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“KEYS TO AGENCY PERPETUATION”
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Transcript of “KEYS TO AGENCY PERPETUATION”
“KEYS TO AGENCY PERPETUATION”
2014 IIAB-CAL BLUE RIBBON CONFERENCEMay 7, 2014
John JaquesJohn H. Jaques, [email protected](530) 475-0200
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Its just a matter of who the Buyer will be: Family Transfer/Sale Key Employees/Minority Owners Larger Independent Agency Established National Broker Private Equity Roll-Up
Every Agency in California TodayWill Be Sold!
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Done Right, Internal Perpetuation always beats an External Sale
Most firms sell to a Third Party not because it was a better deal, but because they failed at Internal Perpetuation
Internal Perpetuation Vs. External Sale
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There are a Great Number of Non-Financial Reasons Why Internal Perpetuation Beats An External Sale: Independent Management, Local Culture Client Focus, Not Outside Shareholder Focus Decisions for the Long Term, Not the Next Quarter Employee Focus, Not Corporate Executive Mgmt
Focus Career Opportunities for Employees, Producers,
Family A Local Business is part of the Community
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However, set the Non-Financial Reasons Aside, Internal Perpetuation Beats An Agency Sale from a Financial Stand Point as Well!!!
Yes, the Initial Value and Cash Down Payment are Higher in an External Sale
But, Add in Career Earnings, Profit Pool Distributions and Gain in Equity Value over just 5 years:
Perpetuation Wins!
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Internal Vs. External Comparative Values$4 Million Commission Agency
A. Internal: EBITA Margin = 20%EBITA = $800,000Value Multiple = 6.0xEnterprise Value = $4,800,000Down Payment = 10% = $480,000Promissory Note = 90% = $4,320,000
10 Year Term4% - 8% Interest
Note: 100% of equity will not be bought at one time, but the 10 year notes could overlap on 100% of agency value.
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Internal Vs. External Comparative Values$4 Million Commission Agency
B. External:EBITA Margin = 25%EBITA $1,000,000Value Multiple = 6.5xGross Value = $6,500,000
Less: 30 Days Working Capital = <$250,000>Net Enterprise Value = $6,250,000Down Payment = 80% = $5,000,0003 Year Earn Out Payment = 20% = $1,250,000
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Internal Vs. External Comparative Values$4 Million Commission Agency
External Value is 30% Higher – Initially External Value provides loads of Cash Must look at Value 5 Years Later Must look at Additional Pro Forma Expense Cuts in
External Sale: Executive Compensation Producer Compensation Staff Headcount Reduction
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External Value – 5 Years Later
i. Cash Down Payment = $ 5,000,000Less: Capital Gain Tax 29% = <$1,450,000>
Net Down = $ 3,550,000Invest 5 Years at 4% = $ 4,319,000
ii. Earn Out Payment 3 Years = $ 1,250,000Less: Capital Gain Tax 29% = <$ 363,000>
Net Payment $ 887,000Invest 2 Years at 4% = $ 959,000
Total Net Value = $ 5,278,000
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Internal Value – 5 Years Lateri. Current Agency Value = $ 4,800,000
5 Year Gain in Value at 5% = $ 6,126,000
Less: Capital Gain Tax 29% = <$1,777,000>
Net Value = $ 4,349,000
ii. Add Earnings Distribution for = $ 3,482,000
5 Yrs at 75% of EBITA ($800,000)
Yr. 1 = $ 630,000
Yr. 2 = $ 662,000
Yr. 3 = $ 695,000
Yr. 4 = $ 729,000
Yr. 5 = $ 766,000
Less: Tax at 42% = <$1,462,000>
$ 2,020,000
Total Value = $ 6,396,000
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Five Absolute Requirements For Perpetuation
1) New Account Production Every Year Equal to minimum12.5% - 15% of Prior Year Gross Commissions
2) Maximum 7.5% Lost Commission on Cancelled, Lost, Non-renewed Accounts
3) 12.5% - 15% Operating EBITA Margin Before Contingent and Interest Income
4) 3% Annual Increase in Non-Producer Staff Productivity (Commission per non-producer staff)
5) 2% of Gross Commission Annual Investment in New Producers (non-validated producers with agency over 4 years) (Difference between paid compensation and earned producer compensation)
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Simple Keys To Internal Structure
5.5 x to 6.0x Pro Forma Realistic EBITA 5 – 10% Down Payment Promissory Note 120 months, interest at Prime, adjusted annual,
Floor 4%, Max 8% Must constantly be investing in and developing new Junior Owners Corporation Buys Shares from Selling Stockholder, Corporation Sells
Shares to Junior Owners (10% Down, 10 Year Note) Distribute 75% of EBITDA to Owners, Invest 25%
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Lifestyle Agency Failure to develop Young Talent as Market for
Future Buyout Tired of Management/Administration/Ownership
Burdens Greed
If Internal Perpetuation has Higher Intangible and Financial Value . . . Why do Most Agencies Sell?
