Agency Valuations: How and Why
Some valuations are performed in support of partnership buy-sell agreements and estate planning. A "track" of annual agency valuations lends credibility and support to the current valuation in the event of the demise of an owner.
Other valuations are performed on behalf of ESOTs (Employee Stock Ownership Trusts) or in support of buy-outs or buy-ins. In each case one or more individuals in the agency need to know the current value of that agency for stock value or stock transfer purposes.
Valuations are required when outside capital is solicited to sponsor an agencies survival or growth. Whether a bank, an insurance company or an outside investor, the agency valuation tells them on an annual basis whether their return on investment is justified by the businesses performance.
Many older agents plan to retire using the value of their agency as one of the principal sources of revenue for their retirement funding. Long gone are the days when the value of an agency was calculated in terms of multiples of commissions or revenues. Many agents come to us when they wish to either internally perpetuate the agency or sell to an outside firm to determine if offers being made are fair and in accordance with the market value of the agency.
Finally, each year we are faced with a number of valuations as the result of the death of a principal, the dissolution of a partnership or a marital divorce. While some of these valuations require discounting due to the loss of an active participant in the agency, the desire of the legal entities is to determine the fair market value for internal transfer, sale or dissolution.
If you wanted to construct your own model for determining the value of your agency, you may want to follow our formulas for valuation.
The base of determining an agency's current value, is its earnings potential into the future. No, we don't have a crystal ball. We can no better foretell the future than you can. However, many years of experience tells us that a growing, profitable agency will likely continue to grow and be profitable while a shrinking, unprofitable agency will likely continue to shrink and remain unprofitable. In the creation of a proforma for valuation, we determine the historical growth, expense and profitability of the agency as a whole. This includes tracking every revenue line over the past five years and every expense line over the same period. We communicate with the agency owners and their staff to determine what, if any, changes have taken place that would alter the revenue or expense track. Using this information we project the revenues (by line) the expenses (by line) and profit projections for at least the next five years. Agencies who perform valuations each year find subtle changes take place in revenue projections or expense projections depending upon the results upon the agency's historical results. The profits of the agency into the future becomes the basis for the valuation (along with the hard net worth of the agency). If you question whether this method of valuation makes sense, ask yourself this question, would you pay more for a business than your reasonable expectation of the profits that the business will generate to you over a reasonable period of time? Well, neither would anyone else!
A valuation, however, is a little trickier than a simple projection of historical performance into the future. Agencies are valued differently for different purposes. For instance, an agency being considered by an out of town buyer who would have to maintain the location and all employees as a branch office in order to provide value from the acquisition would be worth less than the same agency being considered by a neighboring business who could close the shop and consolidate many of the positions into its own location. Obviously, the neighboring agency could show more pro-forma profit than the out of town agency in this example.
Unless we are valuing an agency for a very specific purpose (internal perpetuation, bank loans, specific sale) values are projected as Fair Market Values this typically projects the agencies performance into the future with conditions similar to its current conditions unless otherwise noted. However, your projections are not complete until you add or subtract from the final valuation in accordance with risk factors that would effect the particular agency. We use a list of no fewer than 250 risk factors when considering adding or subtracting value from an insurance agency. However the risk factors fall into a few major categories that you can use yourself when valuing your own or other agencies:
1. Aging - This category insoles the ages of the remaining employees or owners and the aging of a book of business. If you're valuing an agency whose employees are all nearing retirement or whose book of business reflects a generally older population, the risk factors in that agency are higher. The sale, ownership transition or perpetuation of that agency will be more difficult for employees to get used to a new method of operation and for customers whose loyalties may have been with departed principals.
2. Book of Business - In this realm of judging risk, determine whether the agencies revenue base is concentrated in a few large accounts or is spread over many smaller accounts, personal or commercial lines. A large spread of business makes for a safer transition of an agency.
3. Methods of operation - Is the agency automated or manual? Does it carry high receivables or is it historically a strong collector? Are the procedures efficient or is there much redundancy in the handling of customers and paper? Is the decision making centralized or delegated? Depending on the answers to these questions you either add or subtract risk from the value of the insurance operation.
While many other factors are involved in valuing an insurance agency, the points in this article will give you a good basis for creating the pro-forma to establish a value for your own agency. Please don't hesitate to call us with any questions regarding valuation.