CHANGING ENVIRONMENT MAKES HIGH VALUED AGENCIES EASIER TO RECOGNIZE
by Robert Smith
Stories are starting to circulate around agency/brokerage meetings, 'Did you hear what the ABC or XYZ Agency sold for?' Some of the multiples being discussed are actually accurate. However, many describe an inflated price or fail to address the earn-out elements of the transaction. Despite the partial truths about value, the prices many acquirers are willing to pay for the best agencies are higher today than in many years. But the value of many agencies hasn’t increased significantly, while the value of good agencies has grown dramatically.
Acquirers have created the potential for bidding wars for quality agencies. Agencies that are profitable and growing with a strong management team command significant prices in the marketplace. Firms with these characteristics, however, are also the very agencies that control their future because of the way they run their business. The prices paid for many agencies are quite high compared with both historic multiples and with many under-performing agencies. But when you consider the opportunity for the acquirer to leverage the operational and intellectual capabilities of the acquired firm, the price paid for the quality agency is usually quite reasonable.
What are the business characteristics of high-value firms and what steps can an agency owner take today in order to position the agency for the future? How does a local or regional agency make the decisions that will enhance its value? Although there are a variety of features common to the best firms in the nation, the most prolific buyers of agencies have identified a number of characteristics that are vital to them:
High valued firms continually reinvest in their production force. The agency/brokerage business remains a sales and service business. Acquirers have identified sustainable new business and predictable account retention levels in the best firms. Many agencies arrive at a point where the production force is tapped out, burned out, or ineffective. When a potential acquirer begins discussing the value of the agency, management realizes the importance of growth to the value of the firm, to the insurers it represent, and to the overall corporate culture.
A Midwestern firm was growing at a modest 2% rate when a local bank president asked the owners if they’d like to discuss an acquisition. The bank was publicly traded and sensitive to the impact of the buyout on its earnings. The agency could deliver an earnings contribution that would support a premium price in the first year after acquisition through aggressive expense reductions. However, when the bank realized the impact of the agency’s anemic revenue growth on its ability to sustain earnings growth at a level consistent with the bank’s, it discounted the price it was willing to pay for the business.
High-value agencies engage in automation strategic planning. Leading agencies develop a focused and balanced approach to automation. These firms regularly find themselves on the leading edge of technology that works. The purpose of automation is to create improvements in productivity, client service, and information management. Some principals make the initial investment in computer technology, but don’t change their way of doing business to maximize the value of this outlay. Many firms have made automation purchases only to be ensnared in a maze of duplicate systems and procedures. The lack of standards for operating in an electronic environment leads to minimal, if any, improvement in the way they do business or serve their clients.
An agency in the Southeast recently bought a new automation system. The purchase required new hardware and software, as well as a substantial amount of training to standardize workflow procedures. The firm’s stress on consistency and standards allowed it to maintain revenue growth rate without hiring new staff. The result: an increase in revenue per employee in the year of the automation conversion.
High-value agencies run their business like a business. Most local and regional agencies are family owned and/or closely held. The principals of top firms recognize the 'duality' of their relationship with their agency — as both investors and employees. As investors, principals are entitled to economic returns based on the risk associated with their investment. As employees, they deserve appropriate compensation for the job they do. Even though their total paycheck reflects both investor returns and compensation for their job, the principals of top agencies are well aware of the difference between the two.
A firm in the Southwest had three principals who began the agency at a time when they were all totally committed to work. They also paid themselves equally because of their common devotion to the firm. However, as time went by, one of the principals grew increasingly disinterested in the business. When his partners wanted to adjust compensation for each of the owners based on their relative contributions to the firm, the partner who had lost interest vetoed the change. Failure to address this issue led to a significant inequity in compensation and ultimately forced the sale of the agency at a price much lower than it would’ve been worth otherwise
High-value agencies are developing an Internet strategy that, as often as not, is a sales strategy. Although many local and regional agencies won’t conduct a significant amount of business online, most high-value agencies are creating an Internet strategy. The Internet can be used to sell products and services, provide marketing or service information, and/or reinforce existing client relationships. Local and regional agencies should focus their Internet strategy on the areas that add value to their existing and future client relationships.
An agency in the Mid-Atlantic region developed a franchise program that focused on businesses in 22 Eastern and Midwestern states. The firm put coverage and application information on its Web site so that franchisees could download the appropriate information and return it to the agency for further underwriting. As a result, the penetration rate on the franchise program came in twice as high as the initial projections, with retention rates of nearly100%.
The changing environment has created an immediate payback for many of the investments and business practices that define the nation’s best agencies. Owners and managers of these high-value firms are making decisions today that will maximize the value of their businesses.
This article originally appeared in The National Underwriter, Property/Casualty Edition, and is reproduced by permission. Robert Smith is a Principal with Reagan Consulting, Inc., an Atlanta-based management consulting firm that serves insurance agents, brokers and companies, as well as financial institutions. Please send your comments to [email protected].