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Vast majority of agencies generate under $2 million annual revenues and are “Lifestyle” agencies, rather than Business Enterprises
One or two agency principals/producers, very good insurance people, probably handle 70 – 80% of business on books.
Have developed strong service staff (“we have good people”)
High Personal Income, don’t differentiate between Employment Compensation and Agency Profits
Don’t pay any attention to 5 Requirements For Success . . . And don’t have to
Lifestyle Agencies: Sell When Owners Reach 57 to 65 Years Old (Or Sooner)
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Life is good, Income is high, Staff handles most day to day work, Firm has stayed small enough to avoid business enterprise worries/burdens
Hang on to late 50’s / early 60’s, then sell to national or large independent brokerage, fold-into buyer’s location, get paid as a producer until choose to retire, put a pile of purchase price cash in bank
There is nothing wrong with this plan if you choose it!
* Don’t screw it up by trying to be or doing something you are not !!!
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Many mid-size firms $2 - $10 million would like to internally perpetuate and maintain long term independent legacy
Most fail to even try to invest in young talent, instead, they re-tread marginal “seasoned” producers from other firms and buy “wasting assets” from old lifestyle agency owners
If they do attempt to invest in young folks, they don’t bother with developing a disciplined producer development program and/or leadership development
Fail to recognize staff is growing older and are not investing/developing enough key employees for the future
Failure to Develop Young Talent as Market for Future Buyout
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Have no business model or processes in place to achieve the 5 Critical Success Factors for Perpetuation
Owners typically make less personal income than “lifestyle” agencies
These firms sell to national brokers. Should occur two years after consultant helps clean up producer compensation, staff productivity, discretionary expenses and drive EBITDA margin north of 25%. Principals should be under age 62 when sale occurs.
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Strong insurance/relationship people, don’t like or enjoy management/administration or having to achieve the 5 Critical Success Factors for Perpetuation
Typically mid 50’s or younger, still have over 10 year career run to go
This is best possible acquisition for a larger independent agency to make
Principal(s) take some money off table, take equity in the larger firm, participate in profit distributions and stock growth going forward
Tired of Management/Administration/Ownership Burdens
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Large firm with no executive management/leadership behind principal owners, most producers in their 50’s and 60’s (and 80% of revenues in this group), staring at 50% or more of ownership having to be bought in next 5 years:
Greed is good, take the money! Drive pro forma EBITDA to 27% - 30% Get 6.5x to 7.0x multiple < $10 million revenue If over $10 million commission, get 7.5x to 8.0x
guaranteed cash price.
GREED – “Greed is Good”
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Large firm with next generation executives/leadership available; multiple producers under 50 with books over $600k; well managed, focused on and achieving 5 Critical Success Factors; annual profit distributions to shareholders occurring; using Shareholder Buy/Sell Agreement at 6.0x EBITA, 10 year notes.
Largest controlling principals get close to retirement. Listen to extraordinary multiples and cash up front from national brokers and private equity roll-ups. Forget the deal they have enjoyed for last 10 – 20 years (high compensation, profit distributions, increasing stock value) and look at external buyer price.
GREED – “Greed is Bad”
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“Greed is Bad” – basically sell agency out from under next generation of owners. Carve out a slice of sales pie to keep younger folks happy in short term (through earn out period).
Long term, these transactions are great for new agencies being started by younger folks who leave, and provide excellent recruitment opportunities for talented young people who want to be owners in large independent firms.
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Your agency is going to sell, question is who do you plan to sell it to? Pick your marketplace early (Internal or External) and work toward it.
Be Honest: Are you running a “Lifestyle” agency or a Business Enterprise. One is not better than the other, both are rewarding.
Embrace and execute the 5 Critical Success Factors. Whether you choose Internal or External Perpetuation, you will receive a higher return in the long run (profit and value).
SUMMARY