How are Insurance Agencies Valued?

If you’ve ever wondered how to properly value an insurance agency, this is your article. Just throwing out blanket statements of “An insurance agency is worth 2.5x revenue or 8 times EBITDA” can get you in trouble quick if not properly assessed. The good news is that the basis for many offers and negotiations is a multiple of EBITDA, however there is a bit more that goes into valuing an agency.

Uniform Standards for Business Appraisals

Appraisals can have many uses other than preparing for a company sale, so it’s important that the methods, accuracy, and reliability of the analysis meet a high standard. The IRS recently announced a change to rules regulating appraisers due to persistent problems with valuations used for gifting of estate planning purposes.

The Uniform Standards of Professional Appraisal Practice (USPAP) is a guide issued by The Appraisal Foundation; an organization authorized by Congress to issue appraisal standards. Appraisers are considered professional practitioners but are not regulated by a state board like CPAs, Engineers, Attorneys, or other professions which require licensing.

Agency owners planning for a sale, or other valuation uses, should work with an experienced firm that has a proven track record for agency valuations and adherence to USPAP standards.

Why Do You Need An Agency Valuation?

There are a few ways to conduct and complete a valuation analysis without a one size fits all approach. The first thing to determine is the Purpose of the agency valuation. Is it to determine the market value of the business, establish a value that is financeable by a lender, establish a value defendable to the IRS, such as for estate planning, or some other purposes.

The Purpose of the valuation will drive the Standard of Value (e.g. Fair Market Value or “FMV”) and the Premise of Value (e.g. Going Concern premise), which in turn drive the financial adjustments, methods, and discounts/premiums applied to the analysis.

For example, the valuation of an insurance agency for the purpose of determining a share price for an internal sale could be drastically different from a valuation for the purpose of determining the market value of the agency. The projected cash flow is often much different since in one scenario the business is likely to stay status-quo, whereas in the other scenario the valuator may incorporate expense reductions and other synergies that are expected to be realized if the agency were sold to a larger firm. Selling a minority interest (i.e., shares) also warrants a discount since the purchaser is not acquiring control over the business and would require evaluating the balance sheet since the buyer of the shares will become an owner of all company assets.

Generally speaking, though, the Fair Market Value Standard and Going Concern Premise are used in the majority of business valuations, including those involving lenders or the IRS.  Once the Purpose, Standard of Value, and Premise of Value are known, next up is looking at the approaches to valuing a business and, underneath those, the methods to valuing a business.

• Fair Market Value is defined as the price a willing buyer and seller would exchange for a business in a transaction in which both parties have knowledge of all relevant facts.
• Going Concern Premise is defined as the value of the business assuming it will continue to operate into the future as it has in the past.

Approaches to Valuing a Business

In the insurance industry, most people talk about valuing an agency on a revenue multiple or EBITDA multiple. This approach falls under what is called the Market Approach, which is one of the three valuation approaches:

• Asset Approach – Determines a business’s value based on the value of the underlying assets, generally the tangible assets. This isn’t typically relevant for insurance agencies due to a book of business as an intangible asset.
• Income Approach – Determines a business’s value based on its projected earnings and relevant investment return criteria.
• Market Approach – Determines a business’s value based on what other “comparable” businesses have been valued at either in the private or public market

USPAP standards require that a valuation professional consider different approaches and apply multiple valuation methods with an explanation for the reasons for including/excluding any method and why any discounts/premiums were applied to the results.  Why? Not every valuation method is appropriate for each valuation, so the valuator is expected to use his/her expertise to ascertain what is applicable and then provide a defense of the choices and conclusions.

In relation to valuing insurance agencies, the challenges of applying a one-size-fits-all approach to value are numerous:

• Revenue multiples ignore operating efficiencies and cost structures.
• EBITDA multiples ignore the quality of the revenue and revenue risks.
• Private Market Transaction Data is very limited, often lacks transaction details, and includes non-comparable transaction data.
• Public Market Transaction Data requires significant discounts to make the data comparable to a smaller, privately held agency, if possible.
• Capitalization of Earnings Method assumes stable earnings and cost of capital.
• Discounted Future Cash Flow Methods assume predictable earnings and stable cost of capital.

From an appraisal perspective, leaning too heavily on one method can lead to a drastically inaccurate conclusion. Therefore, a prudent valuator will seek to apply multiple methods to valuing the agency to bracket a range of value from which they can then draw an appropriate conclusion of value using a defendable analysis balanced against their own expertise and industry knowledge (“knowledge” being important and a point I will revisit).

