The perceived value of an insurance agency is impacted by a number of different factors, but there are three among them that will have the greatest influence.
These three critical factors are the same as those that would influence the perceived value of any type of investment, and are:
• Market conditions
• Pro forma earnings
• Risk connected with earnings in the future
Market conditions are vital to the sale of any form of investment, and timing can significantly influence the sale’s net gain. The parts of market conditions that matter can include the state of the lending market, the economic outlook, the stock market’s performance, the soft market sale position, and the tax rates of capital gains.
Pro forma earnings are the numbers examined by a potential buyer in order to discover the possible return on investment that they will achieve, and the debt service coverage that will occur on any form of financing that is used. You can take the pro forma earnings or projected renewal commissions and multiply it by a certain amount of years (between 2 and 5 is customary) to help in developing a selling price.
These are calculated from an adjusted Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) formula, which allows the real cash flow to be measured so that can be expected from the agency by a buyer.
The risk that is perceived for the future earnings of the agency will also impact the sale terms and the final price that will be offered by the buyer. The due diligence of the buyer will include a long list of different questions about the agency’s operation and its books.
They will look into details such as the type of policies, the carrier contacts, the class of business, and the size of the accounts, as well as considerations such as marketing strategies, the reputation and longevity, underwriting procedures, the sales force, and any retention plans.