February 2, 2016
How Much Should You Pay?
2 min read
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 takeover plan. You’ve saved money so you have a down payment of 25-35% 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 agencies sell for some multiple of top line revenue like 1.5 times, or even 2 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, 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?
You need to do a budget (called a Pro Forma), 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’sgreater 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!