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What's My Agency Worth?

Author: Al Diamond

A water bottler prices each bottle at $1. But what if the water is transported to the middle of a desert in which there is NO other source of the bottle still worth only $1? If the water comes from a spring that is readily accessible for free to the locals, will they pay $1 a bottle? Agencies are like water and here's why an agency is worth different amounts in different valuation scenarios.


When is a $1 retail priced bottle of water worth $100?

When is a $1 retail priced bottle of water worth NOTHING?

If a water bottler defines a $1 price on a bottle of water, he is considering the cost of the water itself, the cost of bottling and transporting, the cost of labor and a profit margin.  The end result is that $1 is the retail price of the water.

But what if the water was transported to the edge of a desert in which there is NO other source of water.  That bottle could easily be worth $100 to a parched buyer.

On the other hand, if the water were offered next to the source at which it was bottled, a clean spring that also provides the water supply to a community, the bottle may be correctly priced at $1 to achieve the seller’s costs and profit, but who needs to buy it at all?

The value of the water, like the value of a business (including an insurance agency), depends on the condition and needs of the buyer, not just the needs of the seller.

If an insurance agency is a corporation and its owners take all available net funds each year in compensation and/or bonuses and contributions to pension plans (a common occurrence in agencies throughout the US), it may not pay much income tax because the tax responsibility belongs to the individuals receiving the compensation.  It can be valued as a going concern based on the historical and current trends of revenues and expenses.  In order to make up for the lost income if the owners were to die or become disabled, sufficient income or insurance needs to be obtained to replace the Going Concern Value of the agency in its normal operation.

However, if that agency is considered for sale to another agency, the basis of value suddenly becomes the NET income (earnings after taxes) that the acquired agency can substantiate for the acquirer.  This means that if the acquirer can merge the purchased agency into its facilities using its pre-existing employees to service the purchased book of business, it may be able to generate as much as 60% to 70% of the purchased agency’s income as profit (taxable).  The net earnings after tax consideration of the projected profits form the maximum that the acquirer can afford to pay the seller in any given year.  The value is comprised of the total earnings potential over the number of years that the acquirer is willing to forego the additional earnings in order to pay the seller.

On the other hand, if the purchaser requires the seller’s facilities, employees, and perhaps the seller himself to remain for some period of time, that earnings potential diminishes by some degree down to the earnings of the current agency owner (or less).  Some degree of earnings can be generated as long as a) the buyer can pay the seller for a period of time that includes some time that the seller will remain with the agency, b) the seller stays on as a part of the purchase price, and c) any service or consulting fees taken by the seller fall below that which he took while he owned the agency.  The sum of the earnings over a period of time acceptable to the buyer becomes the total value of the agency to that buyer.  That period of time is the time that the buyer will forego any profits in order to pay for the agency.

Therefore, it is perfectly reasonable to find that the Going Concern Value for an agent may be substantially more, the same or substantially less than the Fair Market Value of the agency to a second or third potential set of owners.  An agency may be worth $1 Million as a going concern. The agent should have some level of life insurance up to a maximum of that value in order to provide a replacement to the lost asset value if he were to die.  However, based on the expense benefits or needs of the buyer, the value of the agency to the buyer may be $500,000 or may be $2,000,000 and each of these values is correct (under the circumstances noted).

So, when determining what your agency is worth, add the conditions that you are measuring.  The easiest measurement is to define an agency’s value as a Going Concern because, unless a change occurs in its operations, its historical trends carried into the future will define the revenues, the expenses and the profit potential of the business to the existing owners.  Gross Owners’ Profitability includes all forms of current and deferred compensation, the value of all perquisites and profits. 

If you seek a Market Valuation for your agency, the valuer will construct a proforma of the agency’s operation with changed ownership under the most likely conditions for the agency in question and will, therefore, define different income, expense and profit and earnings scenarios to define the agency’s market value.

Copyright 2002 by Agency Consulting Group, Inc.  Used with permission.

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