Industry the May 2015 issue

Before Selling, Purge

The market is as hot as ever, seeking sellers. Be ready by cleaning house.
By Phil Trem Posted on April 29, 2015

This is important so I can guide them during the due diligence period between signing a term sheet and signing the purchase agreement. 

It probably won’t surprise you to learn not all agencies operate at a pro forma level. The average agency produced an actual EBITDA (Earnings Before Interest Tax Depreciation and Amortization) margin of 17% in 2014. Most firms that sell do so at an EBITDA margin of roughly 30%. Most of that 13% spread is found in excess owner and producer compensation.  However a meaningful amount is found from closely examining the firm’s selling and operating expenses.

While it is a painstaking process, it is a good idea to spend a day or so reviewing your agency’s expenses at a micro level. Major shareholders and top executives can find out a lot about their company by examining the spending habits of key employees. This exercise can also drive significant savings to a firm.

Spend a day or so reviewing your agency’s expenses at a micro level.

Most executives have a CFO or controller whom they trust to keep the ship steady. What the executives forget about is they often have a hard time saying no. Years of side deals with producers on country club dues, car allowances, cell phone reimbursement, charitable contributions and more, begin to add up. So while the finance team may be doing a good job, the ownership often doesn’t comprehend the magnitude their inability to say no and the effect it can have on their bottom line. 

I recommend to my clients they look at every general ledger transaction within the past 12 months. This will likely be 20,000-50,000 rows of data in an Excel file. Ask someone on your finance team to create pivot tables to analyze each specific category individually. Create a separate tab for each major general ledger category. It helps to subtotal expenses by vendor name and sort largest subtotals to smallest. This way you can focus on the largest expenses within each category.

The certain categories that typically yield the greatest return are:

  • Advertising and Promotion: Are you spending money on items that provide little to no return?
  • Charitable Contributions: Are your contributions coordinated or are you sponsoring every golf outing in the northern hemisphere?
  • Outside Services: Make sure you understand which outside broker relationships you are working with and how much they are paid. Also consider how much you are paying for value added services for which you aren’t charging clients. Is it truly value added? Do clients not really care?
  • Professional Services: Legal, accounting, consultants—all need to be reviewed periodically.
  • Travel and Entertainment: This is typically a black hole but you can see which producers are spending the most. If those who have small books and aren’t writing a lot of new business are spending the most, you should take action. If someone has a big book and isn’t spending enough you should encourage them to get in front of their clients more.
  • Telephone: Are you covering everyone’s family plans?
  • Automobile: Does everyone have a car allowance? Is this something that should be earned based on production?

While this may not sound like a fun exercise, it can be incredibly valuable. It can produce tens of thousands of dollars of savings to the firm. This either creates greater owner return or the ability to invest more heavily in the growth of the agency. The majority of our clients who are selling note that, while the process was laborious, it is something they wish they had done long ago. Every company can use a little spring cleaning. You should start yours soon.

The Market

There appears to be a significant lag in announcing transactions this year. As of April 1, 2015, the market has announced 90 transactions—the largest first quarter on record. The timing is a bit strange because a significant number of deals were announced weeks after closing instead a day or two after closing, which is more typical. There were 47 deals in January, 23 in February, and 20 in March. I would anticipate those numbers will grow as more deals are revealed. For comparative purposes, there were 87 deals in the first quarter of 2014. 

Arthur J. Gallagher and AssuredPartners are leading the charge with five deals each. Confie Seguros has four transactions. Rounding out the top five are Acrisure, Brown & Brown and Hub International. Each has three U.S.-based transactions. Six firms completed two transactions, and 55 executed one. 

Only 10 of the 90 transactions involved employee benefits only firms—roughly 11% of the total. This is significantly lower than the average over the last few years, which is around 25%.  This should be watched closely. It could be a timing issue but also could be a new trend in the availability of quality employee benefits only firms. There is still a high demand to acquire consultative benefits firms when they become available. 

I still believe we are in for a record year in 2015. We may not get to the 400 milestone, but the 350 mark is very achievable. This summers’ activity level will be a big indicator since later in the year is always busy. There are rumors that many Top 100 agencies may be on the market.  Also keep an eye on larger, $20 million+ agencies that are ready to move on to the next stage of their business lifecycle.    

Phil Trem President of Financial Advisory, MarshBerry Read More

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