VALUATION
DETRACTORS

Understanding decisions that can pull value away from owners at the time of a sale

A key sign that a firm is vibrant and will achieve an above-average valuation is if the average age
of the staff and ownership group is younger than industry averages.

By James Graham, CVA

Despite record valuations for insurance agencies, many owners take material discounts on value when they complete a transaction. This is often due to poor planning and bad counsel.

The rapid increase of pricing that is driving the current merger and acquisition (M&A) market can dull agency owners’ senses, as even poor results are materially better than historical expectations.

Below is a list of some decisions that can pull value away from owners at the time of a sale. While some of these decisions may be intentional, it is important that agency owners understand the trade-offs and make informed decisions on how to operate their business.

1. Corporate structure. For a variety of compelling reasons, buyers of insurance agencies prefer to purchase the assets of an agency and not its stock. This means that firms structured as a C-Corp may be at risk of taking either a purchase price reduction or being subject to double taxation. Agency owners should consult their tax and legal advisors, but unless a firm plans on having multiple classes of stock or over 100 shareholders there isn’t a compelling reason for a firm to be structured as a C-Corp. It takes five years to fully convert to an S-Corp, so make the change today.
2. Cluster/aggregator relationships. Joining a cluster or aggregator network to gain market access and maximize contingency income is a positive. However, buyer beware, as some of these networks have contracts that can significantly reduce a firm’s value. Avoid networks that require a first right of refusal or require termination fees. There are some networks that extract so much value from their members if a transaction occurs, they effectively make selling at a market price impossible.
3. Overpaying producers. It is common to see agency owners use high renewal commission rates to recruit producers. MarshBerry data suggests that producers who earn higher renewal commission sell less new business and that the best producers don’t often leave their employer over commission splits. Further, at the time of the sale there will be pressure to “right-size” producer compensation. Every producer who gets a compensation change will likely need to get paid, making them de facto equity shareholders. It is often better to have a robust equity plan to reward producers with actual equity or equity-like instruments.
4. Non-employee producers. The value of an insurance agency is largely in the relationships between the agency and its client base. Having 1099 or non-employee producers can result in a significant drag on value, as buyers will want to establish clear ownership of the agency’s relationships, and 1099 producers are, by definition, independent. While there are cases in which having a 1099 relationship will make sense, it should be the exception and not the rule. These relationships must often be bought out in a sale.
5. Average employee and owner age. A key sign that a firm is vibrant and will achieve an above-average valuation is if the average age of the staff and ownership group is younger than industry averages. On the other hand, buyers will perceive additional risk if the average age of employees is closer to or even beyond retirement age. This is because the effort to backfill these positions can be expensive and onerous. If an agency owner holds on too long or doesn’t have multigeneration representation among its staff and leadership, the valuation discounts can be devastating.

The items listed above are just a sample of things that affect agency value. As an agency owner, think ahead and avoid some common missteps. These examples should also illustrate the need to obtain an outside perspective and seek a professional for assistance.

Doing so can prevent owners from operating with their heads in the sand, which could cause them to lose a material amount of value when it is time to sell. n

As of March 31, 2022, there have been 91 announced M&A transactions in the United States this year. Activity in the first quarter was noticeably slower compared to the last four years. However, activity is anticipated to pick back up starting in the second quarter.

Private-capital-backed buyers accounted for 67 (73.9%) of the 91 transactions through March, which is consistent with the proportion of announced transactions that we have observed over the last five years. Total deals by these buyers have increased at a Compound Annual Growth Rate (CAGR) of 26.9% since 2018.

Announced transactions by independent agencies have declined considerably to start the new year. On average, 23.1% of deals were completed by independent agencies from 2018-2021 compared to 9.9% in 2022. High valuations and availability of capital could be two of the main drivers for this section of buyers’ decline in deal activity.

Strong deal activity from the marketplace’s most active acquirers has remained constant to begin 2022. Ten buyers have accounted for 53.8% of all announced transactions observed, while the top three account for 24.2% of the 91 total transactions.

Three notable transactions recently announced include:

March 1: Hub International Limited and Bold Penguin announced an agreement to acquire Insureon Holdings. Insureon is a digital insurance agency that delivers small-business insurance through its online marketplace. As a part of the transaction, Hub will acquire Insureon’s digital insurance agency and brand, while Bold Penguin will acquire its technology platform.

March 8: Keystone Agency Partners announced its acquisition of Strategic Insurance Partners (SIP). Based in Nutley, New Jersey, SIP has been providing insurance solutions for over 100 years, with a specialization in serving Hispanic business owners in the construction, professional services and municipality sectors.

March 16: Unison Risk Advisors (URA) announced a strategic investment partnership with Peloton Capital Management (PCM), a Canadian private equity firm. URA was formed in 2020 through the merger of Oswald Companies and RCM&D. The firm ranks among the country’s 30 largest insurance brokerage and risk management firms overall and in the top five largest independently owned firms. With the transaction, URA remains privately held, and majority employee-owned, with PCM gaining a minority ownership position. MarshBerry served as the exclusive advisor to URA.

Investment banking services offered through MarshBerry Capital, LLC, Member FINRA and SIPC, and an affiliate of Marsh, Berry & Co., LLC. 28601 Chagrin Blvd., Suite 400, Woodmere, Ohio 44122; (440) 354-3230. Disclosure: All deal count metrics are inclusive of completed deals with U.S. targets only. Scorecard year-to-date totals may change from month to month should an acquirer notify MarshBerry or the public of a prior acquisition; 2022 statistics are preliminary and may change in future publications. Please feel free to send any announcements to M&A@MarshBerry.com. Source: S&P Global Market Intelligence and other publicly available sources.

The author

James Graham joined MarshBerry in 2015 and is a vice president on MarshBerry’s Financial Advisory team in its Dana Point, California, office. His expertise includes merger and acquisition advisory, capital raising, business valuation, perpetuation and succession planning, and strategic planning. James provides his clients with customized financial and capital strategies to help them accomplish their goals. He also is a facilitator for MarshBerry’s Connect Network and actively publishes articles relevant to the insurance distribution marketplace.

Prior to joining MarshBerry, James was a Senior Consultant with Deloitte Consulting LLP.

James currently maintains the FINRA Securities Industry Essentials (SIE®) Exam in addition to the Series 62, 79 and 63 FINRA Registrations through MarshBerry Capital, LLC, the affiliated FINRA-registered broker-dealer of Marsh, Berry & Co., LLC. He earned a Bachelor of Science in Finance from Azusa Pacific University and a Master’s in Business Administration (MBA) from George Mason University. He is also a Certified Valuation Analyst (CVA). Contact him at James.Graham@MarshBerry.com or (949) 272-0351.