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Preparing Your Brokerage for Sale

In a 2006 survey, the Canadian Federation of Independent Business asked its members about their succession plans.  It found that even though two thirds of business owners plan to exit their business in the next 10 years, only 10% have a formal plan in place to sell, transfer or wind down their operations; 38% have an informal plan; 52% have no plan at all.  The risks to business owners and the Canadian economy as a whole are significant.  Without a plan in place, owners may be forced to wind down or sell their companies in less than ideal conditions, resulting in a discounted sales price.  The risk is compounded for owners of insurance brokerages who have a disproportionate amount of their assets tied up in their company.

The ideal lead time to prepare for a sale to a successor is seven to 10 years. If there is no plan to sell to an insider, a strategy is still required to prepare the company for a sale to a third party. This article discusses some of the issues insurance brokerage owners should consider when preparing their company for a sale.

  1. What is the company’s sustainable competitive advantage? And how can it be leveraged to the fullest extent in order to increase market share and profitability? A SWOT analysis (Strengths, Weaknesses, Opportunities and Threats) is one way to get the process started. Other techniques may be used as well.
  2. What is driving the inherent value of the company? Note that the industry rule of thumb is most brokerages are valued at anywhere from 2 to 3 times revenue. But consider the example of the following two brokerages where current valuations are at 2 times revenue:
  Brokerage#1 Brokerage#2
Revenue $2,000,000 $2,000,000
EBITDA % 25% 33.3%
EBITDA $ $500,000 $666,000
5 Yr. Avg. Annual Contingent Profits $250,000 $50,000
Customer Retention Rate 95% 90%
Systems Proprietary TAM
Financial Statements Audited Compiled

Which brokerage is the most valuable? Based on revenues only, they would have identical values of $4 million each. Based on EBITDA however, Brokerage #2 is clearly more valuable. Assuming a 6 times multiple, Brokerage #2 is worth $4 million whereas Brokerage #1 is only worth $3 million.

But what about contingent profits? Based on this, Brokerage #1 is clearly more valuable given that its annual contingent profits are significantly higher. However contingent profits usually don’t form part of valuation calculations since they can’t be counted on year after year. But all things being equal, if a brokerage has a history of generating significant profits relative to another broker, it would probably be considered the more valuable of the two.

  1. What are the customer retention rates? The retention rates of brokerages’ customers illustrate how “sticky” the revenues are. The higher the retention rate, the more valuable the company. In the example above, Brokerage #1 would be more valuable.
  2. Are the company’s financial reporting and management information systems top notch? Brokerage #1 uses a proprietary system developed in-house 10 years ago to administer its business. Reports are custom made and new development is costly. Brokerage #2 operates on an administration system used by many brokerages called Total Agency Manager or “TAM”. Reports are standardized and can be easily modified to provide relevant information. If a buyer is on the same or similar system, it makes the integration and conversion of the target broker’s information a relatively simple exercise. In this instance, Brokerage #2 has the advantage.
  3. Are your current and two years prior annual financial statements compiled, reviewed or audited by an outside accounting firm? A review engagement would be the minimum required for many buyers to consider an acquisition. An audit would be ideal since it provides more assurance to a buyer that the statements are fairly presented. However it is more expensive than a review. Brokerage #1 has a clear advantage given its statements are audited. A buyer will have more comfort that their numbers present fairly the results of operations. Given Brokerage #2’s numbers are only compiled, there may be some concern that their statements cannot be relied on and further due diligence may be required.

As can be seen above, valuing a brokerage is not as simple as taking its revenue and multiplying it by 2 or 3. There are a number of other metrics (both quantitative and qualitative) that need to be considered.

So if an owner plans to sell his brokerage in the next few years, it follows that the sooner a plan is put in place to enhance the value drivers and reduce or eliminate the value destroyers, the better given the numerous issues to be dealt with prior to a sale.

Regelle Partners Inc. can assist you with the development and execution of a strategic sales plan of your brokerage. We can identify all issues an owner should review and rectify in order to improve shareholder value. And when it comes time to sell, we will be uniquely qualified to assist you with the sales process. Please contact us at info@regelle.com, 416-572-2110 to see how we can help.