1. SIZE – Size continues to be the most important factor driving the value of an independent agency. The reason is relatively simple. Larger agencies are able to utilize economies of scale which increases profit margins and net income. In addition, larger agencies will attract more potential buyers. This is simple Economics 101 on the supply and demand curve. With fewer large agencies (supply) and an increase in demand, the price invariably is driven up. Many of you may now be asking what is considered a large, medium or small agency. These can generally be divided into five categories based on gross income.
Before we get into describing each category let us first explain why we do not use written or earned premium, and also why we use gross income instead of gross commissions. We do not use written or earned premium simply because neither one is included in a seller’s income statement. The reason we use gross income and not gross commissions is that many agencies are now charging fees such as application fees, new policy fees, reinstatement fees, etc… These fees impact income. However, one thing to consider is that some buyers will not include all of the fees in their calculations since many of the fees are one-time events. Buyers are more willing to include on-going fees in their calculations as long as they occur on a regular renewal basis. The use of fees varies from buyer to buyer and is often influenced by the insurance regulations of the buyer’s home state or the buyer’s general policies.
Now let’s take a look at the five categories by size:
The first size agency labeled “micro” is for agencies with less than $100K in gross income. These agencies are typically only marketable to neighboring competitors. The majority of them do not have enough net income to justify other buyers spending the time, money, and resources to acquire an agency of this size. The key to creating value for a micro agency is to develop a specialty that other competitors do not currently offer.
The second size agency categorized as “small” is for agencies with gross income ranging from $100K to $500K. Small agencies typically have an established book of business with positive cash flow. The buyers of small agencies are usually other local agencies looking to merge the agencies together, or an individual looking to get into the industry with an existing book of business without having to start from scratch.
The third size agency termed “medium” is for agencies with gross income ranging from $500K to $1M. These agencies have an established book of business and are usually known throughout the local area. These medium sized agencies usually attract local agencies looking to expand as well as some regional agencies with existing business in the area.
The fourth size agency which we call “medium+” is for agencies with gross income ranging from $1M to $3M. These are called medium+ because they are still not what we consider to be large, but there is a clear distinction in the number of potential buyers once the agency hits a million dollars in gross income. The medium+ agencies attract other local agencies of similar size looking to merge or create a partnership. They also attract regional agencies both with existing business in the area as well as ones looking to expand into a new market. In addition, they attract some national brokerages with either existing business in the area or that are in the process of acquiring other agencies nearby.
The last size agency categorized as “large” is for agencies with gross income above $3M. The reason we use $3M is that many of the national brokerages use this as the point where they will consider acquiring an agency and creating a regional office. As buyers the national brokerages have the ability to use their economies of scale, relationships with carriers, brand, and financial strength to pay higher multiples than other potential buyers.
In our next blog we will discuss the second most important factor to consider when valuing an agency, which is SELLER'S DISCRETIONARY EARNINGS.