Common Valuation Methods for Insurance Agencies

1. Income Approach

• Capitalization of Earnings calculates the value based on the current earnings and a reasonable expected rate of return. This is done by getting to the pro forma earnings, typically EBITDA or Free Cash Flow, and dividing that by a capitalization rate. While this approach is a great way to compare one investment return to another (e.g. real estate to a business), the major downside of this method is that it doesn’t effectively take into consideration earnings risk or market conditions.
• Discounted Future Cash Flow calculates the cumulative present value of future cash flow. This method uses the same discounts and capitalization rate but is completed by creating a projection of a predictable future income stream for an investor. The DFCF approach is only as good as a the projections that it relies upon, which means that if the financial projections are not realistic than neither is the imputed value.

2. Market Approach

• Private Market Comparables calculates the value by leveraging data on privately held agency sales. This method looks at revenue and earnings multiples of comparable agencies that have sold. While this method is the most applicable for determining the market value of an insurance agency, the analysis requires that the valuator has access to, and detailed knowledge of, a sufficient volume of privately held agency sales. Critical variables include when the comparable agency sold (market value changes over time), the size and growth rate of the agency, the type of agency, where it was located, and many other relevant factors.
• Public Market Comparables calculates the value by leveraging data on publicly traded insurance brokerages. Similar to the above, the method looks at revenue and earnings multiples.  Given the differences in size, management, financial reporting, revenue diversification, and an assortment of other features between a publicly traded company and a privately held one, the greatest challenge is in trying to discount the public market comparable data so that it can be deemed comparable to a much smaller, privately held insurance agency.  The valuator must also incorporate discounts for the differences in control and liquidity between buying a public company’s stock and a 100% interest in a private company.

Sources of Bad Agency Valuations

Our firm has completed thousands of agency valuations and reviewed dozens of reports performed by other firms. Here are the biggest causes of bad valuations:

1. The valuator does not follow professional practices.

One mistake is that Purpose of the valuation is ignored when developing the analysis, which results in improper adjustments being made to the financials. The second mistake has to do with Apples-to-Oranges comparisons being used, such as a P/E multiple of a comparable company being multiplied to an EBITDA of the subject company (FYI – the two are drastically different) OR using comps of agency sales when valuing a book of business sale (FYI – not the same).

2. The valuator does not understand the insurance industry.

This mistake happens when valuations are done by generalist appraisers or accounting firms. They don’t understand the industry (carriers, lines of business, nature of relationships, reports, financial models, etc.) nor the market value.  They are confident in their ability to perform the assignment, until challenged by someone that knows more.

3. The valuator does not have access to agency sale transaction data.

This happens when agency consultants are used to perform a valuation. Because of their industry knowledge, they will incorporate all sorts of industry and economic charts to dazzle the reader, but the valuation is based on theory and gross assumptions since they do not have access to real data nor negotiate transactions in the marketplace. They may understand your agency, but they don’t know what value buyers in the marketplace would put on it.

4. The client withholds information from the valuator.

This happens at no fault of the valuator. The client either intentionally withholds information or simply can’t produce it.  As the saying goes, “garbage in equals garbage out.”  A valuator can’t accurately value a business asset if they do not receive all of the relevant information.

Bringing it All Home

Insurance agencies and valuations are both incredibly nuanced. The first questions to be answered for any valuation engagement are “for whom?” and “for what purpose is the valuation needed?”  The answers to those two questions have a waterfall effect on how an appraiser will tackle evaluating the agency, including handling financial adjustments, selecting appropriate valuation methods, and sorting through a variety of other decisions in the course of completing the analysis.  Additionally, make sure that you work with a professional experienced in valuing and selling insurance agencies to avoid wasting your time and money pursuing what ultimately is a bad valuation report.

Key to Success

1. Be clear from the onset about why you want/need a valuation of your insurance agency.
2. Provide the valuator with the information that they need so that they understand the full picture.
3. Work with a firm that actively sells insurance agencies so that they intricately understand the industry and have access to real market data.
4. Work with an experienced business appraiser so that your evaluation is handled according to professional standards.   They should have designations such as Business Certified Appraiser (BCA), Certified Valuation Analyst (CVA), or Accredited in Business Valuation (ABV).

Agency Brokerage Consultants has performed over 3,000 valuations for agencies and assisted in over 500 agency M&A transactions. If you’ve never had a formal evaluation completed of your agency, or even a second opinion of a valuation contact us to get started.