What’s your agency’s potential when you sell
By Hiren Parmar
2021 brought a red-hot Mergers & Acquisitions (M&A) market for insurance brokers with 802 deals, a 45% increase from the year prior according to Deloitte’s M&A 2022 update. The update points to slight slowdown in the M&A environment in 202[1] 3 but suggests firms with strategic planning can reap the fruits of a cooling market. Agency owners that are contemplating an exit need to have their plan in place if an opportunity presents itself.
A buyer’s initial question will always be what exactly they are buying? The valuation of an agency will often be based on the agency’s ability to generate cash in the future. The use of a forecast is critical in communicating to the buyer what they are buying. An agency’s owner who can articulate a well thought out forecast to a potential buyer can ultimately sell for much more than those that cannot.
Why take the time to make a good forecast?
A well thought out forecast helps set the expectation to the buyer of what they are buying. It is a sales tool to show your agency’s ability to make a return. No two businesses are the same- A good forecast takes some of the guesswork out for buyers. It also helps the buyer understand what the drivers of the business are. The buyer will have a lot of questions about what they are buying, and will want to see plenty of what-if scenarios. The more a seller can educate a potential buyer on how this investment will pay off for them the more likely a buyer is willing to make a deal.
What makes a good forecast?
A good forecast is unbiased. It correctly captures predictable structure in customer behavior, special events, and seasonality. It also considers macroeconomic factors such as labor trends, economic growth, and industry trends. A good forecast takes into consideration that the buyer will not always run the agency in the same way in the future. An unbiased approach creates a realistic picture of the future and can help the buyer gain comfort with what they are about to invest in.
How does one make a good forecast?
An agency must start with the historical performance of the business before it can make any assumptions about the future. At a minimum an agency should be able to produce the following metrics for the last three years.
- The number of clients won, lost, and an overall client count per year
- Revenue by product line, carrier, client, industry, producer, size, and business units
- Historical contingent income by carrier
- Fully-loaded headcount expense
- Overhead expense
Including the following supplemental historical metrics would be handy:
- What organic revenue was growth year over year
- Why customers left by reason
- How much operations headcount is needed to support the current book size
- The average annual premium increases year over year.
Identify revenue streams and create a revenue model
Next, one can project revenues based on what one thinks the producers can sell over the forecast period. This should be close to what has been done historically. Then, one can consider the renewal rates for current clients, and lastly see what churn expectations are. These should produce a revenue model that we can use to finish the forecast.
Consolidate revenue and cost
Now, you are just putting together your revenue model and all your costs. Your costs should presume what a buyer would expect to take over.
Create Contingencies
Stress tests your assumptions with external factors. Compare what the forecast looks like relative to past performance. Can you articulate the confidence you have in the changes?
Review and Adjust
You will likely have several revisions to this model as you stress test and gather inputs from your employees.
Ask for help
If your firm needs help building a forecast or creating a viable exit plan, you are encouraged to get in touch with the CPA, CEPA or banker. Exit planning is exciting and yet one of the most stressful events to go through. An investment in exit planning will enable you to save a lot of heartache later.
A forecast shows that you have a plan and are organized. It demonstrates that the agency is not just a one-man-band, but has systems in place to grow. This instills trust with the buyer as they can see potential for future growth. Buyers want to know what their return on investment (ROI) will be, a good forecast helps answer this question. A well thought out forecast is an essential part of selling your agency. By taking the time to build one, you can increase your chances of getting the best price possible for your business.
Hiren Parmar, CPA CEPA CVA is the owner and principal of HRX Consulting, a firm offering CFO Consulting, business valuations and exit planning services. Hiren is an advocate for agency owners in realizing agency potential and helping business owners navigate a successful exit.
To learn more, go to www.hrx.consulting or call 949-232-8653