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Agency Acquisition - 2008

Some brokers have been buying dozens of smaller agencies every year. Smaller agencies have been buying each other to supplement income and offset costs for the sake of growth and profitability. Now, twenty years after this boom, the ‘Insurance Tree’ is still blooming and growing fruit, but all the low-hanging ripe fruit is already gone. If you want to participate in the harvest you must work harder to get the next set of agencies available to merge or acquire.

“All the good agencies are gone!”

That is a quote from an acquisition-minded agent who was frustrated by his inability to locate an agency acquisition candidate who didn’t have major problems that needed solutions.

And, in a way, he was right. Since 1985 thousands of agencies have been sold, clustered, merged, or associated in ways that make them unavailable in the open market today. By some measures the independent agency network has shrunk by between one-third and one-half in the last twenty years.

ALL THE LOW-HANGING FRUIT HAVE BEEN PICKED!

Before the mid-1980’s most agencies internally perpetuated themselves from one generation of owners to another. One generation would make a good living selling and servicing insurance for their neighbors, then would pass on the business to their children or staff members who would also make a living the same way. The residual value of the business became the former owner’s “retirement plan”, an annuity that continued to supplement other asset contributions to maintain his lifestyle through retirement.

When we encountered family perpetuation plans, it appeared that many included funding the retired owners for the rest of their lives. Agency Consulting Group, Inc. has re-instituted internal perpetuation plans that are funded over prolonged periods of time to permit familial and closely related internal perpetuation to again guarantee funding for life for retiring owners. Call us for more information.

The key to the stability of agency acquisitions and perpetuation was the adequate compensation rates offered by carriers that permitted growth within the agency funded by growing revenue.

In the 1990’s and beyond, the insurance companies began to tighten the reins. Contingency contracts, growth bonuses and, eventually, commission rates, themselves, began to diminish in a perfect storm that included a ‘never-ending’ soft market. Both remuneration and insurance premiums were diminishing simultaneously.

Agencies found that their desire to internally perpetuate and continue payments to the old owners was less likely when costs continued to increase while revenues declined. Simultaneously, the same carriers who were cutting commission, contingency and insurance rates were demanding growth and threatening termination for smaller agents, even those with historically low loss ratios.

These actions also began the trend to acquire and combine businesses for the economies of scale that afforded itself as the result of the combination. Less locations, single administrative staffs, and enhanced productivity resulting in fewer staff needs made the acquisition of agencies, small and large, more attractive (and more valuable) every year. Those acquisitions permitted consolidation of markets that, while not profiting the agency’s growth need, satisfied the primary carrier’s growth need with tried and tested agency clients instead of with one-at-a-time natural growth through individual sales.

Agencies as large as the major brokers in the U.S. and as small as the one agent, four employee agency found themselves looking for other agencies to buy to supplement income and offset costs for the sake of growth and profitability. Some brokers have been buying hundreds of smaller agencies every year. Smaller agencies were buying each other and merging to consolidate the industry.

Now, twenty years later, the ‘Insurance Tree’ is still blooming and growing fruit, but all the low-hanging ripe fruit is already gone. If you want to participate in the harvest you must work harder to get the next set of agencies available to merge or acquire.

MARKETING ACQUISITIONS

The major acquirers in the industry have Acquisition Officers and staffs who spend their full time visiting agencies and “making friends”. Few agencies that they visit are for sale. Most agents will politely allow the acquirer representatives to visit, thinking that there is no harm in listening. Then they are regaled with offers that are far beyond the valuations that they have received as Going Concern Values of their agencies. Many agents are flattered that their agencies are worth as much as the acquirers are offering, but are still not interested because they are counting on their earnings from the agency to sponsor their lifestyles for many more years before they are prepared to retire or consider a sale. Some agents are then offered lucrative employment agreements that seem to solve their long term compensation needs and would permit them to take advantage of a high value in the agency today. These agents may no longer be convinced that their agencies will continue to grow in value and believe the “bird in the hand” concept.

Medium and smaller agencies are marketing for acquisitions like they market for insurance clients. They create marketing plans, they identify targets that accomplish their needs and they proceed to establish relationships with the agents targeted in order to become the logical opportunity when the need for perpetuation arises. This is a long-term plan exercised by many Agency Consulting Group, Inc. clients using Agency Consulting Group, Inc. as the conduit. And that works well to acquire agencies every year if enough prospects are worked consistently enough every year.

Finally, we encounter a growing number of frustrated agents who contact Agency Consulting Group, Inc. for acquisition assistance asking if we “happen to have” any agencies for sale in their particular geographic region. We try very hard to be consultative with these agents, explaining that there are multiple buyer options for every agency for sale, that most agents who are for sale have reasons beyond age and retirement that requires the sale and that the call for agencies for sale is much like calling and asking if we have any businesses who are in need of a good insurance agent. No one questions the need for marketing to insurance prospects. Why do they think that agency acquisition opportunities will just fall into their hands? If any agency would like to merge or acquire other agencies as a growth medium, please re-read the previous paragraph and call us for further advice.

So acquisitions, even of agencies that have not been for sale, continue unabated. It is just relatively more difficult and more expensive to harvest the newly ripening fruit and the ripe fruit higher in the trees.

