BUYERS HAVE MUCH TO CONSIDER IN AGENCY ACQUISITIONS
Business Insurance, March 2003
If you’re the least bit intrigued by the current mergers and acquisition market, you may be equally interested to really understand what these buyers are looking for in an acquisition targets.
The first thing to be understood is that there are two distinctive types of acquisitions in the insurance distribution system; strategic and revenue. Strategic acquisitions generally create more consideration for the seller due to the strategic value that the combination creates for the buyer. These are often referred to as “platform acquisitions”. Typically, platform acquisition means that the seller’s business can operate autonomously in the buyer’s environment and can be further built upon. Revenue acquisitions generally represent an opportunity for a larger, like-kind entity to simply absorb an agency into itself to add revenue to its operation.
The real key for any seller involved in the process is to differentiate exactly what they may be to a buyer. Historically, consideration for a platform company on a relative basis, is about 25 to 50 percent greater for a platform acquisition than it would be for a revenue acquisition when using a multiple of normalized earnings basis for determining value. In essence, revenue acquisitions will result in 4 to 6 times earnings while platforms range from 5 to 8 x.
Thus far, there may be confusion as to which category some agencies would fall. It is important to note that there are hybrid acquisitions which involve agencies that could be considered a platform to one buyer, but present themselves as revenue acquisitions to others. Typically, this is true if the buyer is very large and has a mature infrastructure. Likewise, some acquirers can blend their approach where they see some platform or strategic value in certain parts of the agency, but view other parts as a pure revenue target. This usually results in a multiple of earnings being between the above ranges, falling between 5 and 7x.
Following outlines several of the key categories that are areas of evaluation that most buyers look for and key areas that really act to enhance a seller’s value:
Size and Scale – An agency needs to have size and scale to qualify for premium consideration. Agencies that have between one and three principals or leaders, who are all sales focused and driven, rarely are viewed as platform candidates. Buyers look for sales infrastructure, sound operations leadership in addition to certain key administrative professionals to balance out an agencies top line.
Financial size is equally as important. Acquirers are looking for distributors that have a demonstrated strong financial performance and that can drive profitability to the agency’s bottom line. It is difficult to benchmark exactly how much production, revenue, or profit must be generated to be a platform as buyers needs vary slightly in this area. One agency that can generate 1 million in earnings may be suitable as a platform for one buyer when it would be entirely too small for another.
Distribution Relationships – This generally refers to exclusive, long-term distribution contracts to capture production from a particular regional or national source. Acquirers that are already in the market look upon these as very valuable from a synergistic view. They see an opportunity to cross sell more product through a captive distribution channel. This clearly represents one key factor in differentiating a platform acquisition. The longer the term of the contract, the greater the value to the agency owner.
Aggregation of Production and Agency Compensation Agreements – An agency’s ability to achieve the highest level of production based compensation, or contingent commission, certainly adds value. From the economic perspective, this could enhance a potential acquirer’s portfolio of carrier relationships, particularly if the agency possesses a unique carrier relationship that provides top level compensation. This can sometimes create enormous synergistic value to the market and needs to be taken into consideration.
Operating Proficiency and Profitability – An agency’s ability to provide scalability, operating proficiency, and overall return on revenues are key economic value creators. An evaluation of pending inventory, placed cases, or premium by headcount are key metrics that can add value if the result reflects consistent proficiency. Also, a business that demonstrates ability to fluidly work with the ebbs and flows of case traffic by appropriately deploying processing personnel, can really add increased value. It is equally critical to have seasoned personnel that can work in a potentially caustic environment. If an agency possesses the ability to be able to grow quickly, manage its workflow efficiently, and returns profitability on a per unit basis, significant worth is added to the business. Finally, an agency that has demonstrated above industry average loss experience and possesses a well underwritten book of business presents itself as a much more attractive prospect in the market. This is a key element that adds economic value to many prospective buyers and should be contemplated in the analysis.
