Structuring a successful insurance company sale

The successful sale of an insurance business starts with a strong valuation. However, the structure of the sale is also important as it can impact how much the seller walks away with. Understanding both the complexities of valuing an insurance business and the different sale structures is essential for maximizing the outcome.

Where to start a valuation

According to Chris Hughes, managing director of insurance distribution at M&A Services, “insurance distribution firms, whether those are retail agencies, wholesale agencies, management companies or risk retention groups - any kind of firm that sells the insurance product - those types of businesses are sold off of a multiple of pro forma EBITDA (earnings before interest, taxes, depreciation and amortization).”

Creating a pro forma income statement on which to base EBITDA involves normalizing the revenues and expenses of the business so they will more accurately reflect its expected performance after the sale. In a privately-owned insurance business, that means taking out expenses for family members listed as employees for insurance benefits, adjusting actual salaries for owners and team members either up or down to reflect market rates, and removing business-funded perks such as company cars. It also means subtracting from revenue any one-time bonus commissions that would not be expected to continue after the sale.

Once the adjusted (pro forma) income statement is complete, EBITDA can be calculated. According to Hughes, the expected multiples will vary based on the size of the business, ranging from 8x to 10x for businesses with EBITDA between $500,000 and $2 million all the way up to 12.5x to 14.5x for companies with EBITDA exceeding $5 million.

What drives valuation?

The three biggest contributors to higher valuations, Hughes said, are maximizing organic growth, having a deep bench, and increasing the size and scale of the business.

• Organic growth – Buyers are attracted by businesses with a positive trajectory of organic growth, which comes from bringing on new clients, offering new services and bundling products to expand per-client expenditure.
• Having a deep bench – A company with a strong team is more attractive than a one-person shop. Buyers want to be confident there will be motivated team members to keep the company growing after the sale.
• Size and scale – As noted previously, the size of the business impacts the value multiple that buyers are willing to pay. The larger the company is, the higher the potential multiple will be.

Maximizing valuation through deal structure

Insurance company sales can be structured in many ways, with varying effects on the seller’s eventual payout. The best deal will depend on what combination of the following components are structured into the sale.

• Closing consideration (cash and cash equivalents due at the time of sale)
• Buyer’s equity (a seller’s stake in the buyer’s agency)
• Seller’s equity (a seller’s opportunity to retain ownership in the agency they’re selling, for a specified period)
• Earnout (a portion of the sale price that’s payable upon the business reaching certain performance targets in a set period after the sale)
• Seller financing (a promissory note payable by the buyer held by the seller, separate from any financing provided by an outside lender)

Owners who are willing to stretch out the buyer’s payments by taking buyer’s equity or maintaining seller’s equity may earn a higher payout than an owner who wants to collect a lump sum and walk away. Agreeing to an earnout may allow a seller to get a higher asking price, demonstrating that they have confidence the business will continue to perform at a high level. Choosing to offer seller financing with longer payment terms than a conventional lender could provide a way to obtain a higher selling price and potentially stretch out capital gains tax payments.

Mitigating risks

Insurance company valuations can be negatively impacted by carrier concentration, producer concentration, and client concentration. Essentially, these risks all boil down to the same thing – “having too many eggs in one basket.” Buyers will be wary of insurance businesses that are too dependent on one carrier. What would happen if that carrier decided to stop writing business in that state? Likewise, there is concern if the company is too reliant on one producer. Additionally, it’s always risky to have too narrow a client base. If one client makes up 20% of the company’s revenue, what would happen if they die or take their business elsewhere?

It's wise for a seller to work to limit these concentration risks in the years leading up to a sale.

After building a business over a lifetime, it’s natural to want a healthy return when selling it. Focusing on ways to increase valuation and making informed choices about how to structure the sale can turn a good deal into a great one.

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Rick Dennen is founder and CEO of Oak Street Funding, a First Financial Bank company. Contact him at rick.dennen@innfeedback.com.