GOING CONCERN VALUE VS. ACQUISITION FAIR MARKET VALUE

THE VALUE OF AN AGENCY (OR ANY OTHER BUSINESS OR PROPERTY) IS ITS POTENTIAL EARNINGS CAPACITY OVER TIME AS VIEWED BY THE PARTY CONSTRUCTING THE VALUATION FOR THE EXPRESSED PURPOSE OF THE VALUATION.

As most agents know, Agency Consulting Group, Inc. is a principal valuer of agencies throughout the U.S. And, as you know if you read our publications, agency value is not a static number. The value of an agency depends on the person and circumstances for which the value is being done.

For instance, when agencies are valued for estate planning purposes (insurance needs) and for other internal needs such as adding, buying out and annual value for partners, we use a Going Concern Value – the value of the agency remaining in current hands and operating pretty much as it has historically. On the other hand when one agency is seeking the acquisition of another, we will construct the valuation based on the economies of scale that will be achieved by the acquirer assuming control of the acquired agency. A third scenario involves the death or retirement of the agency owner. A Wasting Asset valuation takes the remaining book of business and wastes it away at a pre-determined retention rate in the hands of another agency who assumes control of the client base.

In each case, and hundreds of other scenarios requiring valuation, we construct the potential future earnings stream of the agency or of the book of business based on the assumptions of continuation or changes in revenue growth (i.e. there is none credited to the deceased or retired owner after the event in the case of a Wasted Asset) and in expenses as the result of the cause of the valuation.

For instance, if a simple acquisition will close one office and move into the acquirer’s office that has sufficient open space to accommodate the acquired agency, we eliminate the acquired agency’s occupancy cost and increase the potential profits and earnings. This will, eventually enhance the value of the acquired agency to the acquirer over the value of the same agency to the original owner who would have to maintain his occupancy costs as is.

THE MULTIPLE MYTH

We still get numerous calls every month from agents simply desiring the current “multiple” for valuation purposes. Regardless of how many times we repeat it, many agents ‘Don’t Get It’ – multiples are created by taking a calculated value and dividing it by the denominator being used (revenue, commission, EBITDA, earnings, etc.). It is meaningful only to the specific agency being valued because the agent doesn’t have to specify how much his agency is worth in real dollars. He can say it is worth 1.4 X or 2.1 X, or 3.3 X. But if I get 50 times annual revenue for a building (that happens to be in mid-town Manhattan) does that mean that every building in the U.S. is now worth 50 times annual revenue?

Public companies routinely release multiples of earnings, EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) that they have paid for other companies. High multiples attract other businesses who feel that if the company has paid that multiple for one agency then it will logically pay the same multiple for other agencies. However, even if the company expresses its offer in terms of multiples, I assure you that they do their due diligence and pay no more than they can afford for each asset that they purchase. It would be a foolish company indeed that continuously pays more for each purchased asset than it will project to earn for the acquirer over time – and an eventually bankrupt company.

THE SELL IT NOW AND COME WORK FOR US MYTH

Agency Consulting Group, Inc. and other consulting firms make a really good living from assisting agents who have sold their businesses and gone to work for their acquirers to re-acquire their businesses and start new agencies.

I once heard a business owner say, “The worst day I have ever had running my own business was better than the best day I have ever had working for someone else.”

We sort of lose sight of that when we sell our agency to an acquirer and go to work for them for a handsome salary. But the salary becomes meaningless quickly if stresses and pressures are put on you that you have never had to experience before or when you are asked to do things to your staff, clients and/or carriers that you find less than acceptable. You must also be careful of offers that appear too good to be true – they often are. Unfortunately, we have experienced many situations as Expert Witnesses on insurance agency disputes with contingent clauses that change the terms of the price and compensation agreements under certain conditions and circumstances.

You must judge your ability to be “managed” by a new employer, individual or large corporation. If you have been an employee earlier in your career, judge by your experience. If you have never been an employee, make sure of your authority and responsibility levels and that you don’t become just another employee after the ink has dried.

If you have lost faith in your business, in the agency business or in the insurance industry, selling or merging your agency is a perfectly good way of cashing out your investment. But be sure that you are financially sound enough that if you hate the resulting employment status you can walk away clean without litigation or the need to re-purchase your agency. But most successful agents should not even consider the sale of their agencies unless they wish to retire, or their health or personal condition requires it, or they have run out of energy to be a business owner. This does not include internal perpetuation in which the old and new owners work together as before, but with a transitioning ownership role over time. And, if an agency sale with an employment agreement sounds too lucrative to avoid, make sure you have appropriate ‘Escape Clauses’ in your contract. Becoming an ‘instant millionaire’ should not include a contract of Indenture. Slavery is still illegal – do not bind yourself to the point that you cannot be bi-laterally released from the agreement.

Reprinted from the PIPELINE, the national newsletter for agency principals, by permission of Agency Consulting Group, Inc., a leading consulting firm for independent agents in the U.S. for more than 20 years. Call 800-779-2430 for information or subscription; e-mail info@agencyconsulting.com; website, www.agencyconsulting.com.