Valuation Drivers
Often when I talk to sellers they have a pre-conceived idea of what their business is worth; 2.5x revenue, 3x revenue, 8x earnings?
While convenient, thinking your firm is worth 2.5x revenue because you are a standard lines retail agency, is a large and unnecessary risk for business owners. Unless you’ve positioned yourself financially to the point where it doesn’t matter what price you get, you’re banking your retirement and your family’s future well-being on a guess.
Putting it in Perspective
Using real estate as an analogy, two 2,500 square foot homes, each with 3 bedrooms and 3 bathrooms, rarely would be valued equally. One home is fully remodeled with a finished basement in a sought-after neighborhood. The other home needs major updates and is located in a low-demand neighborhood. The first home is listed at $450,000 and sells above asking price quickly, with multiple offers. The second home, even though it’s the same size and layout as the first, sits on the market for six months and finally sells for $325,000, after the owner reduced the price four times. The square footage and number of bedrooms in a home are just the tip of the iceberg when it comes to real estate values, the same logic holds true when selling your agency.
If you only use your top line revenue to determine the value of your business, it’s no different than using only the square footage of a home to set a price. Your agency’s commissions are just the starting point for determining the value of your business.
Revenue Size is a Starting Point
Don’t get the impression that revenue size and commissions don’t matter, they absolutely do. It’s the first piece of the puzzle to review when determining an agency’s value. As a general statement, the larger the agency, the larger the purchase multiple is going to be. For example, an agency with $1M in commission revenue commonly sells between 7.0x – 9.0x earnings in today’s market. The revenue size helps us determine the starting point but we use financial and operational drivers to determine a market value.
Financial Value Drivers
Items in this category will tie directly to some sort of numerical figure. These areas are the primary drivers of value in your agency because they have the largest impact on your bottom line. Here are a few key areas in this category: Revenue size, profit margin, loss ratios, growth trends & client concentration.
Operational Value Drivers
Each operational category listed here has an impact on the bottom line, like the Financial Value Drivers listed above, but the primary difference between the two is the Operational Value Drivers aren’t items that show up as a line item on an Income Statement or one of your carrier’s production reports. They have more of an indirect impact. Subject areas in this category include: Carrier lineups, business location, having niche customer specializations, the quality & efficiency of your staff and the ease of transitioning ownership.
Determining the Final Value
As referenced earlier, the overall revenue size of your agency is a starting point in determining the price of your business. It gives us the initial range of what the valuation could be. Once that range is determined, each of the factors above either push the needle up or down within that range. The most important factor is the profitability of your agency. The more money you make, the more the agency is worth. Two agencies with the same top line revenue can have vastly different sales prices based upon the bottom line profit of the two firms.
After revenue size and profit margins, each additional factor can either drive up or decrease the businesses value; some areas do both. Take location for example. An agency located in a large metropolitan city may get a bump in valuation because they will have a larger pool of buyers and have a larger potential customer base to go after. On the flip side, rent may be higher in a large city and your staffing costs could be increased due to competition for top talent.
Summing it Up
It’s important for business owners to understand it’s unwise to make a general assumption about the value of your firm. There are so many small nuances that go into the market value of your agency and they are ever moving based on the appetites of buyers and lenders. However, by recognizing what the key drivers are, you can begin to focus areas that will provide the biggest impact in the shortest amount of time.
About INS Capital Group
INS Capital Group is an M&A and Capital Solutions advisory firm specializing in the insurance industry. Over the past 30 years, our advisors have been a part of over 750 insurance transactions representing over $4B in transaction values. Our clients include Retail Agents, MGAs, Insurance Networks and Program Administrators. To find out more visit our website, www.inscapitalgroup.com, or contact us at info@inscapitalgroup.com.