Agency Valuation is an Art, Not Science

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The benchmarking or valuation of an agency’s value is usually done for one of the following reasons: (1) to establish market value in preparation for acquisition or merger;
(2) To resolve true ownership value in order to change equity positions, whether it is for a buyout or succession planning, ownership disputes or to introduce a new partnership;
(3) To enable the owner to determine the market value of the operation.

There are many reasons why you might want to get a valuation, but these main goals help you understand and obtain the agency’s value.

Valuations should generally be a careful blend of core finance, actuarial and microeconomics. Many of these principles are often overlooked and not properly evaluated when valuing an agency’s worth. Although there are many people who can offer valuations, few understand the intricate dynamics of the insurance industry.

Agencies and agents, as service providers, provide a lot of intangible value. The agency’s intangibles will almost always outweigh their tangibles. This is why it is such an art to determine value. It is subjective to assess intangible value and professionals must have a good understanding of the dynamics and variables within the insurance industry. Generalists can value everything from manufacturers and automobile dealers to hospitals and retailers but they often lack the insight necessary to understand a niche market that is always changing. They want to apply the science aspect to valuation without having a deep understanding of our industry.

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When valuing many businesses, valuation experts typically use one or two methods. Most commonly, there are two methods: (1) Capitalization of earnings. This is done by applying a multiple of a normalized earnings figure in order to determine the value; (2) Discounted future earnings. This uses a future value of future earnings. The valuation professional may use both of these methods to establish ranges. They typically pull industry data from a publication, then use treasury indices and inflationary indexes to predict future growth rates. Finally, they will drop their numbers into a spreadsheet that generates a valuation report. These reports are not accurate and don’t give the agency any value. Sometimes owners are misled and misinformed when trying to sell their life’s work. Your agency’s value cannot be trusted to any calculating engine that measures risk-free discount rates, U.S. Treasury rates or any other publication that serves as an underlying calculator. Your hard work is reduced to a commodity. While published indices are important, it is not a reason to disregard the importance of valuing. Agency owners should be cautious about websites or valuation firms that allow you to enter key numbers in their spreadsheets and receive a result immediately. This makes your agency look like it’s in a pool of similar businesses. Each agency is unique and should be valued in a way that reflects its individual characteristics. While quick and dirty valuations are cheaper, they can leave an agency owner confused. This type of valuation can lead to the owner or agents leaving money on the table if it is used for negotiating purposes.

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It is important to increase our knowledge of the true value indicators that are relevant for current agency owners. Two distinct types of value can be distinguished: goodwill and economic.

In assessing economic value, true quantifiable dollars are used. This means that a specific revenue stream, contract, or property has a dollar value. Goodwill value, which is intangible and more subjective, but still crucial to an agency’s worth, is intangible. These are the primary indicators of goodwill and economic value for an agency.

Recurring revenue – This critical element should be compiled, and included in the valuation. It is essential to assess the in-force business according to policy year, retention or persistency estimates, and future commission streams. They must clearly show liquidation or annuity value for the agency owner.

Distribution Relationships: This refers to long-term, exclusive distribution agreements to capture the production of a specific regional or national source. This can also be used as a goodwill indicator. However, the contract’s economic value can be assigned a value. Because they have potential synergy value, acquirers will often pay more for exclusive distribution relationships. They should also consider offering higher consideration for the contract. The agency owner will receive more value if the contract is extended for a longer period.

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Aggregation and Agency Compensation Agreements – An agency’s ability achieve the highest level production-based compensation or contingent commission is a significant asset. This could be a positive economic factor for potential buyers, especially if the agency has a unique carrier relationship that offers top-level compensation. This can often create tremendous synergistic value for the market and should be considered.

