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“KEYS TO AGENCY PERPETUATION”

“KEYS TO AGENCY PERPETUATION”. 2014 IIAB-CAL BLUE RIBBON CONFERENCE May 7, 2014. John Jaques John H. Jaques, Inc. john@johnjaques.com (530) 475-0200. Every Agency in California Today Will Be Sold!. Its just a matter of who the Buyer will be: Family Transfer/Sale

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“KEYS TO AGENCY PERPETUATION”

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  1. “KEYS TO AGENCY PERPETUATION” 2014 IIAB-CAL BLUE RIBBON CONFERENCE May 7, 2014 John Jaques John H. Jaques, Inc. john@johnjaques.com (530) 475-0200

  2. Every Agency in California TodayWillBeSold! 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

  3. Internal Perpetuation Vs. External Sale 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

  4. 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

  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 Sale But, 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 = $800,000 Value Multiple = 6.0x Enterprise Value = $4,800,000 Down Payment = 10% = $480,000 Promissory Note = 90% = $4,320,000 10 Year Term 4% - 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.

  7. Internal Vs. External Comparative Values$4 Million Commission Agency External: EBITA Margin = 25% EBITA $1,000,000 Value Multiple = 6.5x Gross Value = $6,500,000 Less: 30 Days Working Capital = <$250,000> Net Enterprise Value = $6,250,000 Down Payment = 80% = $5,000,000 3 Year Earn Out Payment = 20% = $1,250,000

  8. 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

  9. External Value – 5 Years Later Cash Down Payment = $ 5,000,000 Less: Capital Gain Tax 29% = <$1,450,000> Net Down = $ 3,550,000 Invest 5 Years at 4% = $ 4,319,000 Earn Out Payment 3 Years = $ 1,250,000 Less: Capital Gain Tax 29% = <$ 363,000> Net Payment $ 887,000 Invest 2 Years at 4% = $ 959,000 Total Net Value = $ 5,278,000

  10. Internal Value – 5 Years Later 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 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

  11. Five Absolute Requirements For Perpetuation New Account Production Every Year Equal to minimum12.5% - 15% of Prior Year Gross Commissions Maximum 7.5% Lost Commission on Cancelled, Lost, Non-renewed Accounts 12.5% - 15% Operating EBITA Margin Before Contingent and Interest Income 3% 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 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%

  13. If Internal Perpetuation has Higher Intangible and Financial Value . . . Why do Most Agencies Sell? Lifestyle Agency Failure to develop Young Talent as Market for Future Buyout Tired of Management/Administration/Ownership Burdens Greed

  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 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

  15. 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 !!!

  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 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

  17. 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.

  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 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

  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 revenue • If 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. SUMMARY 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).

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