An insurance agency growing at 7% per year doubles its value every 10 years. An agency growing at 2% per year doubles its value every 35 years. What??
The last 10 years has seen an explosion in the value of property and casualty insurance agencies. Much of this incredible valuation increase is a function of a private equity industry that has discovered the incredible financial value associated with the business. Agency customers provide these businesses with revenue year in and year out and expand their existing policies over time. These private equity firms, engaging in what they refer to as a roll-up strategy, acquire smaller agencies and build big agencies that have the benefit of scale, skill and capital as they get bigger and bigger. These characteristics, and the regular growth of the organization, create opportunities for the private equity firms to enhance the traditional value of what they are acquiring.
In addition, the recurring nature of property and casualty insurance commissions provide a wonderful basis for the ability to finance these acquisitions. Over the past 10 to 15 years, banks and other financial institutions have learned the safety of lending to independent insurance agencies and have flocked to those private equity buyers to provide significant financial leverage in the acquisition process.
This environment around the valuation of independent insurance agencies has created a bonanza for the individuals and families who have owned these agencies for decades.
Independent agency principals have been, and continue to be, the beneficiary of increased competition to buy agencies, increased interest from banks and other financial institutions to provide more and more leverage to the buyers of those agencies, and an incredibly attractive interest rate environment that has seen interest rates drop from 5 or 6% to 2 or 3% during this ten-year period.
These factors have combined to dramatically increase the prices acquirers are prepared to pay for independent agencies.
All of this is great news, but it is largely not anything owners of independent agencies have any control over.
They have been the beneficiary of these major economic characteristics that have driven increased valuations. At the same time, there are ways that independent agency principals have been able, to and continue to be able, to drive enhanced agency value. Let’s talk about some of those levers that independent agency principals can pull to enhance agency valuation.
Buyers of independent insurance agencies value them as a function of revenue or EBITDA (earnings before interest, taxes, depreciation and amortization), and the multiple that appropriately reflects their perceived value. As a result, any agency principal looking to maximize the value of his or her family’s largest asset will want to drive high levels of growth.
Obviously, growing revenue or EBITDA will expand the ultimate valuation of any agency.
In addition, the multiple, which determines the ultimate value, is driven by growth, agency size and agency profit margin. An agency growing at 7% annually will get a higher multiple than an agency growing at 2% annually. An agency that has $3 million of annual revenue will be valued more highly, at a higher multiple, then an agency with $1 million of revenue. And finally, an agency with a 35% profit margin will receive a higher multiple than an agency with a 25% profit margin.
The agency principal is in full control of these characteristics that enhance the multiple applied by acquirers during evaluation. Driving growth is the key to optimizing these key characteristics.
Higher growth rates themselves result in higher multiples. Higher growth rates by an agency over a 5-10 year timeline will cause an agency to be much bigger, also enhancing the acquirers multiple. And finally, bigger organizations have more scale and typically have higher profit margins. The key to enhancing valuation is growth!
An agency with $10 million in premium and a 3% growth rate will have approximately $13.5 million in premium in 10 years. That company will be valued at 9 to 10 times EBITDA and will likely have a value of approximately $5 million.
That same independent agency, If it grew at 7% per annum over the 10 year time period, would have $20 million in premium at the end of the 10 years and would likely have an 11 to 12 times multiple of EBITDA, being worth approximately $12.5 million.
The difference between 3% growth and 7% growth over a ten-year period is 2.5 times the value of that agency.
Growth is the key to creating wealth.
If you want to start more effectively driving your premium growth, making these 7 things part of your routine is the best place to start.
Chairman & CEO