To calculate the agency’s worth, multiply the pro forma cash flows by the capitalization rate. The higher the capitalization rate, the riskier the agency.
What multiple do insurance agencies sell for?
The difficulty is that as their agencies grow, owners tend to pay themselves larger and larger salaries, or high commission rates, while keeping profits low. When it comes time to sell, this is certainly a mistake!
Paying oneself a lower salary and taking a profit distribution is a superior method to generate long-term worth while retaining income.
Your cash flow and tax bill are both the same, but your agency value and net worth are significantly higher.
To build value while maintaining income, pay yourself a smaller salary and take a distribution of profits
In today’s insurance market, agencies often sell for between 8% and 12.5 percent of their original investment. So, on a $1 million commission revenue, my friend’s agency isn’t actually worth $1.5 million. It is valued at a multiple of its profits, which range from 8% to 12.5 percent.
So, if he earns a $150,000 salary and makes a $50,000 profit, his firm is worth $400,000. However, if he accepts a $100,000 distribution and pays himself a $50,000 income, his agency would be worth an additional $800,000, or $1.2 million!
Now, if he truly works hard to maximize his profits and compares himself to the most profitable agencies, which make around 25% profit, his agency may be valued up to $2 million! Isn’t that a lot more accurate and profitable than the traditional 1.5 times commission? It’s also a lot more believable.
Focusing on increasing agency profitability is vital if you want to enhance the value of your agency and, by extension, the quality of your retirement!
How is an insurance brokerage valued?
The current average valuation for large public insurance brokers is roughly 10 times EBITDA, as seen in the graph. However, the range is wide, ranging from about 7 times EBITDA to over 14 times EBITDA.
What multiple of EBITDA do insurance agencies sell for?
A few publications published by agency valuation experts have questioned the usage of EBITDA multiples in values. It might be claimed that EBITDA isn’t a true cash flow indicator. It may be claimed that such a form of valuing ignores an agency’s intrinsic factors. The difficulty with their reasoning is this: Buyers and their financiers talk about EBITDA multiples, and they are the only two groups that matter when trying to figure out how much an agency is worth.
Earnings Before Interest, (Income) Taxes, Depreciation, and Amortization (EBITDA) is the acronym for earnings before interest, (Income) Taxes, Depreciation, and Amortization for mid-sized to bigger agencies.
Larger agencies usually have solid financials and the owners are paid market rates, so there isn’t much fluff in the income statement.
However, for smaller agencies, particularly those with a single owner, the EBITDA calculation requires more investigation and is referred to as “adjusted EBITDA” because the owner’s personal expenses are often removed through a series of adjustments.
This is referred to as “undoing the owner’s tax approach,” and the tax strategy can be quite complex at times.
The following is an example of a possible analysis:
It’s vital to realize that EBITDA and the owner’s discretionary earnings are not the same thing.
This is a common source of miscommunication and conflict between agency owners and buyers.
I’ve even seen trained appraisers use the incorrect earnings and earnings multiple (e.g., utilizing an EBITDA multiple on DE or a P/E multiple on EBITDA) in their values.
The purpose is to estimate the buyer’s pre-debt, pre-tax earnings after all expenses have been paid, including the cost of replacing or keeping the owner.
Depending on what the owner(s) perform in the agency, the replacement cost could be similar to a manager’s salary, a percentage of the owner’s book of business if they need to transfer accounts to a producer, or a combination of both.
In addition, when dealing with a specific buyer, the EBITDA calculation is referred to as “pro forma EBITDA.”
The buyer is unlikely to offer you their synergies, which could include increased income from better carrier contracts or cost savings from job redundancies.
Many larger buyers, on the other hand, will want to cushion the EBITDA with corporate overhead expenses, typically a few percentage points on revenue, will need to raise employee compensation to match their corporate level, and will include a compensation package for the owner(s) to keep them on-board for a negotiated period.
The end result is a pro forma EBITDA figure that is likely to be lower than the owner’s estimate, perhaps by 10-15% of revenue.
So, in my previous example, if the owner’s earnings are $509,639, they may be tempted to value the agency at 6 times earnings, or around $3 million, because they were informed that was the prevailing rate.
With $150,000 in administrative costs, a buyer may arrive at a pro forma EBITDA of $353,639.
The agency is worth $2.1 million when valued at 6 times, which is a 30% difference from the owner’s estimate.
This doesn’t happen very often, but it does.
