to take advantage of opportunities that arise as a result of approaches from consolidators and other acquirers.
Unfortunately, one does not have the luxury of time to correct agency top and bottom line issues after being approached by an acquirer. Agency principals may forgo a premium price in the interest of getting a deal done. Principals should remember that the agency is one of their greatest assets and should be run in an optimal manner to maximize shareholder value. The professionals at Harbor Capital have a great deal of experience in the merger and acquisition process, both in working with consolidators and working with independent agents in the deal process, and are available to guide our clients. *
The authors
Paul J. Di Stefano, CPA, CPCU, is the managing director of Harbor Capital Advisors, Inc., a New York-based national financial and management consulting firm which offers services to the insurance industry. Services include agency appraisals, merger & acquisition representation, strategic and management consulting. William E. Ryan, CPA, is an associate director for Harbor Capital and was previously head of finance for an insurance agency consolidator. Bill has almost 20 years of experience in valuing, acquiring and managing agency and agency acquisitions. Harbor Capital can be reached at (800) 858-2732.
©COPYRIGHT: The Rough Notes Magazine, 2000