“WHEN A MAN DOES NOT KNOW WHAT HARBOR HE IS HEADED FOR, NO WIND IS A GOOD WIND.”
Seneca, Roman Philosopher
MAJOR CONGLOMERATOR AND AGENCY FINANCER ON THE BRINK OF BANKRUPCY …
As we write the lead to the Annual Composite Group issue of the PIPELINE, the nation is gripped in a financial crisis that threatens to overwhelm our economy. If a solution is not reached before press time of this issue, we will probably experience a deep recession or depression that will affect all of us – including the insurance agencies whose clients will fail or be unable to support their insurance costs.
This is not a discussion of whether or not a “bail out” is an appropriate response. We are treading in unknown waters and, as indicated in the quote above, Congress is trying to avoid the collapse without having a good long-term solution to the problem. I only hope that they stop their partisan politics and election year positioning long enough to realize that they must plug ALL the holes in the boat or we will surely sink together – Republicrats and Democratins, alike. I don’t know about you, but they all look the same from my perspective…
This article is meant to address the problem in a microcosm, the desire for companies to grow revenue without full regard for the costs and risks associated with those acquisitions. I am not smart enough to address the economic issues of writing and covering risky mortgages and loans. We need smarter folks than me (with no profit motive) to address that issue, lay blame and resolve the problem so that it doesn’t occur again. However, I AM smart enough to see insurance businesses, among which are the largest conglomeraters of insurance agencies, spending much more than can be afforded in the acquisition of ever more insurance agencies.
Once again I find myself screaming into the wind that MULTIPLES OF ANYTHING IS A FOOLISH MEASURE OF AN AGENCY’S VALUE!
We are Expert Witnesses on the establishment of agency values in courts all over the United States and we see a dangerous trend of agencies valued by multiples being transacted each year. When those agencies fail to generate sufficient cash flow to sponsor their purchase the buyer must reach into his own pocket to supplement the payments – or default and accuse the seller of wrongdoing to force a change to the price or terms.
One MAJOR financer of insurance agencies is about to face its financial doom. A conglomerater of agencies, this company has purchased, sold and financed many hundreds of insurance agencies over the past several years. The problem is that they did so at whatever cost was needed to complete the transaction. The result is that, especially in an economic downturn and soft insurance market, the buyers do not have the funds to pay for the costs associated with the agency acquisitions. The culprit is avarice of the company that felt it had to keep buying in order to grow revenues from the sponsorship of the loans to the new buyers. The future is unclear for this company. It is desperately trying to restructure its loans to its good agents and clear away the loans made to people who had no business buying the agencies in the first place.
This is only the tip of the iceberg. The lesson to be learned, however, is simple. DEFINE THE VALUE OF AN INSURANCE AGENCY ON ITS NET AFTER-TAX CASH FLOW POTENTIAL TO THE BUYER.
If the cash flow can support the payments without extreme growth or cost-cutting and you don’t use ALL of the cash flow for a long period of time to make the purchase, then the acquisition “fits” the model of a good business decision. If the needs of the buyer requires you to expend more than the cash flow of the agency permits under circumstances that are “normal” to the acquired agency, or to the circumstances of the acquisition, this is a BAD “fit” and should be avoided.
We assist many agencies each year in their desires to acquire and in their desires to sell their agencies. We advise as many agencies that an acquisition is inappropriate for them as we assist in buying or selling. The primary reason is that the financial need of the seller exceeds the cash flow potential of the agency (or would require a much longer commitment to zero cash flow than is appropriate).
If you are positioned to retire and sell your agency, please stop measuring your agency’s worth by ANY KIND OF MULTIPLE. When we (or any other valuer) projects your income and expenses and develops a cash flow projection of the worth of your business, it is easy for us to convert that dollar number into a multiple (of whatever you want, revenue, commissions, earnings, EBITDA, etc). But that multiple is NEVER valid to be used on another transaction.
If you are a buyer, stop trying to “short cut” the acquisition process by either using any kind of standard multiple as an offer – or – simply paying the buyer what he wants and assuming that you can “work it out” on the back end by implementing economies of scale.
The financial world is crumbling as Washington Mutual (WAMU), the nations biggest bank failure, is taken over and sold, as AIG falters on the brink of disassembly (both Berkshire Hathaway and Hank Greenberg have expressed an interest in buying parts of it), as the major trading houses try to convert to bank holding companies and as the major brokerage firms collapse, one after another. We must remain viable businesses as insurance agencies by maintaining relatively conservative financial practices in our acquisition strategies and realistic expectations of our value in a sale.
Agencies will continue to be bought and sold. We simply want to avoid bad deals causing a domino affect in our industry as it is doing in the financial sector of the economy.