Because capital investment in an agency, including depreciation expense, is negligible, the inverse of an EBITDA multiple is the pre-tax, pre-debt return on investment.
A five-times EBITDA valuation, for example, offers a 20% projected return on investment (i.e. 1/5).
The market competitiveness, perceived risk of revenue and profitability, which has several variables of its own, cost and availability of capital, and potential synergies all influence the multiple a buyer is ready to pay.
The market value of an agency as a function of pro forma EBITDA multiple has historically been a sliding scale that grows with the agency’s size.
A small insurance agency is typically valued at 4-6 times pro forma EBITDA, a mid-sized agency at 6-8 times pro forma EBITDA, and a large agency at 8-10 times pro forma EBITDA. However, in today’s market, high values are nearly the norm.
I’ve mentioned before that valuations are nearing historic highs.
Because the buyer pool has swelled in recent years, owing in large part to the capital markets, competition is fierce across the board (i.e. low interest rates and low returns on alternative investments).
Agencies that could have had offers at 6-7 times EBITDA in the past are now getting offers at 8-9 times.
1) The percentage of the value beyond the standard amount is predicated on a 2-3-year earn-out (i.e. it is not guaranteed). An earn-out, to be clear, is a payment dependent on future performance.
2) Growth targets may be included in the earn-out; what appears to be 8-9 times on paper may actually be 7-8 times the agency’s EBITDA at the end of the earn-out.
3) The earn-out could include a claw-back clause, in which the price is reduced if the target EBITDA is not met (for example, $7 every $1 of EBITDA failure).
4) The agency owner is rewarded for locating fold-in acquisitions, which are typically at a lower multiple, and may receive credit on the acquisitions’ earn-out.
5) Revenue and expense synergies are realized by the buyer as a result of the acquisition that are not included in the pro forma.
6) The buyer’s valuation multiple is increasing each year, which is significant to private-equity backed brokers who recapitalize PE partners every 4-6 years.
Using a multiple of pro forma EBITDA to value an insurance agency is a viable technique because practically every buyer does so.
The key is to comprehend how EBITDA is computed as well as the payment structure on a potential acquisition price.
P.S. In the headline image, I did utilize a heart.
Please don’t hold it against me in any way.
Is buying an insurance agency a good investment?
Purchasing an insurance agency is a significant financial commitment. It’s a calculated financial risk that could pay off in the long run. However, it’s a good idea to budget for both the original purchase and continuing overhead costs. Always ensure that your business is lucrative.
What is insurance agency revenue?
The majority of an insurance agency’s revenue comes from paying commissions. A percentage of the entire cost of the coverage offered is paid to the agency. The premium is the overall cost, and the amount earned by the agency is known as agency revenue.
How much should you pay for a book of business?
A book of business costs 1.5-2.5 times the annualized gross commission. A hypothetical book of all Medicare Supplement business that generates $100,000 in revenue per year, for example, would cost between $150,000 and $250,000.
But it’s not as simple as that. When determining the worth of an insurance company, we ask two major questions:
When we look at the income, we want to know how much the book of business generated for you in the previous year, as well as how it has performed over the years.
Because not all products provide residual income, the product mix is also critical.
For example, a Medicare Supplement-only book of business is worth a lot more than an annuity-only book.
There is regular revenue in the Medicare Supplement book of business, but not in the annuity book of business. Is there still a market for annuities? Absolutely! Is it, however, as valuable as a Medicare Supplement business? It doesn’t work that way.
What is a good Ebitda for insurance brokers?
An EBITDA Margin of 20% or more is indicative of a financially sound brokerage, omitting Contingent Profit Commissions (CPCs), which are not always consistent or guaranteed.
How do we calculate Ebitda?
Depreciation and amortization costs of $20 are accounted for as part of Company XYZ’s operating expenses. Determine their earnings before taxes, depreciation, and amortization:
EBITDA = Net Income minus Taxes minus Interest minus Depreciation & Amortization minus Depreciation & Amortization minus Depreciation & Amortization minus Depreciation & Amortization minus Depreci
EBITDA = Revenue Cost of Goods Sold Operating Expenses + Depreciation & Amortization Expense + Depreciation & Amortization Expense + Depreciation & Amortization Expense
Can you make money owning an insurance agency?
Commissions from the sale of insurance to people or corporations are how an insurance broker gets money. Depending on state restrictions, most commissions range between 2% and 8% of premiums. Health insurance, homeowner’s insurance, accident insurance, life insurance, and annuities are all sold through brokers.