Adding it up: to make itself attractive to potential buyers, an agency must show that it is profitable--and that it will stay that way. (Property/Casualty).

When agency owners hear that another agency has been sold or as much as two times revenue, they often gleefully translate that multiple into what such a deal could mean for them. The problem with this speculation is that although the industry expresses price as a multiple of revenue, agency values are determined as a multiple of profit.

A potential buyer is interested in value. Determining value is a complex process, sometimes more art than science, which considers many factors. Some of those factors are outlined below.

* Retention. The most critical factor in determining sustainable profit is retention of business. A buyer wants to have a good indication that the asset purchased will not run off. In its 10 largest accounts, an agency may have a high concentration of revenue, which would seriously affect revenue if any one of the accounts were lost. Considering the expected retention rate of individual accounts can shed light on how vulnerable the agency would be to losing any one account. These top accounts also should be reviewed for cross-selling employee benefits or life cases. After all, the more lines of business sold to a customer, the greater the chance for retaining the account.

In considering retention, evaluating producer contracts is important. Most agencies have employment contracts and noncompete policies in place. But poorly worded nonpiracy agreements make it easier for producers to take their books of business with them or to solicit key staff. Agency principals who allow producers to retain ownership in their books risk the loss of this business if the agency is sold.

Another important factor in retaining business is the level of customer service and the quality of personnel who provide that service. The highest retention rates that I have seen have been in agencies where the staff reviews insurance programs and makes recommendations. Customers appreciate service providers who are knowledgeable, serve as advocates for them and are trustworthy.

* Mix of Business. A high concentration of specialty accounts may be vulnerable to loss of markets or carriers that decide to eliminate niche programs. On the other hand, a well-diversified book of business will have better cross-selling and better retention. The number and size of accounts should be examined for the average commission per account in comparison to industry averages. These statistics should be tied back to revenue per employee. Therefore, an agency that has more large accounts should have higher commissions per customer service representative and per producer.

* Markets and Contracts. Access to markets and maintaining volume with markets is a challenge for most agencies. Those that have a group of highly rated carriers and have preferred contracts have the potential for higher contingencies. Since most contracts today have a high percentage of the incentive based on profitability, careful review of new business and monitoring its placement can have a good effect on contingency payments.

* Growth Rates and Producer Productivity. Organic growth rates are important to agency value, because they show the potential to continue to grow the business. Revenue per employee is an indicator of overall productivity. But individual producer productivity is a good indicator of sales effectiveness and the potential for organic growth. Agencies that have developed books of business greater than $500,000 through new business sales efforts, rather than by inheriting their books, have more potential for growth. A high performer generates at least $100,000 in new business commissions or fees.

* Staff Productivity and Expense Management. Since compensation is the biggest expense for an agency, high productivity is a good way to manage expenses. In many agencies, there are big differences in commissions for each customer service representative. Overcompensated producers significantly affect expenses, and their plans may be difficult for a buyer to address without disrupting sales. Providing excessive perks or expensive services for producers, such as loss control or claims management, can have a negative effect on the bottom line.

Many other factors add value, including the automation system, systems and procedures, the appearance of the office, sales systems and sales management, employee performance management and the strength of the key financial ratios. These all indicate a well-managed business, which should have the potential to grow its book and generate a desirable profit.

Sharon Cunningham, a Best's Review columnist, is president of Business Management Group, a management consulting firm that handles mergers and acquisitions, and agency valuations. She can be reached at [e-mail].