How much is your agency worth? That depends on a number of factors.
“What’s my agency worth?” We’re asked that question at least a dozen times a week. Every agent wants a clear response, such as “1.5 times this” or “2.1 times that.” Would that it were that easy!
First, let’s dispel the rumor that an agency can be valued at a multiple of anything! Let’s say that Agency A and Agency B are next to each other in a medium-size city. Each generates $1 million of commissions. Agency A generated $2 million of commissions five years ago and has been whittled down by competition, a soft market, and other factors to its current state. It has one owner (age 67), no producers, and an employee base all more than 60 years old. Agency B opened five years ago with three young producing owners, and has added staff as it has grown.
Would you pay the same multiple of commissions for each of these agencies?
Obviously, a multiple-of-commission rule just doesn’t work. And we didn’t even address the issues of nonstandard vs. standard business, owned vs. brokered business, and volatile or target accounts vs. standard accounts.
We also realize that value lies in the eye of the beholder. The buyer looks at an acquisition as a source of cash flow. This cash flow must pay for the property purchased over a reasonable number of years, after which it accrues to the benefit of the owners of the purchasing agency. On the other hand, if you’re the seller, the value of your business is often represented in terms beyond simple cash flow. There’s the added value of the “sweat equity” that you’ve spent building it and more value because of the relationships you’ve created that will (theoretically) keep your customers for a long time.
Many owners actually resent the cash flow method of agency acquisition because they feel that the acquirer is purchasing their agency with their money (the continued revenue flow of the business). What they fail to recognize is that the buyers assume the responsibility for retaining and managing that business (for which the owner has received his paycheck before retiring) and take the risk associated with the business continuation. If the business falters, the buyers are still expected to meet their financial obligations.
Although “need” and “value” are different concepts, they can be easy to confuse when an owner wants to retire and begins to calculate the cost of maintaining their standard of living. If you need $250,000 per year to sustain your normal lifestyle and you’re generating $80,000 a year through outside income sources, you feel that the agency sale must support $170,000 per year in income. But for how long? Agents who retire relatively young might need 20 years of income! That’s the calculation of need for the selling owner.
The fair market value calculates the cash flow and risk potential to the specific buyers, including the time that they’re willing to forego profit from that acquisition while the payout occurs. What happens if that agency value supports only $100,000-per-year payments for seven years? Agents then face the unenviable task of scaling back their standard of living (not easy for a high-flying entrepreneur) or refusing an offer that provides the fair market value for their agency.
It’s important for buyers to realize that offers are sometimes rejected, not because of the buyer’s greed, but because of the gap between need and fair market value.
However, sellers often fail to calculate the reduction in living costs associated with the cessation of a career. Even though you might spend more time traveling or in leisure activities, the personal expenses of a business owner related to business-related social or civic activities are often substantial and diminish quickly on retirement. The seller then has more disposable income (or will need less) for the same lifestyle.
Whether you’re buying or selling an agency, if you step into “the other person’s shoes” when considering an offer or a selling price, you’ll find that the transaction can be accomplished in a less stressful manner.
Sellers can calculate their financial need and a pro forma of the cash flow potential of the agency in another agent’s hands. They’ll understand if any gap occurs and won’t have to face a serious problem when a buyer offers a price that, while fair, falls short of their needs.
The buyer should always ask about the financial needs of the seller to determine whether to make an offer on the available asset. If the seller has unrealistic expectations, valuing and performing due diligence will become an exercise in futility.