What multiple does an agency sell for these days? 1.25 times commission? 1.5 times commissions? As a broker and as an appraiser of insurance agencies, Roger Thomas is often asked these questions. He answers them in this document.
Having dealt with hundreds of agency sales and acquisitions, it’s become very clear that many sellers and buyers expect to price an agency using a multiple of commissions. Although this method has been commonplace for decades, using a multiple of commissions to purchase or sell an agency can lead to gross overpayment. Why? It fails to consider the profitability of the agency. Unless every agency has the same expense structure — and we know that expenses vary widely from agency to agency — how can a multiple of commissions be accurate? This is a simplistic approach that can be very costly for an agency purchaser.
To which commissions should a multiple apply? Just Property/Casualty? Would Life and Health use a different multiple? Should you apply the multiple to gross commissions or to net commissions (after paying producers)? What should you do about commissions relating to the vested ownership interest that some producers have in their books of business? Can you sell commissions that are brokered for another agency and that you don’t own? And just what is the correct multiple, anyway? Will it correspond to the agency’s expenses? If so, how will you calculate it?
Here’s something else to think about. Suppose you’re looking at two similar agencies, each with $1 million in total commissions. After expenses, Agency A produces a net profit of $10,000, but Agency B produces a net profit of $200,000. Using a hypothetical multiple of 1.25 times commissions, does it make sense to pay $1.25 million for $10,000 of profit when the same $1.25 million could purchase an agency with $200,000 of profit?
As you can see, a multiple of commissions doesn’t examine the profitability of an agency. The value of any business is an expectation of a consistent stream of profits year after year. This means that the value of an agency is directly related to its profitability, not to its commissions.
This profitability is not the same type of profitability that shows up on the bottom line of your business tax return. Instead, experienced and qualified insurance agency appraisers adjust the income and expenses to exclude items that aren’t absolutely necessary for operating the agency and producing its policy sales. For instance, unless a buyer will also purchase the building, the appraiser might exclude rental income. On the expense side, if three cars are expensed on the corporate books, but only one is needed to produce income, the expenses for the extra two vehicles are excluded. Such adjustments, together with others, usually show what the real cash flow would be for a new owner if they step in and run a 'lean and mean' agency.
In other words, the value of an agency is what the present owner or a new owner perceives as its worth to them in ongoing buying power — what they know they can take home at the end of each month over an extended period. This means that profit is the basis for agency value, not commissions.
As much as we might talk about multiples of commissions, this is an erroneous habit that we must break. Informed buyers base their agency purchase price on profitability and cash flow, not commissions.