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The two certainties in life are death and taxes. The two certainties in insurance agencies sales are that buyers will want to talk about their culture and sellers will be interested in multiples. Buyers will want to pay as little as possible, and sellers will want to receive the highest possible transaction value. We try to avoid early discussions on multiples with new clients. We try to focus on the client’s goals and understanding the nuances of the agency. We then have a very honest discussion about deal multiples. Regardless of the state of the market for agency sales, sellers often have an unrealistic expectation of multiples.
These unrealistic expectations seem to come from two sources. Unfortunately, many other advisors exaggerate multiples to gain new clients. “We just achieved a ten multiple for one of our customers.” The other source is from competitors and friends that have just sold their agency. The source is different, but the quote is very similar.
The short answer is that there are always three sides to every story: Yours, Theirs, and the Truth. The Truth is usually hard to get at when agents are describing the sale of their business because agency owners often invoke their ego and toss out an unrealistic multiple. They merely exaggerate, or they include Earnout proceeds that are only paid if they achieve some pretty lofty growth rates. Unfortunately, we believe that most agency owners exaggerate because they did not understand the transaction. The terms of these deals can become cumbersome and complicated.
There is a way of looking at multiples and figuring out how to present them so an insurance agency owner can compare various proposals and understand what they are receiving for their agency. This was one of the reasons we formed Sukay & Associates. We saw that advisors were presenting the multiples of transactions differently and exaggerating their achievements.
When we look at an offer from a buyer, we try to be sure that we measure it consistently so our clients can make an educated decision between multiple proposals. Here are two items that should not be including in the calculation of a deal multiple:
- Overhead Charges – Many Buyers include an overhead charge for corporate services. These are costs that are to be incurred by the Buyer. They reduce the Seller’s Profits. We exclude these charges when analyzing multiples.
- Earnout – Earnouts are paid if the agency increases the revenue or profits of the agency. The deal multiple should only be calculated on the profits of the existing client base.
We analyze Deal Proposals in Three Parts:
Part One: Proceeds at Closing
This payment is often referred to as the Guaranteed Payment. Some Buyers will offer a higher multiple if the Seller is willing to accept a lower Guaranteed Payment at Closing. This protects the Buyer’s investment if the Sellers do not achieve the earnings they have projected in the Proforma used to value the transaction. We believe that most Sellers place a great deal of weight on the Guaranteed Payment when assessing Buyer proposals. We would calculate a “Guaranteed Multiple” based on the Guaranteed Payment.
Part Two: Proceeds Based on Achievement of the Proforma
The second and most important part is what the Seller will receive if they achieve 100% of the earnings that were projected in the Proforma. If the seller received an 85% Guaranteed Payment, they would be entitled to an additional payment (15%) if they achieved their Proforma profits or revenue. If a realistic Proforma was prepared, there should be a high level of certainty that the Proforma Profits will be realized. The most likely pitfalls are if there is an unexpected loss of a large account or if the market softens.
We believe that the exact multiple is based on the Total of the Part One and Two payments divided by the Proforma profits. As noted earlier, the profits should not be impacted by any corporate overhead charges.
Part Three: Proceeds Received at the End of the Earnout Period
The Third part of the payments received by the Seller is an Earnout Payment at the end of a specified period. The level and structure of these payments vary considerably from Buyer to Buyer. They are typically based on the achievement of growth targets in the Operating Profits or the Gross Revenue of the Seller. We strongly feel that any potential Earnout Payment should not be considered as a part of the deal multiple. The deal multiple is based on the Proforma Profits or Revenue. If an Earnout is achieved, it means that a higher level of Profits or Revenue were obtained, thus not changing the original multiple.
However; we very much consider the potential of the achievement of an Earnout when comparing proposals from many Buyers. The weight it carries is directly proportionate to the ability of our client to achieve it. As an example, if one Earnout provided for a $5 million additional payment if the Seller achieved an annualized compounded growth rate of 25%, we would give the Earnout very little credence. However, if the same amount could be achieved with a 3% growth rate, the Earnout would receive significant consideration.
If you are an agency owner and you want to know what the real multiples that Buyers are paying for agencies, please give us a call and we will be glad to give you the Truth. In the meantime, remember what was stated at the beginning of this blog. There are always three sides to every story.
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