THE AGENCY IN PERPETUATION
How and when should one plan for
passing the business on?
By Lori Widmer
In May 2021, the U.S. Bureau of Labor Statistics recorded 422,600 insurance sales agents working in the insurance industry. According to Data USA, the average age of these agents is just under 45 years old. For agency owners eyeing retirement, the question looms larger with each passing year—how and when should one plan for passing the business on?
While the “how” varies depending on several factors, the actual planning should already be happening, according to John Tiene, managing director of Strategic Agency Partners. That’s because, Tiene says, most planning requires a hard look at what the agency owner wants, how to achieve it, and what needs to be in place to make that transition a smooth one. He says the average time needed to complete a perpetuity plan is anywhere from five to seven years.
Yet, in reality, the perpetuity plan should be a second step in the process, Tiene adds. There should be a plan in place no matter what age the agency owner is in order to resolve any potential unforeseen circumstance such as the sudden passing of the owner. “Agents should, as part of good planning, have a plan for the ‘if something happens to the agency principal, what do you do?’ scenario,” says Tiene. Once that plan is in place, agency owners will have an easier time figuring out the logistics of transferring the agency business to another person or entity.
“No two agencies are alike. The organization, like any small business, reflects the personality of its owners and leaders … .
Perpetuity and that process of transitioning the agency to the next iteration is a unique experience for each agency.”
Strategic Agency Partners
Tiene says there’s plenty of emphasis on the “entity” part of that equation. “There’s no denying the major trend, if you believe all the numbers that are collected by the people who promote the trend, is that private equity is doing the dominant amount of agency acquisitions now,” he says.
That’s exactly what Michael Mensch is seeing, as well. “The value growth of insurance brokerages over the last five to 10 years was nearly all driven by private equity,” says Mensch, CEO and partner with Agency Brokerage Consultants. “Roll back to 2008 and there were only a handful of private equity-backed players in the industry. Today, we have over 30, and valuation multiples went from five to eight times EBITDA in 2008 to eight to 12-plus times in 2021.”
Mensch says that in the mergers and acquisitions (M&A) space, the last seven years have been “a wild ride … . Agency valuation multiples climbed approximately 50% from 2016 through 2021. Nearly every year was a consecutive record breaker in terms of the number of announced acquisitions. The threat of a capital gains tax hike in 2021 threw fuel on the fire and drove a mad rush of exits in Q4.”
Not that all agency sales were to private equity entities. Tiene says that reported sales don’t tell the whole story and says that those promoting the private equity deals are giving agency owners the wrong impression of what their options are. “There are, I think, an equal amount of agency transactions going on that are private. I’m involved in one now. When it’s done, no one will know about it.”
Mitch Jones, senior vice president of sales for Capital Resources, LLC, says the private equity deals gained traction amid the pandemic. Owners who’d decided prior to 2020 to hang on a few more years were hit hard during the height of the pandemic. “Two things happened,” he says. “One was that big companies—MGAs or private equities—swooped into the market and started to buy up a lot of these agencies. Also, buyers looking to continue their enterprise value or grow their footprint are up against competition that seems to have deep, deep pockets.”
The agency owners looking to exit the market were increasingly younger, notes Mensch. “The last few years saw a higher volume of younger (under 55) agency owners sell. The motivation for them was to capitalize on what some called a once-in-a-lifetime opportunity: sell at a high valuation multiple, take 15% to 30% of the proceeds in the form of the buyer’s stock, which in many cases was increasing 50%-plus per year, and work hard for a few years to maximize an earnout. For some, the opportunity translated to yielding two to three times more for their business.”
Private equity also lured plenty of owners who were struggling in a difficult market, in which growing an agency has become a real challenge. Yet, so much private equity brings up another challenge—how others in the market wanting to buy an agency can compete with the private equity crowd. Because larger companies are driving the prices up in the independent market, Jones says, “especially with the cost of capital. With rates being so low, you can pay more for these agencies.”
