Even if it’s going to be decades before you consider selling, agency principals should always be enhancing the value of their business – and carefully consider their exit options when it comes time.
Once they make the decision to retire, insurance agency principals looking to ensure their financial well-being have two choices: sell their agency to an outside party, or perpetuate it by selling within the organization.
An agency’s value is often talked about in terms of multiples of annual revenue – and the multiple of revenue that most buyers/acquirers will pay is largely a function of three key statistics:
- The agency’s profit margin
- Annual cash flow, and
- Revenue growth rate.
In order to ensure the value of their agency, principals need to focus on continually enhancing their profitability to achieve higher levels of annual revenue growth.
When you decide it’s time to hang up your spurs, the best timeline for a profitable, thoughtfully planned exit is two years from the start of your analysis to inking the final deal. This also allows you adequate time to clean up your balance sheet (as I mentioned in Part 1 of this column) and determine your agency’s tangible net worth.
Keep in mind that the value of any business is its future earnings potential for the party that’s doing the valuation.
According to Al Diamond, President of Agency Consulting Group Inc. in Cherry Hill, N.J., and a longstanding expert on valuating insurance agencies, valuations of your agency can vary depending on who’s conducting the analysis. Various potential sellers all have different expenses and revenue flows – and different plans in mind for what they’ll do with the asset once they acquire it.
“It never shocks me to see an agency with five different suitors and five very different values,” said Diamond. “Each one of them is built on the cash flow potential for that particular buyer.”
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If a suitor is only interested in your client base, they may offer you a very attractive price in cash – but they may plan to close your office, let go of some of your people and make a lot more profit on your agency’s book than you could, because those overhead and staff costs have been eliminated.
Alternatively, the person who would succeed you in an internal sale could very well plan to run the agency the way it currently operates. If that’s the case, then you can calculate the agency’s fair market value based on existing trended revenues and expenses. For this reason, the cash-flow analysis for an internal buyout is often less than the cash-flow analysis in an “external” sale.
Diamond noted that one benefit of an internal sale is that if you negotiate properly, you can arrange for a much longer payout and accept smaller payments over an extended period of time, as opposed to a larger sum received up front in an external sale.
The extended payout period makes it easier for an internal successor to afford the payments with the agency’s cashflow. It also provides interest payments to the seller that increases his or her overall return.
There’s also the small matter of the taxes you’ll incur.
“You’re going to get less by selling outside your firm than selling inside because an outside sale most likely will be an asset sale,” said Diamond. “They’re buying your assets from your corporation. And you’re going to pay not only capital gains tax but greater income tax on the revenue that you generated. An internal sale is often a stock sale, and all you’re responsible for as the seller is the capital gains tax.”
In the end, the best decisions around setting yourself up for retirement are those that are carefully considered, and not rushed. Diamond said that in his experience, those types of hastened decisions are unfortunately made quite frequently, often to the agency principal’s detriment.
Agency owners should not wait until six months before they decide to exit to start considering their endgame, nor should they ever put off concentrating on increasing their agency’s value – a practice that will pay dividends throughout their career.
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