By Catherine Oak
There is no end in sight. How can our insurance industry keep the incredible pace of high valued acquisitions happening? It feels like the tide needs to change, but yet the M&A national and regional brokerage firms and private equity money keeps flowing. Telemarketers are not giving up their daily badgering by phone, mail and email.
Independent insurance agents, especially those $10 million and less in revenues cannot compete with this acquisition pricing. Independent buyers might be able to stretch and pay a retiree two times for their agency over five years, and usually have to borrow that from the bank for a large down payment, usually 25% to 40%. In addition, then the buyers need to make sure the selling agency can cashflow a large amount of the future payments due. In order to do so, there needs to be an EBITDA of the seller of no less than 25% and hopefully even 30% or more.
If there is a 30% profit margin, the independents can pay six to seven times EBITDA and that equates to 1.80 to 2.10 times revenues. We never figure out pricing as a multiple of revenue, we simply talk that way after EBITDA calculations are made and valuation methods are applied, in order for our insurance owner/producer clients to understand what the pricing is, in their terms.
What we are seeing if a firm is profitable by at least 25% to 30% plus, is revenue multiples in the 2.75 to 3.5 times range, usually offering some stock and an earn-out that can give them additional bonuses over two to three years. These earn-outs are usually a multiple of EBITDA and sometimes include the buyer’s stock. What we like even better and try to negotiate for is a revenue based earn-out. This is because we feel that if they are not on a revenue earn-out and the sellers cannot add people to grow the firm, because their EBITDA needs to grow. Often on an EBITDA earn-out they cannot control the expenses assigned to them, after the deal is closed. Many agencies today with EBITDA earn-outs, don’t make these additional bonuses at all for those reasons, or if some accounts are lost.
Some buyers completely leave the sellers alone, some merely assist the seller and others completely change the complexities of the sellers. Sometimes the sellers don’t have to change their name ever!
What Buyers Do
Most of our independent agency clients like the first option of being left alone after the purchase. Someof these buyers have been known to completely change the operation, compensation of personnel and producers, their perks, their contracts, their insurances and related benefits, automation, staffing and market relations. One buyer today takes on all of your administrative duties, accounting (you lose your people), insurance benefits and retirement plans for a fixed expense charge, anywhere from 5% to 10%!
Those buyers that assist the seller sometimes allow the seller to have the higher commission rates and better contingents from the buyer and that is added to the earn-out. Beware: some might do this but don’t tell you that it is only for new business, not the whole book, which is a big difference.
The key nationals are all needing to grow, to keep their shareholders happy and to keep up with increasing costs, especially for staff. They also usually like to provide value added services, free of charge to set themselves apart from the independents.
Multiples of EBITDA (if earn-outs are earned and the right EBITDA is in place) can range in the eight to 11 times EBITDA/pro forma profit ballpark. The very highest of multiples often appear in their letters of intent, to attract sellers, before due diligence has begun. Most buyers suggest the seller not use a consultant representative, which avoids the buyer from having to compete with a second or third offer being made. They have more control of the buyer as respects the price being paid as well.
After due diligence the original offer in the letter of intent can often be a very different price and story. Once again because most sellers are insurance salespersons and if the seller does not have their consultant to assist them, it is hard to earn back the first promised offer. Sellers don’t know how to do this and often mistakes are made in the way agency information is submitted. Often the buyers have hired third parties to do the due diligence work.
Buyer Stock Value
There is also often a big difference in value if stock is also offered. Some buyers determine their stock prices, without much clarity given to the seller, as to where those values came from. It is rare for publicly traded national brokers to not have private equity money backing them. If they don’t it is easier for a seller to look at the stock market to determine what the price of the stock offered is.
It is also better for the seller to be able to determine how much of the down-payment or earn-out monies they want to take in stock of the buyer, than be forced as to the amount they have to take. Not all buyers want to retire with a large amount of stock from a buyer, versus cash.It is also important if the stock can be sold back in a reasonable timeframe, such as at retirement or at the end of the seller’s earn-out. Sometimes sellers have to hold the stock for a long time.
Some nationals require stock, no matter what and rarely is it less than 10% to 25% of the down payment and sometimes it also has to be taken on the earn-out.
Tie in the Perpetuation Candidates
Some sellers want to tie in those perpetuation candidates they had hoped could buy them out. But these perpetuation candidates can’t compete with these prices, so the owner might give some of the stock down payment to those candidates to help tie them in for the future earn-out accomplishment and perpetuation of the book of business. Then the seller can retire and ease off into the sunset, without concern for those candidates leaving or how perpetuation of the book will happen.
Take this advice – don’t do it alone, get some help from an advisor and know that all these regional and national buyers today really know what they are doing, and most independent insurance agency owners don’t.
If an owner decides to sell, it is only done once. We believe the seller should get at least two offers and get to know the buyers, as they are all unique. Post-sale is also handled very differently over the years to come. If you aren’t interested and want to internally perpetuation, you should also get assistance on what the options are and how to best do it. A valuation is always needed with family members on internal sales.
Oak is the founder of Oak & Associates, an insurance agency consulting firm that specializes in mergers, acquisitions, valuations, perpetuation planning, compensation issues and consulting work. Phone: 707-935-6565. Email: firstname.lastname@example.org