September 5, 2013
Consider These Things Before Buying An Insurance Agency
8 min read
Agencies are bought and sold every day. Before you buy an agency, there are many things to consider before you know if it’s really right for you. I’m going to discuss some important things to consider.
- The reasons agencies are sold are many, but why would one that’s growing well organically want to purchase another book of business?
- Is buying a good idea in your circumstances?
- This is an excellent time to buy
- How to buy
- How to figure out how much to pay
- Getting ready to buy
Some Reasons to Buy an Agency
- It’s fast! Yep, if you want to really accelerate your growth, just buy a book of business.
- It’s a great way to add volume to your production with a carrier to maximize profit sharing or bonus income.
- It’s a way to get rid of a competitor.
- It’s a way to acquire needed employees and/or expertise
- It may be a way to diversify your agency’s book of business.
- It may be a way to add a needed insurance company to your agency.
- It may be a way to quickly get to a threshold size needed to add expensive capabilities like sales management or accounting to your agency.
- It may be a good investment for your excess profits.
There are probably a lot of other good reasons to consider buying a book of business or an entire agency, these are just a few to get your mind working. Now you have your reason for buying, but is it really a good idea for you?
Should You Buy an Agency?
It’s important to enter into any purchase transaction with a great deal of thought, so make sure you consider these six questions.
- Can you afford it? While most agencies are purchased with some sort of owner financing, a down payment of 25% to 35% is usually required. Have you saved up the necessary cash? If you haven’t, be very careful about borrowing the down payment! Too much leverage is usually the thing that kills an acquisition. It can also kill the acquirer. Be careful!
- Can you manage it? This is a question to take very seriously. When you acquire a large chunk of business you need to be able to service it well enough to keep it. That means additional employees, office space, equipment, and complexity. Do you have the expertise on board to handle that? If not it can bankrupt you!
- Will the carriers allow it? Don’t just assume the insurance companies (yours or theirs) will go along. Check the loss ratios carefully. ASK the insurance companies before pulling the trigger. Get everything in writing or you may be very busy moving business!
- Do you have a plan for integrating it into your agency? Have you thought about what you’ll tell customers? What changes to policies will be necessary to fit into your agency minimums, carriers, etc.? Will the new employees, and the culture they are used to, mesh with yours? Do you share a common automation system or will you have to adopt one?
- Can you make money on it? This is a very big question. What is the historical retention rate and what is yours? Can you keep the business on the books long enough to pay the seller off? How much business will be left, given the retention rate you can expect, when it’s paid for? Is that enough for the risk?
- Related to #5, is this the best investment you can make with your free cash in terms of the overall rate of return, or would you be better off buying your customers one at a time with marketing and sales?
Obviously, this is not a comprehensive list of issues to consider. But they are important. If you’ve decided buying an agency is for you, how do you know how much to pay?
Calculating Your Buying Price
You’ve done your research, and you’re prepared to buy an insurance agency. You’ve prepped your agency for the addition. You’ve done a valuation of your business and know what you’re worth. You’ve created a brief pro forma (budget) takeover plan. You’ve saved money so you have a down payment of 25% to 35% of the purchase price for the size of agency you’re going to target.
You’ve put the word out you’re a buyer. And now an agency owner that wants to sell has contacted you. You’re interested.
You’ve probably heard that agencies sell for some multiple of top-line revenue like one-and-a-half times or even two times commission. From reading my blog you know you should actually figure what the deal is worth to you with a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
So, how much can you pay for this agency and have it be a good financial deal for you?
If you have valued your business and taken a good look at your profit margin you can easily figure the answer.
At the end of the day what you want an acquisition to do is increase not only the number of profit dollars but increase the profit percentage, as well.
A good acquisition should allow you to leverage your employees and your fixed costs of doing business. Also, you should be more profitable on a gross dollar basis as well as a percentage basis.
For example, if you have a $300,000 income agency and your bottom line is $75,000 you have a 25% profit margin. If the target acquisition is a $100,000 agency and the asking price is $300,000 (3 times revenue) can that be a good deal for you?
Calculate Your Profit Margin
You need to do a budget, adding in the new revenue to your existing agency, and any expenses you think will also increase (like commissions, E&O premiums, etc.). What’s the new projected profit margin? If it’s greater than the 25% you started with this is a good deal. If it’s lower, I suggest you need to negotiate harder or look for a different agency to buy.
Now let’s say you’re buying this book of business and by combining the book with yours you increase your profits by $50,000. Your revenue is $400,000 and your profits are $125,000 or 31%. This looks good!
The incremental increase in profit of $50,000 means the asking price of $300,000 is a multiple of six ($50,000 profit for you X 6 = asking price of $300,000). A multiple of six times EBIDTA is at the low end of value. The high end is closer to eight or nine.
So, even though the multiple of revenue seems high, for you, it is probably a good deal! You make more money, your profit margin goes up, and you buy an asset for less than it could be worth.
