That question is asked us at least a dozen times a week. Every agent wishes to get a simple response like 1.5 Times or 2.1 Times – Would that it was that simple !!!
First, let’s dispel the rumor that an agency is valued at a multiple of ANYTHING!
The best way of breaking that bubble is through an example:
Let’s say Agency A and Agency B are next to each other in a medium sized city. Each generates $1 Million of commissions.
Agency A generated $2 Million of commissions five years ago and has been whittled down by competition, soft market, etc. to its current state. It has one owner (age 67), no producers and an employee base all over 60 years old.
Agency B opened five years ago with three young producing owners and has added staff as they have grown to their current position.
WOULD YOU PAY THE SAME MULTIPLE OF COMMISSIONS FOR EACH OF THESE AGENCIES?
That’s why a multiple of commission “rule of thumb” simply doesn’t work. And we didn’t even address the issues of non-standard vs. standard business, owned vs. brokered business and volatile or target accounts vs. standard accounts.
We have also realized that value is in the eye of the beholder. The buyer simply looks at an acquisition as a source of cashflow. The cashflow must pay for the property purchased over a reasonable number of years, after which it accrues to the benefit of the owners of the purchasing agency.
On the other hand, if you are the seller, the value of your business is often represented in terms beyond simple cashflow. There is the added value because of the “sweat equity” that you have spent in building it and because of the relationships you have created that will (theoretically) keep your customers for a long time. Many owners actually resent the cashflow method of agency acquisition because they feel that the acquirer is purchasing THEIR agency with THEIR money (the continued revenue flow of the business). What the seller fails to recognize is that the buyer assumes the responsibility for retaining and managing that business (for which the owner has received his paycheck prior to retirement) and takes the risk associated with the business continuation. If the business falters, they are still expected to meet their financial obligations. Finally, the seller approaches value in terms of his NEEDS.
Need and Value are different concepts. But they become confused when an agent desires to retire and begins to calculate the financial needs required to maintain his standard of living. If you need $250,000/year to sustain your normal life-style and you are generating $80,000/year through your outside income sources, you feel that the agency sale must support $170,000/year in income. But for how long? Agents who retire relatively young may need 20 years of income! – That is the calculation of NEED for the selling owner.
The Fair Market Value calculates the cashflow and risk potential to the specific buyer including the time that he is willing to forego profit from that acquisition while the pay-out occurs. What happens if that agency value only supports $100,000/year payments for seven years? Agents then face the unenviable task of scaling back their standard of living (not easy for a high-flying entrepreneur) or refusing an offer that provides the Fair Market Value for their agency.
It’s important for buyers to realize that, sometimes, offers are rejected, not because of greed on the part of the buyer, but because of the gap between Need and Fair Market Value.
One thing that sellers often fail to calculate is the reduction in living costs associated with the cessation of a career. Even though you may spend more time traveling or in leisure activities, personal expenses of a business owner related to business social or civic activities are often substantial. These diminish quickly once the owner retires and he will have more disposable income (or need less) to maintain his lifestyle.
Whether you are buying or selling an agency, if you step into “the other man’s shoes” when considering an offer or a selling price, you will find the transaction can be accomplished in a less stressful manner. The seller can calculate both his financial need and a pro-forma of the cashflow potential of the agency in another agent’s hands. He will understand if any gap occurs and will not have to face a real anomaly when a buyer offers a price that, while fair, falls short of the seller’s needs. The buyer should always ask about the financial needs of the seller to determine whether or not an offer should be made on the available asset. If the seller has unrealistic requirements, valuing and performing due diligence will be an exercise in futility.