A Summarized Conversation between Michael & Michael

1. The importance of making strategic decisions now regardless of when you’re selling

MICHAEL JANS

I’ll preface this with a couple of assumptions - and you can tell me if they are right.

1. Virtually every agency will sell someday.
2. While owners of different ages and interests may have a different ‘strategic horizon’ - that period between now and when they sell - no matter how long that horizon, there are strategic decisions an owner can and should make now that will seriously impact their valuation. In other words, this conversation applies to every owner.

MICHAEL MENSCH

Yes & Yes

2. The role of EBIDTA and revenue

MICHAEL JANS

Can you explain the role of revenue and earnings in determining the value of an insurance agency? Also, can you speak to the significance of EBIDTA as a percentage of revenue in determining the value of an insurance agency, and how can owners increase their EBIDTA in order to maximize their agency's equity value?

MICHAEL MENSCH

For firms with revenues over around $1M, the value of the agency is determined as a multiple of pro forma EBITDA. Let’s say the market value is 10 x EBITDA. If the agency only has a pro forma EBITDA margin of 20%, then the value equates to 2 x revenue. If the EBITDA margin is 40% (double), then the value equates to 4 x revenue (double).

The “people costs”, by far, are the most significant expense on the P&L and often where agencies go astray from the financial model. I generally look at agencies falling in to three financial models: (1) the marketing model, (2) the producer model, or (3) a hybrid of both. The marketing model is where the agency is driving new business via marketing and staff are basically taking orders. The producer model is where producers are driving new business, obviously, and the hybrid model is a bit of both. Labor expenses under the marketing model typically run 28-33% of revenues, compared to 45-55% under the producer model and somewhere in between for the hybrid.

One notable point on the hybrid model - we often notice that the owner is juggling too much to effectively manage the producers. The result is typically inconsistent producer comp plans and production. The agency will have a handful of producer that collectively don’t generate more than 20% of the agency’s revenue.

We can have a whole separate discussion on labor costs because there are a number of if/then questions that we would drill down on. For example, if we wanted to inspect if the agency was operating efficiently from a labor cost perspective then we would first look at the revenue per employee and revenue per service employee. If those numbers look low, then there is a host of additional questions: (1) Is the agency using good processes? (2) Is the agency writing profitable business? (3) Is the agency experiencing high staff or customer turnover? (4) Does the agency have an overly generous PTO plan?

That’s just the drill down questions on one variable too (i.e. revenue per employee).

3. Location - how it affects valuation

MICHAEL JANS