Insurance Agency Evaluations, EBITDA vs. Revenue Multiple
Written By: Wildhawk Capital
EBITDA is the acronym used for Earnings Before Interest, Tax, Depreciation and Amortization. It is a measurement of an agency's operating performance. Essentially, it's a way to evaluate the agency's performance without having to factor in current financing decisions, accounting decisions or their current tax obligations. It is the process of adding the agency’s earnings/profits, found on the Profit & Loss Statement (P&L), to the Statement’s expense line items of Interest, Tax, Depreciation and Amortization, producing the agency’s EBITDA number. A multiple is applied to EBITDA to determine the agency’s value.
Example: The agency’s EBITDA was $440,000 last year and the multiple of “5” was determined to be a market value, producing an agency value of $2,200,000.
Revenue Multiple is the more common approach to evaluating a smaller insurance agency. This is simply the annual revenue of the agency, multiplied by a factor and not considering the financial strength/profitability of the agency.
Example: $350,000/year agency revenue X 2.5, or an $875,000 value, with the “2.5” being the market value Multiple.
Insurance Agency Evaluations
Since, Wildhawk Capital only lends to the insurance industry, we look daily at Profit & Loss Statement and Balance Sheets for all sizes of insurance agencies. Never the less, we find ourselves looking through adjustments made to earnings, before EBITDA is calculated on an agency for sale and say, “What are they thinking…?”
Owners of agencies run excess personal expenses through their businesses that would not be assumed by a new buyer (example: multiple cars, second home mortgage, motor home, etc.). Many times, family members are paid salaries substantially above market and will not be continuing with the company. Even the revenue of an agency might change slightly after the sale due to a higher commission/bonus structure, or the addition of transaction fees. Adjustments/addbacks to the P&L can be perfectly acceptable and should be considered in the evaluation of the agency. If the revenue or expense item is not going to continue or be incurred by the new buyer, an adjustment should be made to the earnings of the agency you are looking to purchase.
We recently reviewed a P&L of an agency barely breaking even with a sizable adjustment for private air travel. Such adjustments speak volumes to the management style of the agency and should be looked at closely. We have listed some of the larger expense line items you should review when evaluating your acquisition:
- Owner’s Compensation - The most common add-back is the current owner’s compensation plan (salaries, insurance, cars, meals, travel, etc.), boosting the new buyer’s profit by $200,000 to more than $1 million in the larger agencies. But, you will need to addback the compensation plan you will be receiving from the agency after the sale, and if you are taking a smaller compensation plan, that difference will be added directly to agency’s earnings.
- Management/Employee Salaries – Are you keeping all the managers and employees after the purchase or rolling the new acquisition into your existing agency? Addback the full compensation plans for each employee you’re not going to retain, to reflect the correct administrative costs.
- One-time Expenses – Adjustments related to one-time expenses are quite common. A few examples of these expenses could be the purchase of a new website, new office equipment, an agency operating system or severance package. One-time expenses are expenditures or obligations that are not recurring expenses to the agency.
- Legal Fees - The agency last year may have had an unfortunate legal battle that consumed thousands of Dollars in legal fees. Is this a “one-time litigation event” or an agency problem that needs to be reviewed?
Making and understanding EBITDA adjustments will help you better understand the true earning potential of the agency you are looking to acquire. This will also assist you in evaluating the purchase price you are willing to pay, as you now understand the true value of the agency.
What is the best advice on creating a list of adjustments to review before calculating EBITDA for a purchase of a new agency? Be honest and conservative!
About Wildhawk Capital
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