Invariably, the rates will come down, Jones adds, and new owners will lose equity. He likens it to the current housing market, where buyers are competing for homes, and home prices are climbing as a result. Over the next year, many of those new home owners could well lose up to 25% of the home’s value, he says. “Now they’re upside down for what they’re worth. That’s what’s happening in the independent world. These last two years, valuations have skyrocketed.”
“In addition to getting a better pulse on the agency’s value, the valuation process usually provides owners with insight into what should be addressed to enhance the value of the business.”
CEO and Partner
Agency Brokerage Consultants
Planning the exit
That’s why a five- to seven-year plan makes more sense, says Tiene. Agency owners need to slow down and review their options, ideally with expert help. “No two agencies are alike,” Tiene says. “The organization, like any small business, reflects the personality of its owners and leaders … . Perpetuity and that process of transitioning the agency to the next iteration is a unique experience for each agency.”
Tiene suggests agency owners meet with advisors to look at the process in detail. He will “sit with the owner and talk with them about their desires, their needs, and what they hope for the agency after they’ve moved on.”
Mensch adds that owners should get their agency evaluated regularly during the years leading up to their exit. “In addition to getting a better pulse on the agency’s value, the valuation process usually provides owners with insight into what should be addressed to enhance the value of the business.”
Tiene advises agency owners to not take too much stock in what they read about other agency deals. “They see that an agency across town just sold to a big private equity shop and how much money was made and how simple the transition was,” he says. “It’s never simple. It’s highly personal. And it’s something that every agency owner, regardless of where they are in their career, needs to think about.”
The moment agency owners begin the process, Jones says, the real work begins. “You have to know your book—your expenses, your income, your cash flow. Avoid focusing on growth through acquisition rather than on organic growth.”
Mensch recommends always going to market. “The majority of our 250-plus seller clients didn’t know the firm that ended up buying their agency when we started our process. From the seller’s perspective, the benefit of going to market is (1) see all of the options avail-able, (2) yield the best overall deal possible, and (3) greatly increase the odds of actually getting a transaction completed.”
“The people who have struggled over the last two years are the people who have called me to refinance. Reamortization has been big with owners in the last couple of years, and we expect to see it in the upcoming years until we see what rates are going to do.”
Senior Vice President, Sales
Capital Resources, LLC
Should an owner sell to an employee? Mensch says those sales come with distinct challenges. “Does the individual have the financial wherewithal to buy the agency? Do they have experience running a business and managing people? Certainly, internal perpetuations occur, but the off ramp for the departing owner(s) is typically much longer and the success rate is lower due to the limited pool of internal candidates.”
From there, think strategically about financing. Jones says that buyers need to consider longer terms in order to balance out the payments and take advantage of any future refinancing when rates drop. He sees a lot of borrowers wanting a five-year term on their loans. “I ask why and they tell me they don’t want to pay that much interest. But there’s always the option of paying that loan off quicker.”
Reamortizing is also a strategy for some agency owners who had purchased an agency under less appealing terms. “The people who have struggled over the last two years are the people who have called me to refinance. Reamortization has been big with owners in the last couple of years, and we expect to see it in the upcoming years until we see what rates are going to do.”
Before selling to anyone, Tiene says that every agency owner should clean up their house. “The employee base of an agency is a very valuable asset along with the business and whether the agency is growing. Are you growing? What’s your agency made up of? Mostly personal lines? That book of business is worth something, but not worth as much as a larger agency that is growing and moving forward.”
The checklist of things that need to be in place, says Tiene, makes it easier for agency owners to focus on areas of improvement. “I have to make sure that I’ve cleaned up and tightened up my book, make sure I’ve grown every year with new clients, and make sure my producers are in place and growing. By going through that checklist, you can enhance the value of your agency over time,” he concludes.
For more information:
Agency Brokerage Consultants
Capital Resources, LLC
Strategic Agency Partners
Lori Widmer is a Philadelphia-based writer and editor who specializes in insurance and risk management.