ACG - Agency Consulting Group

The PIPELINE

A national monthly newsletter for agency principals dedicated to agency management topic

SHIFTING COMPOSITE GROUPS - ACQUISITIONS CONTINUE UNABATED

We saw it coming several years ago when the revenue of our average Group 3 Composite Group (agencies from $2 to $3 Million revenue) grew to over $2.8 Million. We noticed that the new agencies entering the Composite Group were larger agencies rather than smaller ones growing into Group 2. And the average growth rate (5 year average of 2.1%/yr did not correspond to the actual growth rates of many of our long-term participants.

Simultaneously, we began seeing a creep of agencies growing into Group 4 (over $3 Million) and sharp movement in that group’s average growth rate, even in our soft market, by over 3%/year.

As we analyzed our results we realized that some major acquisitions were taking place at accelerating levels. The results were growth of Group 3 agencies by acquisition (in addition to any natural growth) and the movement of a growing number of Group 3 agencies into Group 4 status.

The result has been a shift of sorts in which both Group 3 and Group 4 average size has decreased, but not because of lack of growth of the participating agencies. More Group 3 agencies acquired their way into the lower echelon of Group 4 while Group 2 agencies similarly acquired their way into the lower levels of Group 3. The result of this shift was to reduce the average size of both Groups even though the agencies reporting have been growing. The growth has been more through acquisition than through natural growth.

What Happened?

1. Medium and large agencies continue to purchase smaller agencies at a rapid pace.

2. While our Composite Groups continue to increase in numbers (3% more agencies reporting in Group 1, .9% in Group 2, .7% in Group 3 and, phenomenally, 10.8% more agencies in Group 4), the growth in the larger agencies are more from medium sized agencies growing into the larger agency group than from the entry of many more NEW large agencies into the Composite Group study.

3. Many more Group 3 agencies than in the past moved to the lower levels of Group 4. New agencies entered Group 3 through acquisitions. Most new agencies entered the study in Groups 1 and 2. Almost every agency leaving the study did so because it was acquired.

What Does It Mean?

1. The small (under $1 Million) agencies who make it to $1 Million and (especially) the Group 2 ($1 Million to $2 Million) agencies who grow to $2 Million revenue are positioned much better to succeed than their counterparts who are treading water.

2. 80% of the agencies acquired and leaving the study were low or no-growth businesses.

3. Acquisitions are being made by Group 2 and Group 3 agencies as much as by the country’s largest agency/brokerage buyers.

This means that consistent GROWTH combined with conservative spending appears to define the difference between successful insurance businesses that transition internally and stagnant agencies that will more likely be sold than perpetuated to another generation.

WHY?

Even stagnant agencies build asset value for their owners. But the value to another generation to continue the same even trend of revenues and profits is much less than the value of that same book of business to agencies who can use their ECONOMIES OF SCALE to warrant stronger earnings potential from those stagnant books of business. The larger agencies already know this. So they can offer substantial premiums to retiring owners AND offer to absorb their internal successors as a part of the bargain.

Where an owner was always intending to perpetuate to his children or his next generation employees, the substantial difference between value available to internal perpetuators and value to external perpetuators sometimes makes a difference.

As most agencies already know, Agency Consulting Group, Inc. built these Composite Groups over the last 24 years as the baseline comparisons for the large and growing number of insurance agency and brokerage valuations that we perform every year. We are proud and humbled by the hundreds of agencies looking to our valuation services annually and each one adds a bit to our Composite Group, as well. We recently valued an agency as a Going Concern for an eventual internal succession. As with most profitable medium-sized agencies, our client was getting five or more inquiries annually for the potential sale of the agency. Immediately after our valuation he received another inquiry from a well-known buyer and he decided to see what the buyer had in mind. The price offered after the buyer’s analysis was 75% higher than the Going Concern value of the agency to the existing participants. Of course the agent came back to us asking if there was something wrong with either the offer or with our valuation. When we analyzed the offer, we found nothing wrong. Nor was there any flaw in our own valuation.

The difference was that the agency could barely make a 3% profit operating as it was (although it was making a good living for its owner) and there was virtually no growth over the last five years (because of the economy, not because of business loss). However – and this is important – the potential buyer’s assumptions included the loss of many of the agency’s current employees and the movement of the agency into a larger location a few towns away. Even considering the potential loss of some clients because of the departure from the area, they calculated a 47.5% potential profit on that book of business. Obviously, if you assume 44% expense savings by cost-cutting, the value you generate (and the price you can pay) will be substantially more than leaving the agency as it was operating.

In this case everything turned out well – the agent decided that, even though the other suitor would have given the owner’s son an executive role in the agency, the loss of the location, the effect of the release of some employees and the hit to his ego of seeing his agency disappear into a larger organization wasn’t worth the money. BUT HE CERTAINLY THOUGHT ABOUT IT!!!

There are many agencies whose owners are less concerned with these quality of life issues than the agent in our example. They may have no internal perpetuation or succession plan. They may desire retirement away from the community. Practically, they may need maximum return on their asset investment to support their retirement. These are the agencies most likely to be absorbed in acquisitions.

The best acquisitions that we are seeing are strategic in nature as opposed to tactical. This means that the acquisition is being done to establish the combined agency for future growth, profit and productivity more than for the immediate gratification of generating strong positive cashflow to the buyer.

And this is the lesson that we can take home from the shifting Composite Groups due to continued acquisitions – Judge your potential acquisitions more for what they can do for you over a five year period than for the potential immediate benefit of cash-flow profit and you will benefit both the buyer, the seller and the clients and employees. There will still be natural economies of scale. But if you force economies, the greatest fallacy is that there will be limited customer drop-off. We have seen projections of 10%-12% customer loss turn into 20%-25% customer loss when the combination of name change, location elimination, and employee terminations (of folks who stay in the community talking about what happened to them) have their full effect on the customer base and the community. For agents who may be tempted by large dollar offers – consider whether you will stay in the community and how you will face your employees and customers after the transaction if the Yellow Brick Road that is advertised by a buyer doesn’t prove to be gold. Litigation is a terrible hobby for a retired owner. And, if you are offered a continuing position, make sure you evaluate how well you will take to the saddle after having been rider-less for so many years.

There are good reasons to buy, sell and merge agencies and there are bad reasons. This article is not meant to discourage perpetuation or succession, only to recommend that you are judicious in your decision-making and that money is the secondary, not the primary reason for a transaction.