Valuing an agency can be a highly complex process.
Who will read the valuation report? Unless otherwise stipulated, a valuation report should always be written for two audiences: 1) the client, and 2) attorneys and/or the IRS. Some appraisers write only for their clients, producing reports that are inexpensive, short, and easy to read. However, if a spouse, partner, or the IRS ever contests an agency's value, such a report can cause more harm than good because it won't hold up to scrutiny.
An appraisal has two purposes. The first is to calculate a reasonable estimate of the agency's value. The second is to prove that calculated value to anyone who might contest its accuracy. Extensive details are required to deter another party from challenging the value.
The report must include the definition of value, a description of the various methods available for calculating value (including common methods that weren't used for the valuation and an explanation of why they weren't), a complete analysis of the agency's operations and financials, an analysis of the industry and the economy in which the agency operates, and many other factors.
Thus, good valuation reports are necessarily thick, often containing information that the agency owner has no desire to ever read. Although the agency owner might think that some of the detailed data pointlessly increases costs, it's necessary for their own protection.
A valuation is a valuation is a valuation, right? No. Different situations require different values. While the recipe for a Snickers bar might be complex, the bar can only be made with one recipe. That's not the case with an agency valuation.
Many factors contribute to the complexity of an agency's value. Attorneys, legislators, and others have developed many valuation recipes, and they dictate which one to use and when. For example, the IRS and case law developed the concept of fair market value. Wall Street, investment bankers and MBAs invented strategic value. The list continues with even more definitions. Any agency, then, can have three or more often quite different values, depending on the definition used.
With so many definitions of value, how does an agency know which one to use for a buy-sell agreement? Many buy-sell agreements use an unreasonable or incorrect definition of agency value. The most common standard is fair market value, but it often is not adequately discounted for a minority position. As a result, someone buying less than 50% of an agency might well face an unaffordable purchase price.
Consult an appraiser before drafting a buy-sell agreement. Don't rely on your attorney to know which definition is best; they might not be qualified to advise on the various definitions of value.
How does a minority position affect value? Compared with majority positions, minority positions are worth less (and maybe even worthless). No market really exists for selling minority positions in insurance agencies, so unless the buy-sell agreement is crystal clear about a minority position's value, a minority partner might discover that their interest has no value.
How does a majority position affect value? If a minority position is worth less, it stands to reason that majority shares are worth more. Thus if a majority interest is sold, a majority premium will probably apply, especially if the buyer is a large firm.
Public companies rarely sell control for less than a 20% premium over their stock price (their stock price is considered fair market value). A controlling interest in an agency should command a premium, although the amount will vary significantly among agencies. This majority position premium applies especially when a single buyer purchases a majority of the agency now and the rest later. In the initial sale, the buyer gets control of the agency and, if the contracts are written without careful protection for the seller, the seller could find that their minority position is worth little when the remaining shares are sold.
Get representation. Most agency owners have little or no experience in selling an agency. These transactions involve huge sums of money, and many sellers rely on the proceeds to fund their retirements. The magnitude of the transaction warrants proper representation. Also, many agencies are sold to large corporations experienced in acquiring other firms. In such cases, the gap between the buyer's experience and the seller's renders the seller vulnerable.
If you're involved in buying, selling, or merging an agency, you should have appropriate representation by a consultant, an accountant, and an attorney knowledgeable in such matters. The money you save will be your own.