Making the Most of Insurance M&A in 2024

In 2023, many people were holding their breath waiting for a recession, but insurance M&A activity was still relatively strong. This year is looking – if not more certain – somewhat more positive, and that points to the likelihood of even more M&A activity in the insurance space.

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Recently, our VP of Strategic Markets, Kim Grathwohl, spoke with Chris Hughes, Managing Director of M&A Services, about the outlook for M&A activity in the year ahead and how to be prepared if you’re selling an insurance agency or are planning to purchase. They identified three main areas of focus to make the most of this improving market: valuation, financing, and flexibility in structuring the deal.

Valuation

The value of an insurance agency is usually calculated as a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization). To come up with a true market value, however, a seller needs to adjust that figure to deduct any revenues or expenses that are unlikely to continue after the sale. This new figure is the company’s pro forma EBITDA.

One of the biggest adjustments almost every agency makes to EBITDA when making a sale valuation is adjusting the owner’s compensation to what the market value is. In privately held businesses, a lot of owners either take zero compensation or they take excess compensation. In valuing the business for sale, that compensation number needs to be adjusted to the going market rate for that role and responsibility. This step normalizes the earnings and makes it less of a personal enterprise and more of a market enterprise.

Other common adjustments include removing expenses that won’t continue, such as an owner’s vehicle, or big-ticket one-time expenses, such as the installation of a new software system. Agency owners may want to make these alterations to the books before the time of sale, ideally three years ahead, so that fewer adjustments are needed to create pro forma documents. The financials are cleaner, and they give buyers and lenders for insurance agency acquisition loans a clearer picture of the agency’s value without large, time-of-sale EBITDA manipulations. It may also be worthwhile to have an audit to further build credibility of financials and demonstrate full transparency.

Once the pro forma EBITDA number is established, an appropriate multiple is applied to come up with a valuation, according to this general format:

Beyond EBITDA, other factors influence valuation. Growth is one of the biggest factors, and it is especially important to lenders providing insurance agency acquisition financing. They want to see the company has a growth trajectory that will allow the new owner to service the debt on the insurance agency loan. Company valuation is also affected by synergies of acquisition growth. Value increases if the acquisition allows the buyer to combine volume with a carrier which would move its contracts into higher commission levels.

Its value could decrease if it’s not growing enough, and especially if its customer base is not wide enough to avoid concentration risk (one customer representing between 5-20% of revenue). Similarly, contract risk is considered. How much of the agency’s revenue comes from a single carrier contract and how reliable is it?

Financing

With 2024 looking like a better year for the economy, buyers and sellers are looking at different ways to finance M&A deals. Cash or cash-equivalent deals are often financed through an insurance agency loan to the buyer. The seller walks away with a lump-sum payout. Deals that come with some type of seller equity rollover provide a level of protection to both buyers and sellers and help with continuity with clients.

These arrangements can take the form of the seller staying on in a minority-ownership capacity or a managerial role. Nearly every deal comes with some type of earnout component which rewards the seller with future payouts based on the agency hitting predetermined growth targets.

Flexibility

There’s almost no limit to the forms insurance agency acquisition financing can take, so it’s wise to consider options. Getting business loans for insurance agents through the SBA comes with a lot of strings and regulations. The buyer’s home usually must be listed as collateral, for example. Specialty lenders familiar with the insurance industry and its cash flows, however, can be more flexible and can put together deals that benefit both buyer and seller.

Lenders doing insurance agency financing like deals that keep the seller in the picture longer. These arrangements create an alignment between buyer and seller where the collateral, which is the revenue stream of the business, is not going to be stripped away or be in jeopardy of being stripped away.

Some of the strongest deals combine several components. For example, a purchase could involve a partial lump sum of cash paid for by an insurance agent loan to the buyer, the seller staying on as a part-time advisor while rolling equity forward, and a set of growth-target earnouts.

There may be a seller note as well, in which the sitting owner accepts future payments toward the final purchase price. Deals that stack these tools often are the most effective at getting both buyers and sellers purchase arrangements they want. They give more people skin in the game of making the business continue to grow. Lenders who provide insurance agency funding like these arrangements because they protect the cash flow of the business which is the collateral for the loan.

2024 Outlook

Many experts in 2023 expected insurance agency valuations to dip, but they held steady. In 2024, with interest rates expected to hold steady or soften, valuations could be on the increase and could stimulate more M&A activity. With less uncertainty about interest rates, there is more stability in the market and buyers and sellers may feel more confident making deals.

Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.