Presentation on theme: "“KEYS TO AGENCY PERPETUATION”"— Presentation transcript:
1 “KEYS TO AGENCY PERPETUATION” 2014 IIAB-CAL BLUE RIBBON CONFERENCEMay 7, 2014John JaquesJohn H. Jaques, Inc.(530)
2 Every Agency in California Today Will Be Sold! Its just a matter of who the Buyer will be:Family Transfer/SaleKey Employees/Minority OwnersLarger Independent AgencyEstablished National BrokerPrivate Equity Roll-Up
3 Internal Perpetuation Vs. External Sale Done Right, Internal Perpetuation always beats an External SaleMost firms sell to a Third Party not because it was a better deal, but because they failed at Internal Perpetuation
4 There are a Great Number of Non-Financial Reasons Why Internal Perpetuation Beats An External Sale: Independent Management, Local CultureClient Focus, Not Outside Shareholder FocusDecisions for the Long Term, Not the Next QuarterEmployee Focus, Not Corporate Executive Mgmt FocusCareer Opportunities for Employees, Producers, FamilyA Local Business is part of the Community
5 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 SaleBut, Add in Career Earnings, Profit Pool Distributions and Gain in Equity Value over just 5 years:Perpetuation Wins!
6 Internal Vs. External Comparative Values $4 Million Commission Agency Internal: EBITA Margin = 20%EBITA = $800,000Value Multiple = 6.0xEnterprise Value = $4,800,000Down Payment = 10% = $480,000Promissory Note = 90% = $4,320,00010 Year Term4% - 8% InterestNote: 100% of equity will not be bought at one time, but the 10 year notes could overlap on 100% of agency value.
7 Internal Vs. External Comparative Values $4 Million Commission Agency EBITA Margin = 25%EBITA $1,000,000Value Multiple = 6.5xGross Value = $6,500,000Less: 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
8 Internal Vs. External Comparative Values $4 Million Commission Agency External Value is 30% Higher – InitiallyExternal Value provides loads of CashMust look at Value 5 Years LaterMust look at Additional Pro Forma Expense Cuts in External Sale:Executive CompensationProducer CompensationStaff Headcount Reduction
9 External Value – 5 Years Later Cash Down Payment = $ 5,000,000Less: Capital Gain Tax 29% = <$1,450,000>Net Down = $ 3,550,000Invest 5 Years at 4% = $ 4,319,000Earn Out Payment 3 Years = $ 1,250,000Less: Capital Gain Tax 29% = <$ 363,000>Net Payment $ ,000Invest 2 Years at 4% = $ ,000Total Net Value = $ 5,278,000
10 Internal Value – 5 Years Later Current Agency Value = $ 4,800,0005 Year Gain in Value at 5% = $ 6,126,000Less: Capital Gain Tax 29% = <$1,777,000>Net Value = $ 4,349,000Add Earnings Distribution for = $ 3,482,0005 Yrs at 75% of EBITA ($800,000)Yr. 1 = $ 630,000Yr. 2 = $ 662,000Yr. 3 = $ 695,000Yr. 4 = $ 729,000Yr. 5 = $ 766,000Less: Tax at 42% = <$1,462,000>$ 2,020,000Total Value = $ 6,396,000
11 Five Absolute Requirements For Perpetuation New Account Production Every Year Equal to minimum12.5% - 15% of Prior Year Gross CommissionsMaximum 7.5% Lost Commission on Cancelled, Lost, Non-renewed Accounts12.5% - 15% Operating EBITA Margin Before Contingent and Interest Income3% Annual Increase in Non-Producer Staff Productivity (Commission per non-producer staff)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)
12 Simple Keys To Internal Structure 5.5 x to 6.0x Pro Forma Realistic EBITA5 – 10% Down PaymentPromissory Note 120 months, interest at Prime, adjusted annual, Floor 4%, Max 8%Must constantly be investing in and developing new Junior OwnersCorporation Buys Shares from Selling Stockholder, Corporation Sells Shares to Junior Owners (10% Down, 10 Year Note)Distribute 75% of EBITDA to Owners, Invest 25%
13 If Internal Perpetuation has Higher Intangible and Financial Value If Internal Perpetuation has Higher Intangible and Financial Value Why do Most Agencies Sell?Lifestyle AgencyFailure to develop Young Talent as Market for Future BuyoutTired of Management/Administration/Ownership BurdensGreed
14 Lifestyle Agencies: Sell When Owners Reach 57 to 65 Years Old (Or Sooner) Vast majority of agencies generate under $2 million annual revenues and are “Lifestyle” agencies, rather than Business EnterprisesOne 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 ProfitsDon’t pay any attention to 5 Requirements For Success And don’t have to
15 * Don’t screw it up by trying to be or doing something you are not !!! Life is good, Income is high, Staff handles most day to day work, Firm has stayed small enough to avoid business enterprise worries/burdensHang 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 bankThere 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 !!!
16 Failure to Develop Young Talent as Market for Future Buyout Many mid-size firms $2 - $10 million would like to internally perpetuate and maintain long term independent legacyMost 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 ownersIf they do attempt to invest in young folks, they don’t bother with developing a disciplined producer development program and/or leadership developmentFail to recognize staff is growing older and are not investing/developing enough key employees for the future
17 Have no business model or processes in place to achieve the 5 Critical Success Factors for PerpetuationOwners typically make less personal income than “lifestyle” agenciesThese 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.
18 Tired of Management/Administration/Ownership Burdens Strong insurance/relationship people, don’t like or enjoy management/administration or having to achieve the 5 Critical Success Factors for PerpetuationTypically mid 50’s or younger, still have over 10 year career run to goThis is best possible acquisition for a larger independent agency to makePrincipal(s) take some money off table, take equity in the larger firm, participate in profit distributions and stock growth going forward
19 GREED – “Greed is Good”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 revenueIf over $10 million commission, get 7.5x to 8.0x guaranteed cash price.
20 GREED – “Greed is Bad”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.
21 “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.
22 SUMMARYYour 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).