There are two important takeaways in this article. First, you can’t spend a multiple. Second, hire a reputable advisor who will ensure you understand your real value, not just the multiple. If you are considering selling your agency, you should stop here and call me. If you hired another advisor or are considering doing a deal on your own, keep reading.
So I saw an article from one of our competitors that spoke about multiples on transactions and how insurance agencies with revenue between $3 and $5 million are selling for 12.5 times EBITDA. The problem with many of these articles is that they never show their work. This creates an emotional reaction in many of our clients and potential clients. Our response is always the same. How did they calculate the multiple? The answer to that question is always elusive. It is elusive because most clients don’t really care to ask.
Clients and potential clients read these articles and use them to compare what their value is to the value in these articles. Even worse, they compare them to what their buddy just selling their agency received. The problem is that they don’t know what the second part of the value will be in a transaction. That part is controlled by the buyer. The buyer will put their own pro forma together and come up with their idea of the estimated EBITDA. This number is important but is never really discussed in these articles.
Clients and potential clients need to make sure they hire an advisor they can trust because a trusted advisor will tell them both numbers. The next statement might surprise many sellers. We have received offers with multiples of 12.5 times EBITDA, resulting in lower transaction values than offers at 10.5 times EBITDA. “How is that possible?” you might ask.
There are many reasons, but generally, it comes down to the details. First, most buyers know that the idea of a “Higher Multiple” excites many sellers and leads them to decide to begin the sale process. The reality is that most buyers know that sellers are focused on the multiple and not how it is calculated. This often results in setting expectations that are usually not achievable.
While the multiples are usually different, sellers will find that the total transaction values will be very similar except for the structures. The reason is that when clients are represented, the buyers know that they are in competition, and they understand what it will take to win in a competition. The buyers also all have different transaction structures. This is where the details come into play. There are too many structures to describe, but some buyers have very aggressive earn-out provisions in their transaction structures that allow a seller to earn additional deal value over the 2 to 3-year period after the transaction closes. The problem is that many of these earn-outs require growth hurdles that are sometimes difficult to attain, but buyers sometimes include this in their calculation of the multiple. Some buyers even include the potential growth of their stock in the multiple because of the history of stock growth over the company’s lifetime. Buyers also have holdback provisions in their structures that require sellers to achieve certain goals before they receive any additional proceeds. There are escrows in some transactions and working capital requirements that also affect the total transaction value and the multiple.
I am no longer surprised when I receive a call from a potential client that starts out, “I just got an offer from a buyer, and the multiple is 12 times!” I then ask for the offer and do the math; the true multiple is always a lower number than they thought.
I have only touched on some of the issues that sellers face in these transactions. Buyers have a team of people on their side to make sure the transaction works for them. Sellers need to understand that advisors do more than just help you find a buyer. In fact, finding a buyer is the easy part.
The hard part is ensuring that the buyer pays a fair amount for the type of agency they are purchasing.