Technology – The use of technology can be a two-edged sword. Value is created when an agency is able to deploy an efficient, cost effective, systematic approach to its operations. Value is further enhanced when proprietary or unique applications such as web technology, application order taking, status, rating or underwriting is used. These add enhancement to the company. It is important to note that companies who pour money down a hole for technology and have serious development burn rates and no return on their investment are extremely difficult to add value to. Many companies who followed the dot-com parade and built their own technology infrastructure cannot get additional value without clear representation that they have something very unique, it provides economic value, and/or that it enhances their business in some way. Unfortunately, many owners fall prey to the “hire” rather than “acquire” technology and are still paying the price.
Internal Growth Rate – Historical growth rates are also important at adding value. If the agency management can navigate through market cycles and demonstrate the ability to continuously add new business through new products, carriers and distribution, this adds significant value to the company. Trending is very important and if an agency can weather the storms of the market, they reap the additional value.
Product margins – Another key issue is the net retention of the agency on a per unit basis. What is the agency receiving in gross compensation and what is it paying to its distribution to acquire the revenue? This is an assessment that can make a big difference particularly when an acquirer is assessing the company. If the agency is rapidly adding new distribution and demonstrating top-line growth through aggressively paying compensation, this does not necessarily support a platform qualification. This presents a scenario where an acquirer will be forced to lower compensation paid to producers in order to level the playing field on net retained commission, post transaction. The acquirer will certainly view this as a high risk move. Acquirers are typically leery of agencies that pay the lion’s share of compensation out to producers and survive on razor thin margins and inferior service. The best model is one that demonstrates good fluid growth through unmatched service.
Management Infrastructure – This is extremely important to buyers who are new to the market. A target that presents depth and breadth of management across all core channels definitely presents itself as a solid platform for growth. If the management further demonstrates a cultural environment that is conducive to the buyer’s, this again enhances its value.
Product Diversity or Niche – If there are proprietary product offerings or they have a form of exclusive right to certain distribution channels or carriers, chances remain greater that this can greatly enhances an agency’s ability to be viewed as a platform. Also, an agency that has a broad product offering may demonstrate the ability to be counter-cyclical or at least be able to ride out market downturns due to their diversity. This enables them to spread market risk throughout numerous products and carrier relationships. Agencies that are entirely commodity-based and reside in easily accessed markets generally hold the least value.
Operating Model – An agency that demonstrates a boutique environment, or one that provides “high touch” service, always gets greater valuation consideration. This clearly denotes more repeat business, greater penetration among producers, better product submissions, and accolades from carriers and other industry professionals. The translation is always lower marketing costs, better underwriting results, and better financial metrics within the agency.
Brand Name Recognition – An agency who has an industry name presents a great deal of goodwill value. If the agency is easily identified within the industry based on its name or that of its principals, this really solidifies its presence as a stalwart. Agency owners or management that is viewed as industry luminaries and is recognized throughout the industry further bolsters goodwill value. Management depth within an agency is another key value factor. All key areas of agency operations that are represented with industry professionals present very significant value. All of these intangibles translate into one key point; the agency is well grounded, stable, and possesses real going concern value.
Recurring Revenue – This is a critical element that should be compiled and included as part of the valuation. An assessment of the in-force business by policy year, estimated retention or persistency and future commission streams are a must. They clearly demonstrate liquidation or annuity value to the agency owner(s).
The above-mentioned items clearly add value to any agency contemplating a sale or merger. That is not to say that all of the above have to be clearly met in order to maximize the sale of an agency. It is intended to outline some of the salient aspects of an agency that can enhance its consideration in a transaction. Remember that every buyer is different in its needs and how much of a premium that it would ascribe to any one area. It is extremely important to remember to contemplate several potential transaction partners prior to making the commitment. This way, the playing field remains level and it allows the seller to control the process by evaluating multiple opportunities. Jumping into the first offer that comes along is rarely the correct strategic move. |
