When buying or selling an agency, is the value based on what the agency made in the past or what it will earn in the future?

Agency Consulting Group, Inc. is one of the nation’s leaders for performing valuation for agencies annually. The majority of agency valuation is for internal purposes such as for estate planning, partnership stock values, ESOP, etc., but many are for potential transactions from sales to mergers and to purchases and other forms of association.

A recent call illustrated the common fallacy attached to agency valuation.

An agency owner was interested in acquiring another agency and asked Agency Consulting to perform an agency valuation prior to the purchase. The target agency was generating around $500,000 in total revenues, but it was growing at 10% /yr. and was dropping several hundred thousand dollars a year to the profit line. They were very efficient and their market didn’t require a host of employees. The owner was going to stay on to manage the agency for five more years before his retirement but wanted to cash out now for personal reasons.

As you can imagine, the value of the agency was relatively high, much more than the proverbial “multiple” to which so many agents still tie themselves. The buyer called me asking why the value was so much higher than his expected multiple of last year’s revenue. I asked him the very question that I asked at the beginning of this article.

Did the buyer want to buy the agency’s history or its future earnings potential?

The answer, of course, was that the buyer wanted to buy future earnings.

So I proceeded to show the buyer how we project both income and expenses on a line-by-line basis based on the agency’s history and any changes that we know or suspect will occur once the transaction takes place. Since there were none, the agency was going to continue to run as is with the same staff in the same place, just using the additional markets of the buyer, we were able to simply progress each line of income and expense based on the agency’s historical trend and contracts (leases, etc.) and form the projected profit stream of the agency against which we took the buyer’s tax liabilities. We told the buyer that this agency would likely throw off more than $1.5 Million of value over the next five years, even with a 14% discount for risk factors associated with that particular agency. This means that the trend would have generated 14% more than our value estimate but we found sufficient risk factors associated with the agency to discount the value for our estimate.

The buyer was in shock that the value was so high again falling back on his favorite multiple “of something”. So I turned the tables and asked the buyer, “If you owned this agency and someone wanted to buy it from you and you projected that you as the owner would take over $1.5 Million in earnings from the agency (after taxes) in the next five years, would you be concerned over the multiple that represented, or would you want to be paid in some degree what you would likely have made over a period of time as your asset value?”

When he thought about the situation from that viewpoint, the buyer admitted that he would expect a reasonable price equivalent to what he would make in the agency if he kept it. “So,” I asked, “ Wouldn’t it be logical to pay the seller a fair price for the agency, giving up some or all of the profits of the agency for a period of time (determined by the buyer) to purchase the agency, after which ALL profits would accrue to the new owner including the cost savings once the old owner retired?”

This put the question of Value vs. Multiples in perspective. You, too, can judge the value of any agency that you are considering buying or considering selling your own agency in the same way. It is of utmost fairness to identify the earnings (after taxes) that the seller would generate from operating his agency in the future AND the earnings that a buyer would generate from the agency if he were to purchase it. Somewhere between those two dollar amounts is the proper value of the agency in a sale.

Please reach out to us for our valuation service or, to conduct due diligence and assist the buyer and seller negotiate the price and terms of any transaction to the end result of a Win/Win situation.