Operational Proficiency and Profitability: The ability of an agency to provide scaleability, operating proficiency and overall return on revenue are key economic value generators. If the results are consistent, proficiency can be a key indicator of value. These metrics include pending inventory, cases placed, and premium by headcount. A business that can adapt to the changing demands of case traffic and deploy processing staff appropriately can add value. Experienced personnel are equally important in dealing with a hostile environment. A business is worth a lot if it can grow quickly, manage its workflow efficiently, return profitability per unit, and has the ability to do so. A market prospect that has a better track record than the industry and has a well-underwritten book of business is more appealing to potential buyers. This key aspect adds economic value for many potential buyers and should be considered in the analysis.

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Technology – Technology can have a dual purpose. An agency that is able to implement a systematic, efficient, and cost-effective approach to its operations can create value. Utilizing proprietary or special applications, such as web technology, order taking, rating, or underwriting, can further enhance value. These are a great addition to the company. It is very difficult to add value to companies that have invested in technology but are unable to return their investments. Companies that followed the dotcom path and created their own technology infrastructure are unlikely to get additional value unless they can show that their product is unique, that it has economic value and/or that it improves their business. Many owners succumb to the temptation to “hire” instead of “acquire technology, and they still pay the price.

Internal Growth Rate – Historical growth rates can also be important in adding value. Agency management that can manage market cycles and show the ability to add business through new products and carriers, and distribution, adds substantial value to the company. It is important to be able to adapt to market changes.

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Product margins – Another important issue is the net retained of the agency per unit. What amount is the agency getting in gross compensation? And what are they paying for its distribution to get the revenue? This assessment can make a huge difference, especially when the acquirer is looking at the company. Value may be lost if the agency is adding distribution quickly and showing top-line growth by aggressively paying compensation. In this scenario, an acquirer may have to reduce compensation to producers to even out the net retained commission. This will be viewed by the acquirer as a risky move. Agencies that pay the largest percentage of compensation to producers are often avoided by acquirers. They can survive on very small margins and poor service. A model that exhibits fluid growth and unmatched service is the best one.

This is a crucial factor. Partnerships, limited partnerships, and sub-Chapter S corporations offer greater financial benefits to the acquiring market. Traditional C corporations can have a negative impact on the agency’s market value due to tax consequences of stock purchases. In essence, acquirers must forego deducting amortization from a C-corporation so that the seller can receive capital gains treatment. This issue is complicated and can only be resolved by a tax specialist.

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Niche or Product Diversity – Although it may seem contradictory, this can add economic value if an agency is well-positioned within a niche. This is especially true if the agency has exclusive rights to certain distribution channels and carriers. A broad product range may also show that an agency can be counter-cyclical, or at the very least, be able to weather market downturns. This allows them to spread market risk across multiple products and carrier relationships. The lowest value agencies are those that are solely commodity-based and located in easy to access markets.

Operating Model – A boutique agency or one that offers “high touch” service always receives a higher valuation consideration. This is a sign of more repeat business, higher penetration among producers, better product submissions and recognitions from industry professionals and carriers. This means that the agency will have lower marketing costs and better underwriting results.

Concentration of production – This is a huge value deflator, and it also depends on how large the agency is. If agency production is heavily geared towards one carrier or comes only from a handful of sources, it can cause a discount in value. The agency may suffer economic loss if one source of production is lost or canceled. An agency should not have more than 25% of its net operating income from a single production source.

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Brand name recognition – A brand that is well-known in the industry can bring a lot of goodwill. It is important that the agency can be easily identified in the industry by its name or the names of its principals. This helps to establish its status as a stronghold. Goodwill is further enhanced by agency owners and management who are considered industry luminaries and are recognized throughout the industry.

Another important value factor is the agency’s management depth. The industry professionals can represent all key areas of agency operations, which is a significant advantage. These intangibles all translate into one thing: the agency is solidly grounded, stable and has real going concern value.

These indicators are just a small portion of the areas that must be considered when assessing agency value. To determine the value of your business, don’t trust any web site, spreadsheet template or calculation engine. A valuable asset that an insurance agency can provide is a wealth of information and should not be diminished to the same extent as an automobile appraisal. Many agency owners and principals have worked hard to build their businesses. They should only trust industry professionals who are able to understand the business’ operating facets and maximize its value.

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