Agency Valuation, Is It Based on the Past or the Future?

When buying or selling an agency, is the valuebased on what the agency made in the past or what it will earn in the future?

AgencyConsulting Group, Inc. is one of the nation’s leaders for performingvaluation for agencies annually. The majority of agency valuation is forinternal purposes such as for estate planning, partnership stock values, ESOP,etc., but many are for potential transactions from sales to mergers and topurchases and other forms of association.

A recent call illustrated the common fallacyattached to agency valuation.

An agency owner was interested in acquiringanother agency and asked Agency Consulting to perform an agency valuation priorto the purchase. The target agency was generating around $500,000 in totalrevenues, but it was growing at 10% /yr. and was dropping several hundredthousand dollars a year to the profit line. They were very efficient and theirmarket didn’t require a host of employees. The owner was going to stay on tomanage the agency for five more years before his retirement but wanted to cashout now for personal reasons.

As you can imagine, the value of the agency wasrelatively high, much more than the proverbial “multiple” to which so manyagents still tie themselves. The buyer called me asking why the value was somuch higher than his expected multiple of last year’s revenue. I asked him thevery question that I asked at the beginning of this article.

Did the buyer want to buy the agency’s historyor its future earnings potential?

The answer, of course, was that the buyer wantedto buy future earnings.

So I proceeded to show the buyer how we projectboth income and expenses on a line-by-line basis based on the agency’s historyand any changes that we know or suspect will occur once the transaction takesplace. Since there were none, the agency was going to continue to run as iswith the same staff in the same place, just using the additional markets of thebuyer, we were able to simply progress each line of income and expense based onthe agency’s historical trend and contracts (leases, etc.) and form theprojected profit stream of the agency against which we took the buyer’s taxliabilities. We told the buyer that this agency would likely throw off morethan $1.5 Million of value over the next five years, even with a 14% discountfor risk factors associated with that particular agency. This means that thetrend would have generated 14% more than our value estimate but we foundsufficient risk factors associated with the agency to discount the value forour estimate.

The buyer was in shock that the value was sohigh again falling back on his favorite multiple “of something.” So I turnedthe tables and asked the buyer, “If you owned this agency and someone wanted tobuy it from you and you projected that you as the owner would take over $1.5Million in earnings from the agency (after taxes) in the next five years, wouldyou be concerned over the multiple that represented, or would you want to bepaid in some degree what you would likely have made over a period of time asyour asset value?”

When he thought about the situation from thatviewpoint, the buyer admitted that he would expect a reasonable priceequivalent to what he would make in the agency if he kept it. “So,” I asked, “Wouldn’t it be logical to pay the seller a fair price for the agency, giving upsome or all of the profits of the agency for a period of time (determined bythe buyer) to purchase the agency, after which ALL profits would accrue to thenew owner including the cost savings once the old owner retired?”

This put the question of Value vs. Multiples inperspective. You, too, can judge the value of any agency that you are consideringbuying or considering selling your own agency in the same way. It is of utmostfairness to identify the earnings (after taxes) that the seller would generatefrom operating his agency in the future AND the earnings that a buyer wouldgenerate from the agency if he were to purchase it. Somewhere between those twodollar amounts is the proper value of the agency in a sale.

Please reach out to us for our valuation service or, to conductdue diligence and assist the buyer and seller negotiate the price and terms ofany transaction to the end result of a Win/Win situation.

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Reprinted from The PIPELINE, the national newsletter for agencyprincipals. The PIPELINE is published by Agency Consulting Group, Inc.,a leading consulting firm for independent agents in the U.S. for over 30 years.Call 800-779-2430, E-mail info@agencyconsulting.com, or visit www.agencyconsulting.comfor information about the content of this article or PIPELINE subscriptioninformation.

LastUpdated: May19, 2016