Agency Financial Management

The case for selling now

Change in tax rates provides a different set of numbers

By Mathew K. Klossner

Everyone has heard the saying, “Timing is everything.” Recently, when we have been talking to agency owners about whether the “timing is right” to sell their agency, we have often met with a lot of skepticism and hesitation.

Let me provide a few examples of conversations.

Agency Owner #1, a co-owner of a Southwestern U.S.-based wholesaler: “We are down over 10% in net revenue because the market pricing is so soft. Standard markets are writing a lot of business they would have never considered a few years ago. Why would I sell now during a dip in the market? The timing just isn’t right.”

Agency Owner #2, a sole owner of a Northeastern U.S.-based retail broker: “I hear sale multiples are down. Why would I do anything now? That would be like selling my house at the bottom.”

Agency Owner #3, a partner in a Northeastern U.S. retail employee benefits brokerage: “The economy has been so bad that a lot of our clients are laying off their staff, so even though we haven’t lost too many accounts, the number of lives in the accounts we have retained is down, and so is our revenue. And besides, my partner and I would collectively need $10 million to retire.”

All three of these owners are in their 60s, are expecting to retire within the next five years, and have a significant percentage of their personal wealth tied up in the value of their agency.

More important, all of these owners may be failing to recognize that a sale in 2010 may be the best opportunity for them to maximize the value of a sale of their agency.

Why? The current capital gains tax rates are historically low, and agency owners may be facing an uphill battle if they do not consummate a sale in 2010.

To illustrate this point, assume the following: On a federal basis, capital gains rates are expected to increase from the current rate of 15% in 2010 to 20% in 2011. Capital gains rates vary on a state-by-state basis, but for this example, assume that they are currently 5% and will rise to 8% in 2011 and beyond (which may be conservative given the soaring deficits in many states).

How much would you have to grow your agency to get back to the same after-tax value today if the federal and state capital gains rates increase 8 points overall (from 20% to 28%)? We estimate you will have to grow your agency bottom line at least 12% annually.

Let’s look at a simple comparison to further illustrate this point. Consider two scenarios: sell in 2010, or sell in 2011. The table at the top of page 96 lists the assumptions.

In this simple example, the agency owner would be more than $414,000 worse off by waiting a year to sell his or her business. Keep in mind that this is a static example that assumes no growth. If revenues decline or margins contract, the situation becomes even bleaker.

When discussing these numbers with the three agency owners, it becomes clear that all three are going to “bury their head in the sand” and hope the problem goes away. They say things like, “We are going to wait until market pricing hardens before we sell the agency,” or, “We are just going to have to work harder to grow organically.” The unfortunate reality is that no one knows when pricing will harden or if that will even translate into revenue and margin growth for these agencies.

While the changes in tax rates are a key factor in determining the correct time to sell an agency, the agency owner needs to not lose sight of other key issues as well.

One factor is the age of the selling owner. The three owners—in their 60s—all run the risk of waiting too long to sell. Most buyers want a commitment from a selling agency owner that he or she is willing to work for a number of years after the transaction, both to ensure the transition of the purchased business and to help grow additional revenue. Transactions where a selling agency owner “hands over the keys and heads for the door” tend to have a significantly lower multiple, as they are viewed by a buyer as being riskier. Even if the intention of the selling owner is to continue with the business, buyers tend to apply a bigger discount, knowing that even with the best intentions, a selling owner is less likely to live up to these intentions.

Additionally, a selling agency owner should not ignore political and legislative risk. If state and federal governments continue to amass record deficits and are starving for tax revenue, there is a chance that tax rates will go even higher! Even with the expected increases in 2011, top tax rates in the United States are nowhere near as high as they were from the 1940s through the 1970s.

Health care reform is another political issue. It is unclear how the recently passed legislation will affect health insurance brokers, but the simple uncertainty of the current environment has caused several of the larger national and regional brokers to be more cautious in acquiring employee benefits brokers until the picture becomes clearer.

The sale process for most transactions typically takes six to eight months from inception to closing, so if you are thinking about selling in the next five years, you should seriously consider starting the sale process now in order to have the ability to complete a transaction in 2010. After testing the market, you may come to the realization that the timing really is not right for you to consummate a transaction, but you will never know this unless you have embarked on the process. By not doing anything, you are burying your head in the sand, and you are limiting your options in the future.

The bottom line is that you need to forget about what you thought the agency was worth a few years ago; it’s irrelevant. You need to forget about what “you need” to retire, it’s also irrelevant in terms of the value of the agency. Do the analysis and make a calculated decision. Plan wisely!

The author
Mathew K. Klossner is director of Mystic Capital Advisors Group, LLC.