Strategic Resources for Your Insurance Agency

How can you Determine the Value of your Agency?


If only the value of your agency were listed everyday in the Wall Street Journal like stock prices of public companies!   You would be able to track the changes in value from the impact of the hard or soft market, new or lost business, new producers, healthcare reform, market consolidation, or many of the other factors that contribute to the determination of value.  But in reality, even  Wall Street ‘s values aren’t perfect, as we’ve all seen many instances where publicly traded companies are subject to wild swings based on rumor, political discord or international calamities.    

So how does an agency principal determine the value of their privately held business if one of the most efficient markets in the world on Wall Street is not perfect all the time?  The reality is that “value” has a number of definitions, and you first have to know which version of value is being considered.  Each of the following terms is used to describe value, but they will likely all have different results:

  • Fair market value, or internal sale value
  • Replacement value
  • Investment value (value to a specific buyer)

The most common of these are Fair Market Value and Investment Value, but even these generally result in very different numbers because of the underlying assumptions implicit in their respective calculations.  Replacement value is not relevant as an insurance agency’s value is principally in its intangible assets or the book of business, not the hard assets like cars and houses. 

Let’s start with Fair Market Value (“FMV”), where the Internal Revenue Service ("IRS") Revenue Ruling 59-60 defines value as:

"the price at which the property (or business) would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell; both parties having reasonable knowledge of relevant facts.”

Combined with the other requirements of the IRS Revenue Ruling, the core presumptions of the FMV process is for a hypothetical buyer making a cash purchase of the existing operations of the business without regard to any specific synergies or cost savings that could be realized in a third party sale.  This is often referred to as the internal transaction value, as it is generally used as the basis for sales between current owners, for internal perpetuation, estate planning and related purposes.

The benefit of a FMV study is that it approaches the value of the business from an unbiased and objective perspective.  Despite the name, the FMV may not be indicative of the value of the business if it were being sold in the open market, as will be discussed in more detail below. 

Once the FMV of the core business operation has been established, it can be used as a reference point in the future.  Using earnings or revenue multiples, assuming there hasn’t been a material change in the core operations and risk attributes of the business, the agency principal can apply the respective multiples from the FMV to current Pro Forma revenue or profits to estimate the FMV of the core business, then add or deduct the net value of applicable assets and liabilities.  The key here is to develop an appropriate Pro Forma statement of revenue, expense and profitability as this may be materially different than the actual results.

During the valuation process, the appraiser will closely review the actual revenue and expense components to determine whether there is anything unusual, non-recurring or missing in order to arrive at the Pro Forma totals.  Additionally, expense items such as excess owner compensation or discretionary expenses must be adjusted to arms length amounts in arriving at Pro Forma earnings. 

Once the appraiser has established the Pro Forma revenue and expenses, and assessed the appropriate risk attributes of the specific firm in question, there are several different series of calculations and projections that can be used together to establish the value of the core earnings of the business, or the Business Enterprise Value (“BEV”).  This is generally the most significant component of value to any particular business, but the FMV must also include a review the assets and liabilities of the business.  The net value of the balance sheet needs to be added or subtracted, on a dollar for dollar basis, from the BEV to arrive at the FMV.  The main components of the balance sheet include the following:

  • Working capital:  generally additive to value if more than 10% of Pro Forma expenses, or a deduction from value if less
  • Non-operating assets such as automobiles, cash surrender value of life insurance, notes receivable from non-owners, investments and real estate are all additive to value based on their current market values
  • Long term debt, recorded or unrecorded deferred compensation or similar obligations and non-owned books of business are examples of items that would be deductions to the value of the business.

The combination of the value of the core earnings of the business or BEV and the net adjustment for assets and liabilities will yield the fair market value of a 100% ownership position of the business.   Depending on the level of assets and liabilities of the business, there could be a material difference between the BEV and the combined FMV.  Being aware of and understanding the distinction between these two value components is critical when considering each unique situation.

The other value agency principals are often interested in is the potential sales price in the marketplace.  We’ve all heard the stories of how some agencies sell for 10x earnings or 3-4x revenue, and the natural reaction is this should apply to apply to everyone’s agency.  Unfortunately, often times these kinds of numbers are very misleading, or they represent a unique set of circumstances that will virtually never be replicated. 

For example, a seller being paid 30% of their renewing commissions for 10 years may report to their peers that they sold for 3x revenue.  In reality, assuming even 5% annual attrition and a 5% discount rate, the real value of this sale is less than 1.9x revenue.  Over a 10-year period, a 5% annual attrition rate would likely be very conservative, especially if the selling principal is no longer involved with the agency and their former accounts.


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