If, on the other hand, your analysis shows you only make an additional $10,000 of profit, what then? You’d have an agency with the same $400,000 of revenue but now your margin is only 21%. You’ve actually gotten less profitable! Bad deal. You need a lower price!
It’s a Good Time to Buy
There may never be a better time to buy an independent insurance agency.
If you didn’t know anything else about the environment for agency acquisitions and I told you the following, what would you think?
- The average agency owner is 56 years old, and 18% of them are 66 or older.
- 50% of the industry’s workforce will retire in the next decade.
- Premiums, and therefore commissions, are at an all-time high.
When I consider those three facts, I see opportunity. In the first place, there are a lot of people who are getting close to the “normal” retirement age. Their biggest retirement asset is likely their business. So, they want to sell.
When half of the workers in an industry are retiring in a short period of time, then the business risk for the owners increases. The increased risk raises the urgency to sell. When premiums and commissions are up, owners tend to think this is a good time to get out. Also, buyers may have more profits themselves to make purchases. This means more transactions, more attention to selling, and more opportunity for buyers.
Some other unique things going on in the economy make this an excellent time to consider investing in an agency. Low-interest rates create the opportunity for buyers to finance acquisitions for less or support higher offering prices. The increasing demand by insurance companies for agencies to “grow or go” creates pressure on marginal agency owners to sell. And the quick pace of technological development further pressures older owners to sell rather than invest in new technology.
Some caveats to my optimism for buyers is also in order.
- Obviously, higher premiums and commissions mean higher agency prices.
- Technology changes coming to the industry means increased customer turnover risk.
- And the challenge of finding qualified employees which is driving some owners to sell will be a significant business issue for agents who are expanding through acquisition.
On balance, though, I think the opportunity for well-positioned, and well-prepared agents, to prosper by purchasing books of business or agencies is excellent.
Now let’s talk about how to get ready!
Prepare to Purchase
As I said, this is an excellent time for agents to grow their business through acquisition. The pace of buying and selling is already feverish for agents with $1 million of revenue and greater. I think the pace will pick up for smaller agencies soon.
But while there is significant opportunity it isn’t for everyone. The ill-prepared can hurt themselves very badly. How can you prepare to be a good purchaser?
Agencies sell on economic value. For smaller agencies, that is usually expressed as a multiple of revenue. But you need to understand that buying revenue isn’t what counts, buying profits is!
So, the starting place is for you to understand very clearly your own profitability. If you get this right you’ll be able to value your own agency correctly, which will give you creditworthiness for an acquisition. It will also help you to understand how to value a prospective purchase in terms of what it adds to your bottom line and not just your top line.
First, Figure Out Your EBITDA
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This is the key number to understand in valuing an agency. You need to know yours. Agencies are trading today between four-time and 10 times EBITDA.
Sellers talk multiples of revenue. Smart buyers talk about multiples of EBITDA, and when you know how to figure out yours, you will also know how to calculate whether an acquisition is a good deal for you or not.
Second, Make Sure Your Hours is in Order
- Are you retaining business at 90% or do you need to work on your customer retention plan?
- Are your employees servicing a volume of commission, and creating a spread (the difference between commission earned and employee cost) in the upper 25% of all agencies?
- Are your paperless procedures state of the art? Do you have enough working capital saved to not only support your ongoing operations but to provide a 25% to 35% down payment?
- Is your personal credit score well north of 700?
- Have you lined up a line of credit with your bank so you can handle any unexpected contingencies? Do you have a written-procedures-manual to train new employees?
- Do you have a successful new business program in place?
- Do you have an effective cross-marketing program in operation?
- Have you developed a written takeover plan and business plan for a “typical” agency you might acquire?
These are all things you need to do to minimize risk and maximize potential from an acquisition. The best opportunities always come to those who are prepared. Now is the time to get ready!
Tony Caldwell is a modern “renaissance man,” who is not only immensely successful in the field of insurance, but is also a writer, children’s advocate, mentor and even a licensed pilot.
Always keen on helping others make their dreams come true, Tony and his team have helped independent agents grow into more than 250 independent agencies. This has made OAA the number one ranked Strategic Master Agency of SIAA for the last 5 years, and one of Oklahoma's 25 Best Companies to Work for.
Tony loves to share his knowledge, insight and wisdom through his bestselling books as well as in free mediums including podcasts and blogs.
Tony and his family are members of Crossings Community Church, and he is very active in community initiatives: he’s chairman of It’s My Community Initiative, Inc., a nonprofit working with disadvantaged people in Oklahoma City; and chairman of the Oklahoma Board of Juvenile Affairs., and he has served through many other organizations including the Salvation Army, Last Frontier Council of the Boy Scouts of America, and the Rotary Club.
In his spare time, Tony enjoys time with his family. He’s also an active outdoorsman and instrument-rated commercial pilot.
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