What Drives Valuations?
Despite what you may have been told by some kind-hearted but misleading people, size matters. Size is the biggest driver of valuations, according to Clarke’s observations, and he’s got the sales data from Allstate transactions to back it up. Larger businesses can simply be purchased and administered more efficiently than smaller ones, thanks to economies of scale. The larger agencies – those with annual revenues of $300,000 and over in annual commission income attain higher multiples than smaller ones. The premium they earn over smaller agencies is consistent every quarter, year in and year out.
Other significant valuation drivers, according to Clarke, include:
- Retention. The more effective you are at getting your clients to renew, the more valuable your agency will be.
- Profitability. Clarke advises owners to work hard to eliminate needless expenses and overhead in order to maximize options and value upon sale. “If you have a $2 million earned premium agency to sell, and you have 5% in unnecessary business expenses included with your true operating expenses, this results in a purchaser having $10,000 less free cash flow per year, which if applied towards debt, could result in approximately $70,000 in lost value.”
- Transition plans. Sellers who no longer want to remain active in the acquired agency fetch lower valuations than those who are willing to remain, or at least sign a non-compete agreement to protect the buyer.
- Compulsion. Sellers under the gun have less pricing power than sellers who don’t have to sell.
- Local market conditions.
- Corporate policy. – For PPCLoan, of course, this means Allstate corporate policy, including the freedom they grant to agents to engage in mergers, etc. But the chief carrier of any agency could affect agency valuation.
Platform or satellite office acquisitions are often valued as a multiple of the agency’s profitability, including discretionary earnings, pro forma or adjusted EBITDA (earnings before taxes, depreciation and amortization), or other similar metric. For fold-in acquisitions, buyers often use a multiple of ‘net revenue’, states Mensch.
What to do now
If you’re an agency principal looking to increase the value of your agency at sale, Clarke has the following advice:
- Identify every factor that could affect the eventual valuation of your business and designate each one as a strength or a weakness.
- Work on those items that you can control.
- Start by attacking the low hanging fruit.
- Set goals with deadlines – This is especially critical if you are possibly selling in the near future.
