As most readers know, Agency Consulting Group, Inc. does a lot of valuation work. While it is only one part of our consulting offering (visiting agents to make them more productive and profitable continues to be our ‘mainstay’ service), valuation is critically important to agencies in transition – succession and perpetuation situations.
When our role is limited to only a Valuation with the client retaining responsibility for the negotiation and pricing of an acquisition, it astonishes us how often the Fair Market Valuation becomes just one component among many of final agency price instead of THE primary component of agency value.
Regardless of how often we reiterate our methodology, acquiring agents become lost in the transaction and overshoot the affordability of an acquisition to conclude a purchase. IF YOU PAY TOO MUCH FOR AN ACQUISITION IT BECOMES AN ANCHOR INSTEAD OF AN ACCELERATOR TO PROFIT.
The principals of valuation require us to calculate the future earnings potential of an agency and the cash flow potential of the agency as components of its value.
The Future Earnings Potential determines what the value is to the buyer based on the changes (if any) that will be made to the target’s operating income and expenses and the chance that the projected results will actually occur to yield the expected results. The Cash Flow Potential of the agency tells the buyer over what period the payments need to be made in order to use the acquisition’s cash to pay for the transaction without imperiling the buyer’s own income stream.
So, if we value an agency at $1 Million and tell a buyer that he will be able to pay for the acquisition over five years we mean that, with the knowledge of the agency’s past performance and trends, we feel that the agency is worth five years of its cash flow after which it is expected to perform to enhance the annual profits of the host agency.
Our valuation includes discounting the earnings potential of the agency by considering up to 300 risk factors that could impact its chances of successfully attaining those earnings (both positively or negatively). It also includes changes that the buyer of the agency (whether internal or external) intends to make in the agency’s operations to enhance its top line or bottom line growth.
And our valuation also includes a Cash Flow Analysis that will tell the buyer when the agency will be in positive or negative cash flow positions that would add cash or require the buyer’s cash to pay for the agency including principal and interest. This Cash Flow Analysis is given to valuation clients as a spreadsheet that can be changed to show the buyer the effect of any changes made to Price, Down Payment, Terms, Interest Rate and Tax Rate.
So when we tell a buyer that his acquisition is worth $1 Million over five years and he pays more or over a shorter period of time the buyer is using his own money in the hopes that the acquired agency will generate more income or greater profit or cash flow than our projections. While that is certainly possible, since we have been valuing agencies for over 35 years our track record of valuation accuracy has been very strong. Agency Consulting Group, Inc. values many agencies relative to their Strategic Planning and we facilitate those plans over many years including annual re-valuations to validate and change projections. Our original valuations are generally within a few percentage points of our projections over five year periods in the future.
Unfortunately, once a buyer gets enthusiastic about a potential acquisition he may pursue it beyond the reasonable realm of its value or cash flow to his agency. Of course you can buy as many agencies as you desire if you overpay in either total value or in cash flow payments. But a fully reasonable acquisition becomes an albatross around your neck if you have to spend more money than the agency will provide you over so long a period of time that you are ready to retire yourself before you have gotten the benefit of the potential net profit on the agency.
Enthusiasm is wonderful for an acquisition until and unless it makes a profitable transaction unprofitable.